Running Head: IT OUTSOURCING IN CHINA
Examining China as a Supplier of Skilled IT Workers
Gabriel Haukness
Concordia University, St. Paul
Global Economics, MBA 505, Cohort 469
Professor Jeremiah Palmer
June 13, 2011
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This research examines the feasibility of using China as a country for IT outsourcing.
Specifically, building a network of knowledge workers with various skill sets with enough
competencies to be able to coordinate with U.S. project managers on IT and healthcare IT
projects. To see if such a venture would be advisable we examine both the Internal and External
Balance of China. In addition we will uncover the cultural, political, market, economic and
exchange rate risks which China possesses. The use of Joel Barker’s Strategy Matrix is then
applied to the risk categories to reveal the likelihood of using our strategic objectives
successfully.
The macroeconomic Policy Cross gives us the best and most broad view of China’s
current state as shown in Figure 1. As the figure shows, China currently has accelerating
inflation and a Current Account surplus. Inflation appears to be becoming more of an issue but
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the appreciation of the Yuan is helping that. However, the excessive external balance in savings
appears to be creating possible asset bubbles and is not necessarily a good thing (Davis, n.d.).
The report is presented in three sections: China’s position on the policy cross, Risk
assessments and strategic planning. Section one examines both the Internal and External
balances and some implications for labor inputs. Section two goes into depth on the various risk
dimensions and their effects on building a global IT contracting network. Section three uses he
information presented from the other sections to determine the legitimacy of the plan to identify
and access the labor market.
China’s Policy Cross
China’s Internal Balance
Internal Balance can best be understood by viewing four items. Meade argued that
financial stability should be included when calculating Internal Balance and this paper agrees
with that point and “it makes sense to look for regulatory and prudential policies that directly
address the relevant externalities and market” (Bean, 2009). Inflation and prices are another key
and interlinked item. These can influence and create asset bubbles. Finally, employment numbers
will be examined as that may arguably be the most important number.
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Chinese employment has remained markedly strong even throughout the Crisis era of the
last few years. Overall, the unemployment levels in the last decade have never rose above 5%
(World Bank, 2011). Figure 2 displays the figures from 1980 today. These numbers show a very
healthy Internal Balance. It should also be noted that there is a wide gap between the modern
China of cities such as Shanghai and the rural inland areas. In the rural areas employment may
consist of substance farming on a village contrasting with a construction worker building luxury
condos on the upscale Hanai Island. This gap is relevant as it relates to productivity.
Just as America’s debt levels are creating problems, so too is the excessive amount of
money in China. This is clearly driving inflation and prices upward. The excess amount of
dollars in China’s reserve was requiring China to buy $15 Bn / mo in 2006 (Hill, 2007, p. 371).
In spite of that there are a few reports that show inflation as a problem. The Economist states that
inflation rose at 5.4%. In the first quarter of 2011 and more importantly “Food prices are rising at a 12%
annual rate, which is an unsettling development in a country where households spend a third of their
budget on food items.” (“Overheating China,” 2011).
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It is important to also note that the inflation is helping the Yuan to appreciate as Tim Geithner has
stated when “Taking inflation into account, the Yuan is rising at a rate of about 10 percent a year, so if
that appreciation was sustained over time, it would make a very substantial difference (“That’s yuan way
to adjust,” 2011). The Chinese accumulation of capital helps to offset this but even with excessive
reserves they are unable to control inflation lately. This means that despite their efforts the Chinese will
be best off letting the Yuan appreciate and move toward a floating regime. As Cavallo finds ““even in
the presence of balance sheet effects, flexible exchange rates still provide more output
stabilization in response to a negative external shock” (Cavallo, 2008, p. 265).
In addition to inflation, asset bubbles in property are starting to be seen: “After years of housing
prices gone wild, China's property bubble is starting to deflate” (Davis, n.d.). Davis goes on to state
that as real estate is a foundation for the economy because of all the sectors involved the economy may
actually slow more than anticipated. The Wall Street Journal also reports that equities may also be
overvalued as “shares of many of these Chinese companies have tumbled amid questions from
regulators and investors about the truthfulness of these companies' finances and operations”
(Eder, Pilon, & Rapoport, n.d.). With possible looming asset and equity bubbles this may indicate that
financial stability may not be healthy as numbers appear.
Very often in China, the line is blurred between the government and private firms. Historically
most utilities, businesses and service agencies were state run. Recent liberalizations over the last
30 years have increased domestic services and infrastructure for private and globalized use
(Hanson & Kujis, 2010, p.2). This also applies the financial industry which is still under a long
deregulation but is being integrated globally (A.M. Best, 2010).
China’s healthy employment numbers are being clearly balanced by inflation and
possible bubbles as well as corresponding financial stability. The appreciation of the Yuan in a
stable manner will help to mitigate this. However, growth which has not been below 7% very
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often in the last twenty years may have to moderate as well. None of this dooms a plan to obtain
labor in China. Profit margins will be slimmer with a Yuan appreciation but slowing growth will
also mean an increased chance of finding workers available to work on a contract basis.
Managers will also be best off keeping an eye of inflation and pegging pay to that. A nominal
inflation target within a set range would best determine exact pay rates and could be adjusted for
location.
China’s External Balance
China’s External Balance helps to contribute to the above problems through an arguable
over-dependence on cheap exports creating large trade surpluses. FDI is one core driver of this
balance. We can clearly see that Chinese exports, due to an undervalued Yuan, help in this
imbalance to.
Figure 3 above shows China’s extraordinary strength in exports. It can be seen from the
above graph how China relies heavily on exports as its primary growth driver. This is why China
is attempting to rebalance its economy in its next 5 years by increasing domestic consumption
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(Roach, n.d.). This plan is at odds with the Chinese cultural characteristic of thrift so its efficacy
will be put to the test (Hofsteade, 2010). Reuters reports that by 2015 its trade surplus is set to
contract by 2015 and the Chinese Commerce Minister indicated that in 2011 imports “will
probably grow faster than exports”. (“China 2011 export growth to slow to 10 percent” n.d.).
This reliance on exports has created a large account balance, which has historically
helped in keeping inflation under control. Figure 4 shows this balance. But one can also see that
this account balance, while still quite large, is normalizing.
FDI was also helping to create a high account balance. Foreign companies come to China
because of its spectacular growth. With this foreign direct investment inflows rose 17% last year
and totaled $100 billion. (“China 2011 export growth to slow to 10 percent | Reuters,” n.d.). FDI
inflows into China are also a significant driver of their Account Balance. As Kumar finds there
has been a rise in FDI inflows into foreign countries which positively correlate to economic
performance (Kumar, 2008, p. 124). The U.S. will continue to provide FDI in the foreseeable
future which will help performance to continue. While the external balance is high and the
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savings have helped China, these imbalances have helped to create uncertainties in the Internal
Balance.
What this means for businesses attempting to deal with China is that they can expect a
slowing economy, but also a Yuan which will rise. This will play into importing into China as
the prices of imports will fall, spurring demand. This may be balanced out by slowing growth.
Bubbles in assets or equities could harm the chances of finding educated or high-skilled help if
government programs to create these centers begin to falter. The less developed areas of China
will provide the cheapest labor as the margins will be slimmer from the more modern coastal
cities. This should be taken into account when finding employees to do IT work.
Examining China’s Risk Dimensions
Section one examined the Internal and External Balances of China. Some of those
insights revealed the risks that China may possess when doing business. There is some overlap
when examining the Internal Balance of China and foreign exchange risk. Section two of this
report examines five specific risk categories. Some of these affect business more than others but
al are important in mapping a strategic landscape. For the purposes of this report they are
relevant in finding the risks associated with the acquisition of Chinese IT labor. Specifically
what is important is how each of those dimensions can affect the acquisition of labor. The
findings of this report were aggregated below in figure 6. Low to high risks were given and those
values appear in the figure from green (low risk) to red (high risk). The dimensions examined are
political, cultural, market, foreign exchange and economic. This report places more weight on
exchange rate, market and economic risks over political and cultural risk when determining
possible impacts to labor outsourcing.
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Cultural Risks
A key unique feature of Chinese and other regional Asian countries such as Korea and
Japan is the embedding of Confucian culture into daily life (Hill, 2011, p.104). While it is
important to note that officially practicing religion in China is banned, Confucian beliefs are too
deeply ingrained in the lives of the people to be simply “removed.” These Confucian ethics are
very important as they stress harmony, hierarchical authority, honesty and reciprocity, thus
creating a hospitable business environment (Hendry, 2003, p.138). Chinese people rank very
low on individualism in Geer Hofsteade’s cultural dimensions. This is in alignment with
Confucian ideals because a low individualism score means that groups and family are more
important. The resulting collectivist culture makes it much easier to exert authority. Chinese
managers and organizations will be more successful when creating organizations or teams which
are very tight knit, group oriented and are treated as family. This may pose a challenge to the
nature of remote IT work but it does not cancel out the other beneficial Confucian values.
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This willingness to authority would help explain the very high power distance index
score as exhibited by Hofsteade’s cultural dimensions. This indicates that society is willing and
accepts that very few people exercise authority. Culturally this is acceptable but recent growth of
a middle class who expects increased freedoms is undermining that. Overall, this power index
should be beneficial in managing remote or virtual workers.
Hofsteade’s long term outlook for Chinese people is also very high. This indicates a
belief in overcoming obstacles with time. Both of the positively and negatively rated values of
that dimension are again rooted in Confucian belief (Hofsteade, 2010). The other two dimensions
are the Masculinity index and the Uncertainty Avoidance Index. Both of these values fall in a
middle range. The last dimension also with a below average score rank is the Uncertainty
Avoidance Index. This indicates willingness for ambiguity and lack of structure in dealings. This
would result in less rules and regulations.
One could postulate that when managing employees those strategies for managing
“saving face” will be more effective than written rules, policies or procedures. For example,
instead of communicating rules regarding project deadlines, having employees who miss
deadlines apologize to their peers would be much more effective. This is capitalizing on the high
collectivist and low individual scores.
Figure 6 below shows the totals of each of Hofsteade’s dimensions. This report finds that
most of these values, especially the emphasis on Confucian principals, results in a low cultural
risk. However, these same ideals do mean that building relationships, and the most effective way
would be to cultivate “guanxiwang” in which reciprocity is the backbone of the relationship
(Hill, 2007b, p. 105). Finding ways of reinforcing collective values will be important in
maintaining an organization.
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Political Risk
China faces some societal problems which may impede growth. Its rapid modernization
and growth have resulted in degradation of its natural resources. Chinese cities have high
pollution levels which may create health problems and employed workers may require some
form of healthcare to accommodate or plan for this. Many of the industrial centers have also
polluted the river system and created problems for clean drinking water so if living incentives are
provided to lure workers clean sites with potable water should be chosen to avoid long term
problems. Finally, the party still faces problems stemming from corruption and economic crimes
which are ultimately a hindrance to competitiveness. Some of these above issues affect the
country’s political stability.
Going off of multiple sources across the academic spectrum, the political system of China
is not seen as anywhere near optimal for business. There are risks in inherent in China’s legal
system. We could assume there risks come from the small distribution of power, lack of personal
freedoms and centralized controls over non Han-speaking peoples of outlying Chinese provincial
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areas who are not necessarily Chinese in culture. These people are less integrated in society and
include the people of Tibet, Mongols in northern areas and Muslims from Uighur.
Indeed, recently over the last few months social unrest and political dissention is
increasing. Though the “Jasmine Revolution” never occurred along with the Arab Spring as of
late the country has grown more unstable and this has begun to unnerve the ruing party and also
makes the country less attractive to investors. The Wall Street Journal recently reported that “A
wave of violent unrest in urban areas of China over the past three weeks is testing the
Communist Party's efforts to maintain control over an increasingly complex and fractious
society, forcing it to repeatedly deploy its massive security forces to contain public anger over
economic and political grievances“ (Page, 2011, p. a1). If trends such as this continue, doing
business in China could be risky. However, the unrest and violence is directed at the government
rather than foreigners so outsourced workers may not be significantly impacted.
Looking at govindicators.org we see a pattern of low scores in multiple dimensions.
Voice and Accountability rate at -1.653, which is notably lower than Hong Kong (0.537) and
Japan (1.032). Political stability is ranked higher at -0.439 which is markedly lower than Japan
and Hong Kong also. Government effectiveness is rated higher at 1.116. Regulatory quality is
negative at -0.199. Rule of law is also lower at -0.348. Control of corruption is also low at 0.528. Corruption in a soviet styled centrally run government will be expected. All this paints a
picture of a country which does not have good transparency, accountability or regulatory controls
in place but backed by a government which has the ability to be effective if it needs to.
A different ranking agency report, the AM Best Country Risk Report, measures high
overall political risk. It is still considered overall a developing country in terms of GDP per
capita, infrastructure, regulation and transparency (AM Best, 2010). Areas of all risk are higher
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than average including low scores for: fiscal policy, monetary policy, international transactions
policy, legal system, regional stability, social stability, government stability, labor flexibility and
business environment (AM Best, 2010).
This report gives China a high ranking in political risk. The purpose of this report is to
examine the difficulty with finding reliable IT outsourcing help in China. The political risk does
not immediately affect that in our methodology of outreach attempts to employees. However, in
the long term strategic aspect, political risk could be harmful or disruptive to retaining the IT
team. Such possible risk could be mitigated by having contractors available in a variety of
geographic locales which will be elaborated on in section 3.
Economic Risk
Despite a risky political environment China has a very strong economy with less risk.
Real GDP ranges from 6.5 – 11.6% over the last 5 years and continues to grow with 2009 seeing
4,985.46 Bn in (World Bank, 2010). As section one revealed, unemployment remains very low at
around 4% along with strong markers for savings, trade surplus, exports, strong foreign direct
investment and increasingly available credit (World Bank, 2010). Total debt service is very low
at 2.2% of exports with a large cash surplus at 11.1% of 2009 GDP (World Bank, 2010). China
has a surplus of savings and a corresponding lack of domestic demand (Hanson & Kujis, 2010,
p.2). Increasing domestic demand requires a cultural change in the Hofsteade’s Long-Term
Orientation which will not be done in any short amount of time.
Many recent articles appearing in the media as well as key indicators show that the
economic growth is slowing, though this may be a good thing as inflation is reined in. Nouriel
Roubini argues that China is headed for a hard landing much like the Asian crisis of 1997. He
convincingly states “Sixty years of data had shown that over- investment led to hard landings”
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and when China has 50% investment of its GDP that point does carry validity (Reuters, 2011).
China’s Internal Balance is showing possible asset bubbles and inflation already so his point
cannot be entirely dismissed. More evidence of slowing is that Chinese banks issued 55 Billion
Yuan of new loans in May, down from 739 billion Yuan in April (Dean, 2011, p. a11). The
Chinese are taking inflation seriously and clearly reducing their money supply. While the
economy is slowing, this is a market correction due to improper currency pricing. It seems that
Chinese leadership “stands to play an equally important role in driving the fight against inflation,
asset bubbles, and deteriorating loan quality” (Roach, n.d.).
This report gives China a medium low economic risk. While uncertainties remain and
there is an ongoing balancing movement in its currency and trade surpluses, the economy of
China does not appear any more unstable than the Euro-zone or the U.S. If the Chinese
government was able to increase aggregate domestic demand, then China’s economic prospects
would truly look quite good and this is something their next 5 year plan is working toward.
Foreign Exchange Risk
As section one touched one, there is volatility and movement in the Yuan “from 2005 to
2008 cumulative appreciation of the Remnibi to the U.S. dollar was more than 20%” (WorldFact
Book, 2010). Their pegged system is beginning to falter from the excessive trade imbalance
with the United States and it appears that their dirty float is unable to handle the external shock.
This is to be expected and the movement of the Yuan is actually a good thing. However, as the
Yuan and the Dollar continue toward a more true equilibrium this means that Chinese labor will
no longer be as cheap as before. In the short term such employees would still be very affordable,
even with inflation.
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A Yuan which appreciates too fast will increase inflationary pressures making it harder to
do business, which would result in international managers dealing with wage spirals. This makes
payrolls hard. But measures appear to be that China is taking appropriate steps to stop inflation
and allow a gradual movement. Analysts are predicting still more tightening for the economy
which should mean a steady trajectory for the Yuan (Dean, 2011, p. a11).
This report ranks exchange risk as medium. It would be high if the government and the
markets were not acting. It appears that Beijing is actively taking measures to rein in inflation
and growth. This indicates a more stable than not Yuan, though appreciation will reduce the
profit margins from foreign workers as wage arbitrage takes place.
Market Risk
Historically most utilities, businesses and service agencies were state run. Recent
liberalizations over the last 30 years have increased domestic services and infrastructure for
private and globalized use (Hanson & Kujis, 2010, p.2). The financial industry is still under a
long deregulation but is being integrated globally (A.M. Best, 2010). Broadcast media outlets,
telecommunications and the Internet remain under state control (World Factbook, 2010). This
results in companies which operate as businesses but actually serve the interest and work as
agents or proxies of the Chinese government. Therefore businesses in China will be more
successful if they can demonstrate value to not only business but the benefit they give to the
ruling party.
Findings from doingbusiness.org overall indicate a relatively middle ranged country for
doing business in when ranked in comparison to the rest of the world. Starting a business,
dealing with construction permits and paying taxes are all more difficult than average
(doingbusiness.org). Registering property, getting credit, trading across borders and especially
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enforcing contracts are easier in that economic environment relative to the world
(doingbusineess.org). Overall it is a mixed assortment with no clearly high numbers such as
those of Hong Kong (which is being integrated into Chinese rule).
Findings from Global Edge give a rosier picture of market stability in China. Market size
and market growth rates are both ranked number 1. Overall on the index they rank China number
2 behind Hong Kong. There are also several lagging indicators such as market consumption
capacity, economics freedom and market receptivity (Global EDGE, 2010). In the overall
rankings GlobalEDGE gives China a number two ranking.
This report gives China’s market risk a medium rating. While some categories are not
good, other categories balance it out creating a neutral environment. For the purposes of our
exploration the categories weigh negatively. The most difficult hurdle would be getting the
permits necessary to be able to pay employees. The odds of success would be increased by acts
of reciprocity with government officials, while maintaining ethical business virtues. In this
business environment that may be hard so demonstrating value to the party in some form would
be helpful.
Calculating Probabilities of Strategic Objectives Success
The recommendations for identifying professional educated Chinese speaking workers
encompass strategic objectives which would apply to several emerging economies. This plan
involves finding domestic, U.S. employees as well as the foreign market. The primary objectives
to finding labor are as follows: Finding pools of educated IT professionals with at least one
coding expertise by 2014, Obtaining U.S. interpreters / cultural liaisons by 2013, the creation of
an incentive based recruitment system with revenue generated from future earnings by mid 2013,
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Identifying cheaper non-coastal geographic locales by 2014 and the implementation of a payroll
system by mid 2013.
These objectives were mapped in comparing the risk interactions from section 2 and by
using the key characteristics of a global IT firm. Such characteristics are: being globally
dispersed, few if any time or transportation costs, a necessity to have the latest technology and
continual implementation of automatic and dynamic coding technologies. Most of these key IT
characteristics, especially limited time and transportation costs give the organization an
advantage with global trade. Global disbursement also allows the organization to have
comparative advantage in multiple countries.
Team with U.S. Interpreters / Cultural Liaisons
The first and essential step toward successfully finding workers is finding Mandarin and
Cantonese speakers. They would serve to bridge the language gap and communicate project
requirements and details to IT workers abroad. This presents a disadvantage from outsourcing to
English speaking countries as such countries could be directly coordinated with. Looking at the
strategy matrix we find that this objective would be nearly neutral in the short term but
significantly advantageous in the long run. Market and economic risks serve to create an initially
neutral environment.
Identifying Pools of IT Workers
This reports recommendation is to probe the market virtually through the Internet. This
will allow the initial penetration and access to the domestic labor market. This action would be
coordinated and then executed by the cultural liaison(s). With their language and cultural
knowledge they can more quickly find Chinese IT workers. They could then build and retain a
network of workers seeking employment on a contract basis, for which there will still be
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demand. When comparing risk factors and key characteristics the strategy matrix reveals that this
approach would be positive both in the short and long run.
Develop an Incentive Based recruitment System
The key to starting up the objective above would be to develop an incentive based
recruitment system. Pay would largely be determined on the future productivity of the recruited
member. Translator willingness could be affected by a negotiation of these rates. This would
result in less capital needed to start up and find the workers, though it would present reduced
incentive to the interpreters. However, if the incentive system was competitive as well as
supplemented with upfront payments this would help in retaining the recruiters to find IT
workers. The calculations for this objective indicate a positive in the short run and are neutral in
the long run.
Identify Low Cost Labor Geographic Locales
The appreciation of the Yuan will eventually squeeze profit margins. The point of IT
sourcing is to find cheap labor and the Yuan’s appreciation will adversely affect this during its
climb. But there is still a gap between areas which are modernized such as Shanghai and still
developing cities off the coast such as Xian or Zhengzhou. Such areas still have a lower cost of
living. The largest risk here is political if unrest continues and disrupts activities in these areas.
Still, such disruptions do not affect the identification of these areas as much as retaining help
there. Anti-government sentiment there may even be beneficial to Westerners as Western firms
are not affiliated with the Communist Party. The long term advantages of this strategy would be
more beneficial than an initial attempt to penetrate the market. Their isolation and still
developing nature would make initial efforts less desirable than finding help in the larger more
developed cities.
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Implement a Payroll
The most difficult step and obstacle is establishing a way to pay the offshore workers.
The market risks explained before make this difficult in the short term. This step is obviously
essential once the business starts running so its significance cannot be ignored within the larger
framework of the plan. Electronic payment systems would be required, likely with a high
overhead. With this step legal business requirements would have to be satisfied. Most agencies
rate this as somewhat hard to do. In the long term the maintenance of a payroll would be easy.
They key here again would be the use of Guanxiwang within the context of dealing with local
officials. The key characteristics which usually make IT advantageous globally are negated here
as this step has little to do with virtual IT and requires a physical presence.
Overall Recommendation
Most of the objectives are strategically feasible and are quite manageable. The two most
problematic aspects are retaining interpreters through a carefully designed recruitment system
and establishing a payroll / obtaining the required business permits. Because these two are the
most problematic aspects of this plan they will require the most attention. In the long run the
business model would do well with the identification of cheaper geographic locales being
balanced by Yuan appreciation.
The two difficulties above of retaining interpreters and establishing a foothold could be
accomplished more easily in other countries. Pay is higher in India and there an English speaker
would not be required but a cultural expert may still be needed for success. India would also
have lower barriers to entry. But when viewing China’s long term economic outlook and growth
China seems to be an obvious candidate for finding educated labor.
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The recruitment system coupled with an on contract basis for employees would negate
risks. The highest loss would occur from the costs attempting to start a business. But the
opportunities which could arise from having a Chinese pool of skilled IT workers would
outweigh that. As China rapidly modernizes so too do will the availability in finding labor. By
the time the strategic objectives are enacted and with the help of a cultural expert these
opportunities could be better realized. In summation the short term carries hurdles but the long
term landscape looks promising enough to explore such a venture. At the same time finding and
identifying other interpreters for to find IT workers in other countries may be advisable. This
would be accomplished with the sue of a flexible recruitment system.
Exploratory Report Summary
This report finds that the Chinese economic prospects in the long term look well for
doing business. In particular China possesses a vast potential pool of labor. As the country
develops the workers capable of doing IT work will grow. The External balance of the country is
excessive and the country is showing the typical effects of the imbalance. However, if the
government can manage the shift toward equilibrium while maintaining political stability the
country will remain viable. That shift toward equilibrium will make outsourcing less lucrative
than it has been previously but it does not cancel out the benefits that the country may provide.
Of large concern will be the ability to grow aggregate domestic demand. This will affect the
labor which the country produces with a shift from exports to services, such as IT, The overall
risk assessment of the country is mixed but the economy and culture are especially favorable.
The largest liability will be the political risk in engaging in such a country as well as barriers to
market access. It is advisable to farm out help not only from China but also other developing
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nations in the short term. In the long term a Chinese labor IT input could be beneficial for all
parties involved.
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