DRAFT; COMMENTS WELCOME
THE RESILIENCE OF SERVICES TRADE
Ingo Borchert and Aaditya Mattoo*
April 10, 2009
Abstract
Much attention has focused on the impact of the current crisis on goods trade; hardly any on
its impact on services trade. Using new trade data from the United States, we show that
services trade is weathering the current crisis much better than goods trade. In January 2009,
the year-on-year decline of the value of goods imports was 26 per cent while the value of
services imports declined by less than 5 per cent. Within services, interesting patterns are
emerging. Imports of goods-related transport services and crisis-related financial services
have shrunk (both by about 13 per cent), as has expenditure on tourism abroad (by 7 per
cent). But imports of a range of business, professional, and technical services (which include
business process outsourcing) have actually grown (by 7 per cent). Hence, developing
countries like India, which are relatively specialized in business services, have suffered much
smaller declines in exports to the United States than countries like Brazil and China and
regions like Africa which are specialized in exports of goods, transport services or tourism
services. In fact, employment in the Indian export-oriented IT and business process
outsourcing services is expected to grow by about 5 per cent (around 100,000 jobs) in 2009.
Based on new evidence from Indian services exporters, we find that services trade is buoyant
relative to goods trade for three reasons: demand for a range of traded services is less
cyclical; services trade and production are less dependent on external finance; and services
trade involves less international back-and-forth movement of components. Even though few
protectionist measures have so far been taken in services, the growing political and social
aversion to outsourcing is a threat to trade.
Keywords: Services, trade, crisis
JEL Classification: F13, F14
*World Bank, 1818 H Street NW, Washington DC 20433. iborchert@worldbank.org,
amattoo@worldbank.org. The views contained in this paper are of the authors and not necessarily those of the
World Bank. We are grateful to Bernard Hoekman for asking the interesting question and for providing
valuable direction. We would like to thank Caroline Freund, Leo Iacovone, Will Martin, Caglar Ozden, Arvind
Subramanian and Randeep Sudan for helpful discussions. We also thank Margrith Lütschg-Emmenegger,
president of FIMBank plc, Ganesh Natarajan, chairman of NASSCOM, and Raju Bhatnagar, NASSCOM’s
Vice President BPO and Government Relations, for discussing with us ongoing developments in services trade.
I.
INTRODUCTION
The current gloom and doom about goods trade has obscured the quiet resilience of services
trade. Services account for over one-fifth of global cross-border trade, and for some
countries such as India and the US close to a third of all exports. This paper uses data on
cross-border trade in services from the United States released in mid-March 2009 to show
that while trade in goods trade has declined drastically, trade in services has held up
remarkably well.1 Monthly US imports of goods declined in value terms by one-third from a
peak of $195 bn in July 2008 to $129 bn in January 2009; the corresponding decline in
services imports was less than one-tenth, from $28.8 bn to $26.5 bn.2 In January 2009, the
year-on-year decline of the value of goods imports was 26 per cent; the decline in the value
of services imports was less than 5 per cent.3
Within services, interesting patterns emerge. Imports of goods-related services such as
international transport have shrunk (year-on-year by 13 per cent) as has expenditure on
tourism abroad (by 7 per cent), but imports of other private services have actually grown
slightly. Within private services, imports of financial services have contracted (12.5 per
cent), but imports have grown of insurance (3 per cent), telecommunications (2.5 per cent)
and, in particular, a range of business, professional and technical services (7 per cent).4 The
positive outlook is corroborated by Indian industry sources, which suggest that employment
in the export-oriented IT and business process outsourcing services is expected to grow by
about 5 per cent (around 100,000 jobs) in 2009.
Overall exports of services-specialized developing countries which are relatively specialized
in services, like India (38 per cent share of services in total exports) have declined less than
exports of countries and regions for which services are less important, such as Brazil (12 per
cent share), China (9 per cent share) and Africa (15 per cent share). The contractions in their
total exports (goods and services) to the United States in the fourth-quarter were: India (2.5
per cent), Brazil (13 per cent), China (9 per cent), and Africa (36 per cent).
Based on new evidence from Indian services exporters, we find that services trade is buoyant
for three reasons. First, on the supply side, services trade, especially in business services, is
much less dependent on trade finance than goods trade and has therefore been less hurt by the
financial crisis. Moreover, production of certain key services is less dependent on external
finance than goods production. For example, two of India’s largest exporters of software and
This data also includes consumption of services abroad (in the category “travel”), but does not encompass
sales through foreign affiliates or through the presence of foreign natural persons. Recent data is not available
for sales through affiliates and sales by natural persons are not properly measured.
2
Part of the decline in the value of goods imports could be due to the fall in commodity prices. But note that
US goods exports also declined over the last six months by one-third, and services exports by less than onetenth.
3
US exports present a similar picture of year-on-year declines: of goods exports by 21 per cent; of services
exports by less than 5 per cent.
4
US exports present an even starker contrast: financial services have contracted (17 per cent), but exports are
growing of insurance (9 per cent), telecommunications (25 per cent), and business, professional, and technical
services (10 per cent).
1
2
business-process services, Infosys and Tata Consultancy Services, have no external debt at
all and rely completely on retained earnings for their operations.
Second, demand for a range of services seems to have contracted less than demand for goods.
One reason is that services are not storable and so are less subject to the big declines in
demand in downturns that affect durable goods like shoes and televisions. This is because
services neither suffer from the “vintage effect” – i.e. the willingness to wear an older pair of
shoes or drive an older car – nor from the “inventory effect” – i.e. the fact that cuts in final
demand translate into bigger immediate cuts in demand for factory output because of
inventory adjustment. Another reason is that a larger part of international demand for
services – e.g. outsourced back-office services - is less discretionary than demand for goods
such as computers. This is both because many services are “necessities” for producers, and
because a larger part of services trade seems to be covered by long-term contracts.
Third, measured trade in services has shrunk less because services production is much less
fragmented than goods production. Therefore, measured services trade is less subject to the
multiplier effects on trade that are being seen in goods trade - if one less car is bought by a
consumer, the value of trade shrinks much more because car production today involves the
back-and-forth international movement of components. The limited fragmentation also
implies that any reduction in services exports translates into a larger reduction in value added
in the source country than a similar reduction in goods exports. For example, if China’s
exports of computers decline by $1, imports into China of components from other countries
may decline by as much as 70 cents and value added in China by only 30 cents; but if India’s
exports of business-processing services decline by $1, value added in India may decline by as
much as 70 cents.
The relative buoyancy of services trade cannot be taken for granted. Over it too hangs the
Damocles sword of protectionism. But protection is taking a subtle form, perhaps in
deference to the invisibility of services. First, explicit discrimination through preferential
procurement seems at this stage less damaging than the implicit social and political
disapproval of outsourcing. Developing country service exporters argue that it is the latter
that has had a chilling effect on demand for their services. Similarly, the few visible explicit
restrictions on employing or contracting foreign services providers in specific areas (e.g.
financial services) are not as costly for both host and source as the increasing social and
political aversion to immigration. Second, in the longer term, subsidies to banks are
probably less damaging than financial protectionism. The former are arguably necessary to
ensure the stability of the financial system. The latter seriously erode the case for openness.
Inducing national banks to lend domestically in a crisis deprives developing countries in
particular of capital when they most need it and greatly strengthens the case for financial
self-sufficiency.
Section II describes the trends revealed by the US services trade data. Section III suggests
reasons for the resilience of services trade drawing upon evidence from India. Section IV
assesses the significance of protectionist measures affecting services trade.
3
II.
SERVICES TRADE DURING THE CRISIS
In this section, we consider in turn the impact on US imports, in the aggregate and from
specific trading partners, on US exports, and finally on US affiliates trade.
The evidence from US imports of services
Trade in services has proved more resilient than trade in goods. Figure 1 shows that monthly
US imports of goods declined in value terms by one-third from a peak of $195 bn in July
2008 to $129 bn in January 2009; the corresponding decline in services imports was less than
one-tenth, from $28.8 bn to $26.5 bn. Figure 2 (top panel) shows that in January 2009, the
year-on-year decline of goods imports was 26 per cent; of services it was less than 5 per cent.
Over the entire period plotted, services imports appear much less volatile than goods imports
and have stopped growing only recently.
Figure 1: U.S. Monthly Imports of Goods and Services, January 2006 – January 2009
250,000
USD million
200,000
150,000
100,000
50,000
20
06
J
20 an
06
A
20 p r
06
20 Jul
06
O
ct
20
07
J
20 an
07
A
20 p r
07
20 Jul
07
O
ct
20
08
J
20 an
08
A
20 p r
08
20 Jul
08
O
ct
20
09
Ja
n
0
Goods
Services
Source: BEA, U.S. International Trade in Goods and Services, millions of dollars,
months seasonally adjusted.
The contrast is even more striking when we look at the components of services imports
(Figure 2, middle panel). It is no surprise to see imports of transportation services turn
sharply negative (by 13 per cent) given the contraction of international freight services.
Interestingly, of the major components of commercial services, imports of “other private
services” are still growing, albeit moderately (2.5 per cent).
4
Figure 2: U.S. Imports of Goods and Services, Shares (2008) and Annual Growth Rates:
(a) Total Goods and Services
(b) Sub-Categories of Services
(c) Sub-Categories of “Other Private Services”
30.0
Goods
85%
20.0
%
10.0
20
06
J
20 an
06
A
20 p r
06
20 Jul
06
O
20
c
07 t
J
a
20
n
07
Ap
20
r
07
20 Jul
07
20 Oct
08
J
20 an
08
A
20 p r
08
20 Jul
08
O
20
c
09 t
Ja
n
0.0
-10.0
-20.0
-30.0
Services
15%
Goods
Services
40.0
30.0
Transport
29%
20.0
%
Travel
22%
10.0
Royalties
7%
20
06
J
20 an
06
A
20 p r
06
20 Jul
06
O
ct
20
07
Ja
20
n
07
A
20 p r
07
20 Jul
07
O
ct
20
08
J
20 an
08
A
20 p r
08
20 Jul
08
O
ct
20
09
Ja
n
0.0
-10.0
Other
Private
Services
42%
-20.0
Travel
Transport
Other Private Serv
60.0
Business
49%
%
40.0
Other
5%
Telecom
5%
20.0
Insurance
29%
20
06
:
20 I
06
:I
20 I
06
:
20 III
06
:IV
20
07
:
20 I
07
:I
20 I
07
:
20 III
07
:IV
20
08
:
20 I
08
:I
20 I
08
:
20 III
08
:IV
0.0
Financial
12%
-20.0
Financial
5
Insurance
Telecom
Business/Prof
Figure 2 (bottom panel) breaks down “other private services” into its major components,
namely financial, insurance, telecommunications, and professional/business services. Even
in the last quarter of 2008, well into the crisis, most growth rates are substantially above
anything seen in the merchandise goods realm. Not surprisingly, given the financial origins
of the current crisis, trade in financial services has shrunk (7 per cent). But interestingly,
growth rates of telecommunications, insurance and business services are still positive, after
hovering between zero and five percent for much of 2007 and 2008.
The impact on US trading partners
The vastly different time series behavior of goods vs. services is again seen in Figure 3,
which contrasts U.S. imports of goods and the main sub-categories of services imports from a
particular source, namely South and Central America. From the third to the fourth quarter
2008, growth of goods imports collapsed along with transportation services, tourism imports
dipped somewhat, while other private services remained unscathed.
In general, the impact on developing countries’ exports to the United States depends on the
composition of these exports. Figure 4 shows the relationship between the decline in growth
rates of exports during the crisis (i.e. between the fourth and third quarter of 2008) and the
share of private services in total exports. Exports of developing countries which are
relatively specialized in services, like India (24 per cent share of private services in total
exports to the US), have declined less than exports of countries and regions for which
services are less important, such as Brazil (9 per cent share), China (1 per cent share) and
Africa (2 per cent share).5 The reductions in growth rates of their total exports (goods and
services) to the United States in the fourth-quarter were: India (8 percentage points), Brazil
(16 percentage points), China (26 percentage points), and Africa (35 percentage points).
40
20
-20
0
Annual Growth Rate
60
Figure 3: U.S. Imports from South and Central America, Annual Growth Rates, 2006 – 2008
2006q1
2006q3
2007q1
2007q3
Goods
Transport Serv
5
2008q1
Travel Serv
Other Priv Serv
For countries’ shares of services in their overall exports, see Annex Figure A.3.
6
2008q3
40
Figure 4: Reduction in Growth Rates of Exports to the US and Share of Private Services in
Imports, Selected Countries and Regions
30
Africa
China
20
SCA
AsiaPac
Brazil
10
Europe
India
0
5
10
15
20
Share of Private Services in Total Exports to U.S. (Pre-Crisis)
25
Reduction in Export Growth Rate During Crisis
Fitted Values
Source (Figs. 3 and 4): BEA, U.S. International Transactions Accounts Data, Tab.12:
U.S. International Transactions by Area, millions of dollars, not seasonally adjusted.
The evidence from US exports of services
The qualitative picture for United States’ services exports (Figure 5) resembles that for US
imports (Figure 1).
Figure 5: U.S. Monthly Exports of Goods and Services, January 2006 – January 2009
140,000
USD million
120,000
100,000
80,000
60,000
40,000
20,000
20
06
J
20 an
06
A
20 p r
06
20 Jul
06
O
20
c
07 t
Ja
20
n
07
Ap
20
r
07
20 Jul
07
O
20
c
08 t
Ja
20
n
08
Ap
20
r
08
20 Jul
08
O
20
c
09 t
Ja
n
0
Goods
Services
Source: BEA, U.S. International Trade in Goods and Services, millions of dollars,
months seasonally adjusted.
7
Figure 6: U.S. Exports of Goods and Services, Shares (2008) and Annual Growth Rates:
(a) Total Goods and Services
(b) Sub-Categories of Services
(c) Sub-Categories of “Other Private Services”
30.0
Goods
71%
20.0
%
10.0
20
06
J
20 an
06
A
20 p r
06
20 Jul
06
O
ct
20
07
Ja
20
n
07
Ap
20
r
07
J
u
20
07 l
O
20
c
08 t
Ja
20
n
08
Ap
20
r
08
J
20
u
08 l
O
ct
20
09
Ja
n
0.0
-10.0
-20.0
-30.0
Services
29%
Goods
Services
40.0
Transport
17%
30.0
Royalties
17%
%
20.0
Travel
21%
10.0
20
06
J
20 an
06
A
20 p r
06
20 Jul
06
O
ct
20
07
Ja
20
n
07
Ap
20
r
07
J
20
u
07 l
O
ct
20
08
Ja
20
n
08
Ap
20
r
08
J
u
20
08 l
O
ct
20
09
Ja
n
0.0
-10.0
Other
Private
Services
45%
-20.0
Travel
Transport
Other Private Serv
60.0
Business
51%
%
40.0
Telecom
4%
Insurance
5%
20.0
Financial
24%
20
06
:I
20
06
:
20 II
06
:I
20 II
06
:IV
20
07
:
20 I
07
:I
20 I
07
:I
20 II
07
:IV
20
08
:I
20
08
:I
20 I
08
:
20 III
08
:IV
0.0
Other
16%
-20.0
Financial
8
Insurance
Telecom
Business/Prof
Monthly US exports of goods declined in value terms by one-third from a peak of $121 bn in
July 2008 to $82 bn in January 2009; the corresponding decline in services exports was by
about one-tenth, from $38 bn to $34 bn. Figure 6 (top panel) shows that in January 2009, the
year-on-year decline of goods exports was 21 per cent; decline of services exports was less
than 5 per cent.
Within services, exports of transport services declined (13 per cent), as did expenditure by
foreign tourists in the US (9 per cent), but exports of private services increased marginally
(0.5 per cent) (Figure 6 middle panel). Within private services, there are interesting
contrasts: exports of financial services have contracted significantly (17 per cent), but
exports are growing in insurance (9 per cent), telecommunications (25 per cent), and
business, professional, and technical services (10 per cent), respectively.
The evidence from foreign affiliates’ trade
Figure 7 provides an alternative breakdown of “other private services” into payment flows
associated with services imports from affiliates and non-affiliates. Over the longer term, the
growth of intra-corporate payment flows has generally been more volatile. However, during
the crisis, intra-corporate flows have continued to grow at rates of about 10 per cent per
annum. In contrast, the growth of arms-length payments has declined in each of the past three
quarters and is now close to zero.
Figure 7a: Payments from U.S. Companies for Imports of Other Private Services to
Affiliated and Non-Affiliated Entities, 2006 – 2008, Annual Growth Rates
50.0
40.0
20.0
10.0
0.0
20
06
:
20 I
06
:
20 II
06
:I
20 II
06
:IV
20
07
:
20 I
07
:I
20 I
07
:
20 III
07
:IV
20
08
:I
20
08
:
20 II
08
:
20 III
08
:IV
%
30.0
-10.0
US parent to FA
9
US to foreign unaffiliated
Figure 7b: Receipts of U.S. Companies for Exports of Other Private Services from Affiliated
and Non-Affiliated Entities, 2006 – 2008, Annual Growth Rates
50.0
40.0
%
30.0
20.0
10.0
20
06
:I
20
06
:I
20 I
06
:
20 III
06
:IV
20
07
:I
20
07
:I
20 I
07
:I
20 II
07
:IV
20
08
:
20 I
08
:I
20 I
08
:I
20 II
08
:IV
0.0
-10.0
FA to US parent
Foreign unaffiliated to US
Source: BEA, U.S. International Transactions Accounts Data, Table 3a: Private
Services Transactions, breakdown by affiliation. Millions of dollars, months
seasonally adjusted, annual growth rates. 4th quarter 2008 preliminary data. “FA”
denotes “foreign affiliate”.
III.
UNDERSTANDING THE RESILIENCE: INDIAN SERVICES EXPORTERS
This section provides a new perspective on the crisis from the point of view of services
exporters. Specifically, we explore the impact of the crisis on Indian companies that export
information technology (IT) services or IT-enabled services (ITES) (also referred to as
business process outsourcing (BPO)).6
At first glance, two aspects of the current crisis do not bode well for Indian services firms’
prospects. First, the epicenter of the crisis, the U.S. with its 60% share remains the largest
export market for IT and BPO services. Second, in terms of revenues, financial services and
insurance remain the biggest of all vertical markets in which Indian services exporters are
active.
However, even though the financial turmoil is clearly hurting the services industry, Indian
exporters have weathered the crisis (much) better than companies engaged in merchandise
trade. Growth rates of sales and employment are expected to be cut in half, but this still
leaves the sector with growth rates that would be considered buoyant in many manufacturing
sectors. Instead of slashing jobs, the industry continues to remain a net hirer. In absolute
terms, around 100-110,000 new jobs will be created in 2009, as compared to 223,000 in
2008. Since a counterfactual 160,000 jobs would conceivably have been added in the
6
Estimates in this section are based on interviews with industry and industry association sources.
10
absence of the current crises, the employment dent left by the financial crisis amounts to
about one-third of new job additions lost.
The muted impact at the industry level does hide considerable heterogeneity at the firm level,
in terms of size as well as business field (IT versus BPO). Moreover, uncertainty about the
consequences for outsourcing providers of growing demands for protectionism in the U.S.
and elsewhere further cloud Indian exporters’ prospects.
Impact on demand
India’s IT and IT-enabled service sector is heavily geared towards foreign markets. In fiscal
year 2008, roughly three-quarters (or $40bn) of the sector’s output was destined for exports.
As far as the IT export market is concerned, the slump in demand clearly shows up in export
figures: while sales grew by some 24% during the first half of the fiscal year 2008 (Apr-Sep),
growth slowed down to 12% in the second half (Oct-Mar), so that overall year-on-year
growth is expected to attain 16-17%. In the ITES sector, growth in 2008 fiscal year is widely
expected to be somewhat higher at 20-22%. No significant growth is expected in 2009, and
average growth over the next two years is likely to fall to around 15% - which is one-half of
last decade’s annual average growth rate of 30%.
According to industry sources, two factors are contributing to the recent slow-down. First,
the negative demand shock is being felt particularly in the case of discretionary IT projects.
Secondly, there has been a general mood swing against outsourcing in crisis-hit countries,
particularly in the U.S., which is discussed in Section IV.
As far as demand contraction is concerned, there are significant differences between the IT
and the ITES subsector. Indian exporters’ business is more severely affected in IT services,
where about 60% of sales are of a discretionary nature, i.e. projects can be withdrawn, or not
contracted at all, in times of economic hardship. ITES exports are apparently much less
discretionary, with an estimated 70-80% of business characterized as non-discretionary.
These latter types of services exports are likely to be more insulated from negative demand
shocks, for it represents business that is required to be carried on even during the current
crisis. For instance, in health care a system upgrading project (IT) is discretionary whereas
the processing of claims (ITES) has to continue. In banking, a project to realize end-to-end
automation of payments (IT) is discretionary even though it might be cost saving, whereas
transaction processing is non-discretionary.
Another reason for IT to be affected differently than ITES is the difference in contractual
relations between the two segments. In IT, only about 25% of foreign trade takes place
between captives and their parents, whereas in ITES this share stands at some 40-45%. Most
of the large financial firms, e.g. JP Morgan, have traditionally conducted their outsourcing
business via captives. As demand contracts, Indian firms are apparently also being asked by
buyers to reduce prices. The ensuing margin squeeze is likely to be greater in IT services
where a larger portion of projects is conducted as arms-length trade.
The industry’s increasing diversification in terms of geographic base, industries served, and
the portfolio of services offered, has to some extent cushioned against the negative demand
shock that originated mainly from the U.S. economy. Furthermore, IT and BPO exporters
11
may stand to gain from the current crisis as firms in industrialized countries are under
increased pressure to cut costs.
Such cost pressures have so far tended to manifest themselves in greater demand for
outsourcing in core BPO areas rather than to entice companies to venture into new “context”
areas in which outsourcing has been less common. Outsourcing options both with captive
firms and at arms-length are being pursued more vigorously in traditional BPO areas. There
has also been a discernable acceleration in the speed with which outsourcing decisions are
being taken. While decisions were being taken within 9-12 months before the crisis, the
decision time has now shrunk to 6 months.
The impact of parental distress in sectors such as finance and automobiles is less clear. On
the one hand, industry officials indicate that an increased quantum of work is being done
offshore in banking, along the lines discussing in the previous paragraph. In insurance, while
AIG may have drastically reduced the amount of outsourcing, AXA has not. In the
automotive industry, on the other hand, outsourcing has been significantly reduced (by some
50%) as many operations, e.g. warranty claims or customer care, are discretionary. Thus,
experiences of, and choices made by, one firm are not necessarily representative of the
industry at large.
Industry sources expect that domestic demand, which accounts for only a quarter of total
demand, may compensate for the loss in export demand. Domestic sales are expected to
grow significantly from their current level of about $11bn.
Impact on employment
The Indian IT and ITES sectors directly employ some 2.2 million people, of which 1.7
million are associated with services exports. The number of people indirectly employed –
i.e. providing auxiliary services - is a factor of 3.5 to 4 greater than the directly employed, or
an estimated 7-8 million. As in the case of revenues, the employment effects of the crisis
largely take the form of reductions in growth rates, rather than layoffs, and a more intensive
use of the existing workforce.
The latter effect leads to growth in employment being considerably more muted than growth
in sales. In 2009, while sales are still expected to grow by a rate in excess of 10%,
employment is projected to expand by 5-6%. As noted above, cast in absolute numbers this
means that around 100-110,000 new jobs will be created in 2009 (in comparison: 223,000
jobs in 2008). According to industry estimates, in the absence of the current crises a
counterfactual 160,000 jobs would conceivably have been added, thus the employment dent
left by the financial crisis amounts to about one-third of new jobs not created.
This assessment provides us with a good idea about the order of magnitude of direct
employment effects; however, no such guidance is available with respect to indirectly
employed persons. As a consequence, those figures should be viewed as a rather
conservative lower bound; in evaluating the negative demand shock one should not forget the
second-round impact on upstream business such as the education sector that caters to the
Indian services exports industry.
Furthermore, companies seek to maximize the utilization of their currently employed labor
force through three channels. First, firms are pushing up utilization of their existing labor
12
force, e.g. by eliminating reserves such as the 12-18% of labor-time that previously lay idle
(workers were not engaged in billable activity but waiting to be employed). This reserve has
now come down to 5-8%. Steps such as cutting breaks between login and logout have led to
a further increase in productivity of about 6-8%. Second, there is a shift in the service line
portfolio towards higher value added services, which likewise leads to increased labor
productivity. Third, companies seek to utilize templates that were already created prior to the
crisis for ongoing or new business.
Labor contracts in India are in general not very flexible since a “hire and fire” approach is
precluded on legal grounds. Nonetheless there has always been a high level of attrition in the
industry. On an annual basis, companies are “culling” non-performers such that the bottom x
percent would be asked to leave.
Limited dependence on external finance
The previous sections suggest that the unfolding financial crisis affects Indian services
exporters predominantly through adverse demand shocks. In stark contrast to the
manufacturing sector, tightening credit conditions are not constraining the production and
export of services. The rationale for this resilience is twofold. First, the fact that many
services are delivered electronically across borders, as digitized products, and occasionally
through the movement of individuals to provide consulting onsite, obviates the need for
traditional trade finance, whose deteriorating conditions so far have impacted badly on goods
trade.
Quite apart from international trade, the second reason for the sector’s tenacity is found in its
relative independence from external finance. Indeed, the financial structure of IT and ITES
firms is in general characterized by low leverage with little, if any, debt. While access to
external finance is of some importance, working capital is predominately financed by
retained earnings. Mature firms rely largely on their profits, and a fair amount of venture
capital (some $500m) is available for nascent firms.
To the extent that external funds are needed, factoring has largely solved any financing
needs. This instrument is available to small and large firms alike (even though the discount
margins for large firms may be smaller). Even before turning receivables into cash, many
Indian IT firms are able to leverage contracts for pre-financing working capital, at the time
when the order is placed provided that it involves a recognized party or government.
Importantly, receivables in the BPO industry are very fungible and easily factorized because
they typically involve a short-term transaction, a buyer who is highly creditworthy, and
dispute over the service rendered is usually excluded. The latter feature makes the
receivables a negotiable, irrevocable instrument that is detached from the underlying
transaction. Since factoring as a trade credit instrument is on the rise, at least as compared to
conventional documentary credit, reliance on this particular form of credit puts BPO services
a step ahead of other sectors, notably manufacturing.
A brief glance at Infosys, one of the largest BPO services exporters and a leader in the
industry, drives home the point of minimal financial dependence. With over 100,000
employees, Infosys is debt-free. On the cost side, software development expenses are the
single most important item, eating up 57% of gross revenues, the overwhelming part of
13
which consists of salaries. It may seem that under these circumstances financing working
capital poses quite a challenge as nothing tangible is produced that could be used as
collateral. But this kind of services production involves few intermediate inputs so that 86%
of revenue is value added. Thus in the case of Infosys, internal cash flow is sufficient to
cover working capital, capital expenditure, investment in subsidiaries, dividends, and still
leaving a surplus. While the excellent financial condition of Infosys might not be fully
representative, Tata Consultancy Services (TCS), another large BPO supplier, likewise does
not carry any debt on its balance sheet.
Overall, industry officials do not consider access to finance as a major concern for Indian
services exporters. The way the crisis is affecting the financial position of services suppliers
is by potentially squeezing their margins. To the extent that the length of the working capital
cycle is elongated, the cost of funds is increasing which in turn reduces margins.
There is also evidence that the crisis has prompted some changes in payment patterns. As a
means of financing, advance payments used to be a common feature in the industry.
Allegedly, prior to the crisis no serious offshore firm would have considered an outsourcing
project without a down payment. The unfolding crisis and the associated slump in demand
are eroding Indian exporters’ bargaining position to the effect that some deferral of fees and
invoices is increasingly observed.
It seems likely that the low dependence on external finance—which works to the benefit of
services firms at a time when sources of external credit dry up—is the result of the fact that
services producing firms have to stand on their own feet even in “normal” times. Software
development services, for instance, require potentially large upfront expenses which must be
financed until payment can finally be collected, and in addition such products typically carry
a high degree of uncertainty regarding future profits. With no tangible collateral on hand,
financing of working capital is a generic problem of services suppliers that existed well
before the current credit crisis. Developing a financial strategy that relies largely on retained
earnings is a consequence of services providers’ inherent difficulty to access commercial
credit.
An interesting yet unresolved question is how the crisis affects alternative organizational
forms of outsourcing. One might have thought that in a time of rapidly deteriorating access
to credit intra-firm relations enjoy a relative advantage over arms-length trade relationships
due to the captives’ exclusive access to intra-MNC funding and the flexibility afforded by
transfer pricing. This advantage does not seem to have materialized, partly because this
crisis has in fact started at MNC headquarters in industrialized countries, and partly because
of the remarkable financial strength of most independent Indian suppliers.
Finally, the relatively comfortable situation of BPO services exporters does not necessarily
represent the situation of all services firms, as matters are highly specific to individual
sectors. Agents providing transportation services, for example, face more or less the same
problems in the crisis as do manufacturing firms. Quite apart from the slump in demand,
freight charges are usually paid in advance and are financed as part of the trade credit
package. Therefore the collapse of trade credit is hitting transport agents as hard as it affects
merchandise exporters.
14
IV.
PROTECTIONISM
Services industry sources in developing countries suggest that a bigger problem than any
explicit restrictions is the general mood of protectionism emerging in crisis-hit countries,
particularly in the U.S. This mood has not produced visible restrictions but generated
increasingly strong implicit political pressure to retain jobs domestically. While the negative
demand shock can to some extent be quantified, evaluating the effect of the incipient
protectionist sentiment is harder. Consider two examples.
In light of the Buy-American provisions in recent U.S. legislation, it is instructive to recall
the history of past sub-federal initiatives that sought to promote onshore employment. For
instance, in 2001-02 New Jersey drafted legislation for preferential procurement, including
stipulations that work was to be done by firms with US employees rather than firms that
outsourced. At each step, however, the legislation was diluted. To begin with, the Act would
only apply to government funded project, thereby excluding any private sector financed
projects. Moreover, in case of a cost differential between potential providers exceeding a
certain percentage (approx 15-20%) a waiver would be automatically granted. These
modifications rendered the Act ultimately ineffectual, and the New Jersey experience seems
to represent the fate of several like-minded legislative projects by other U.S. States. The
apparent popularity of such measures notwithstanding, there appears to be a sizable U.S.
business constituency that would potentially be hurt by such measures, as evidenced by the
recent letter 150 U.S. companies sent to President Obama in which they caution against the
Buy American initiative.
Contrast this experience with the following example. On April 6, 2009, Sallie Mae, a
company which manages $180 billion in education loans and has 10 million student and
parent customers, announced plans to move 2,000 overseas jobs back to the United States
from India and the Philippines, reversing a cost-savings measure the company took a year
ago.7 The company said it plans to fill jobs, including positions in call centers, information
technology and operations, in the United States over the next 18 months. The projected cost
is about $35 million annually because of higher labor expenses. The Sallie Mae chief
executive Albert L. Lord was quoted as saying: "It's the right thing to do. The value of a
company's franchise is essentially measured in financial terms, but there are a lot of values in
a company that relate to the long-term value of a franchise. It's a wise investment in the
company's future…It was a tough decision to move these jobs overseas. It was a lot easier to
make the decision to bring them back." Rep. Paul E. Kanjorski (Democrat from
Pennsylvania), who’s Wilkes-Barre district will receive 600 new Sallie Mae jobs was quoted
as saying: “It's a patriotic act. It sends a great message to corporate America to think as
deeply as you can."8
Another example of explicit restrictions is the provision in the recent US stimulus bill
making it difficult for financial institutions that have received tax payers’ funds to hire
specialty occupation (H-1B) visa holders if they have recently made US workers redundant.
7
SLM to Transfer Overseas Jobs to U.S.: Reston Student Lender to Move 2,000 Workers Out of Asia, by
Thomas Heath in the Washington Post, April 7, 2009.
8
Kanjorski chairs a House Financial Services subcommittee that has jurisdiction over securities, exchanges and
most insurance matters, except for health insurance. Sallie Mae has been the biggest donor to Kanjorski's
congressional campaigns, giving $86,000 over his career, according to the Center for Responsive Politics.
15
Given the binding aggregate quota on H-1B visas, a restriction on employment in a particular
sector probably has limited impact, other than on foreign workers with skills that are specific
to the restricted sectors. Thus the restrictions on employing or contracting foreign services
providers in specific areas (e.g. financial services) are not as costly for both host and source
as the increasing social and political aversion to immigration of service providers and the
possibility of retaliatory restrictions. As Lloyd Blankfein, the chief executive of Goldman
Sachs warned, the company had 200 people in the US on H1-B visas but also 2000
employees who worked overseas but paid US taxes; the latter could be the target of
retaliatory measures by other governments.9
Finally, in the longer term, subsidies to banks are probably less damaging than financial
protectionism.10 The former are arguably necessary to ensure the stability of the financial
system. The latter seriously erode the case for openness. Inducing national banks to lend
domestically in a crisis deprives developing countries in particular of capital when they most
need it and greatly strengthens the case for financial self-sufficiency.
Francesco Guerrera, “Blankfein attacks bankers’ pay,” Financial Times, April 8, 2009.
See, for example, Anthony Faiola and Mary Jordan, “British Bank To the World Takes Its Cash Back Home:
Battered RBS Caught In Protectionist Storm,” Washington Post, March 28, 2009.
9
10
16
Annex: Longer Term Trends in Services Trade
Cross-border exports of commercial services account for around 20 percent of overall global
exports in both goods and services. Figure A.1 shows that over the last decade the share of
services in worldwide exports has been fairly constant. This development masks interesting
regional differences, for the share of services has been steadily increasing in North America
and Europe but decreasing, at times sharply so, in South and Central America as well as in
Africa.
In terms of world regions’ overall exposure to services trade, there has not been much change
over the past decade. As Figure A.2 shows, Europe accounts for about 50% of global
services exports, with North America and Asia each hovering around 20%.
Figure A.1
Share of Services Exports in Total Trade
14
16
18
percent
20
22
24
By World Region
1998
2000
2002
2004
2006
Year
World
Asia
Africa
Europe
S/C America
N America
Source: WTO.
Figure A.2
60
40
20
0
percent
80
100
Services: Region's Share in World
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Europe
S/C America
Asia
Africa
17
N America
2008
The panels in Figure A.3 show the development over time of goods and services imports by
the United States from selected source countries or regions. Services flows are broken down
into travel, transportation services and other private services. Focusing on the time series
chart of growth rates on the right-hand side, imports of goods and transportation services
decline sharply in the fourth quarter of 2008, whereas other private services fare remarkably
better. Tourism services appear relatively unaffected by the crisis so far. Imports from
Africa exhibit a slightly different pattern in that growth rates of services have declined as
well in the last quarter of 2008. Nonetheless it is true even for Africa that the relative effect
on other private services and tourism is much more muted as compared to goods and
transportation services.
Figure A.3
Composition of Total Exports
U.S. Imports from China
China, 2007
2.8%
2.3%
4.0%
50
100
Annual growth rates
-50
0
90.9%
2006q1
Goods
2006q3
Travel
Other Private
Services
Transportation
2007q3
tvar
Goods
Transport Serv
Composition of Total Exports
2008q1
2008q3
Travel Serv
Other Priv Serv
U.S. Imports from India
India, 2007
100
Annual growth rates
30.1%
0
50
3.7%
4.6%
2007q1
-50
61.6%
2006q1
Goods
Transportation
2006q3
Travel
Other Private
Services
2007q1
Goods
Transport Serv
18
2007q3
tvar
2008q1
Travel Serv
Other Priv Serv
2008q3
Composition of Total Exports
U.S. Imports from Brazil
Brazil, 2007
2.7%
2.2%
150
200
250
Annual growth rates
100
7.4%
0
50
87.7%
2006q1
Goods
Transportation
2006q3
Travel
Other Private
Services
2007q1
2007q3
tvar
Goods
Transport Serv
Composition of Total Exports
2008q1
2008q3
Travel Serv
Other Priv Serv
U.S. Imports from Africa
Africa, 2007
7.4%
40
60
Annual growth rates
3.4%
20
4.4%
-20
0
84.8%
2006q1
Goods
Transportation
2006q3
Travel
Other Private
Services
2007q1
Goods
Transport Serv
19
2007q3
tvar
2008q1
Travel Serv
Other Priv Serv
2008q3