Economics Essay - Indian Economy World

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Indian Economy World

Chapter 1: Introduction

The Indian economy is the second fastest growing economy in the world today. It is second only to China. And if some statistics are to be believed, it is just a matter of time before it develops into the largest economy in the world. This document aims to answer the question whether there has been a significance impact of Information Technology (IT) on this sudden rise in the Indian economy.

A look into the recent history of the Indian corporate sector will show that in the early nineties, it was facing a developing crisis. There was an imbalance in the payment scheme. This led to the Indian government introducing a series of economic reforms in 1991. These reforms had a great role to play in the liberalisation of the Corporate Sector. This also eased the restrictions earlier imposed on the activities of the firms operating in the sector and increased the competition. It favoured foreign trade and opened up the financial sector to new investors. The number of foreign investors increased and there were a lot of new financial opportunities including large number of new equities.

Probably, these reforms deserve a lot of credit for the fact that the Asian financial crisis of 1997-1998 didn’t have a catastrophic effect on the Indian corporate sector. India withstood the crisis, and the economy survived. However, it was not like the corporate sector in India was completely immune to the crisis. An immediate impact was the lesser number of investments coming in. There was an increase in the non-performing loans (NPLs). A very important conclusion from this whole episode was the fact that the corporate sector has a very important role to play in the stability of the financial sector.

The nineties was a great period for the Indian companies, especially, in the first half of the decade. There was a great atmosphere for the companies as it was a period of high growth in sales, improvement in the profits and stronger finances. By the second half of the decade the rift between the performances in the companies started to show. The companies that had been maintaining high growth became richer and bigger. The divide was showing more.

The reforms of 1991 made a significant change to the environment the Indian companies operated in. According to Chopra et. al. (1995), the abolishment of the Industries Development and Regulations Act (1951) increased the competition. Many major laws were modified including the Companies Act. The authors think that this lifted the legal and regulatory burden imposed on the Indian companies earlier. The cut in tariff rates and the streamlining of the import licence lead to a steady increase in the foreign trade. The result was an increased number of tie-ups and joint-ventures between Indian companies and multinational companies. New technologies were imported, productive capacity was increased and new products were introduced without industrial licences.

Further, Chopra et. al. (1995), states that there was good support for the small scale industries with potential. They were de-reserved. This helped the small scale industries to grow along with the industry bigwigs and companies with multinational backing. Competition laws were introduced to curb anti-competitive practices. This ensured there was no abuse of market dominance.

According to the figure 1.1 obtained from the World Bank report released in 2007, the growth of the services sector can be seen to be much more than that of the agriculture or industry sectors. The service sector includes the IT and BPO (Business Process Outsourcing) service industries. While the growth in the agriculture sector has been negative and the industrial sector has been negligible, the services sector has seen a massive growth. The major contribution to this has been from the IT and IT enabled services segment. This will be discussed in later chapters.

The above figure (figure 1.2) shows the link between the increase in the GDP (Gross Domestic Product) per capita and the increase in export of goods and services. India is the main exporter of IT services in the world. The annual average growth of GDP per capita grew with rates of 3.4% between 1985 and 1995 and 4.3% between 1995 and 2005 (World Bank 2007). The economic growth is expected to almost double between 2005 and 2009.

This dissertation aims at finding out what effect the Information Technology industry has had on the Indian economy. The Indian economy has been growing at an astonishing rate. The IT sector in India has been growing at an even higher rate. India exports IT services to US and UK, more than any other country. Its growth has been tremendous and the Indian economy’s growth is also progressing in an almost similar ratio. This report will examine and try to prove the hypothesis that the excellent growth rate of the Indian Economy at present is mainly due to the effect of its highly performing and growing IT industry. The research methodology is explained in a later chapter and also is the modes of data collection. Below is a brief description of the breakdown of chapters in this report.

Chapter 2 is the literature review. Part I explains International Economics, Economic Systems and the Microeconomic and Macroeconomic principles. Part II describes how nations measure and try to improve their Competitive Advantage. It includes a discussion on Porter’s Diamond Framework used to measure Competitive Advantage. Chapter 3 discusses the Indian Economy in detail in Part I and Part II gives an idea of the Indian Information Technology industry. Chapter 4 describes the Research Methodologies and the methods used in this report. Chapter 5 discusses the findings and analysis and chapter 6 the conclusions and recommendations.

Chapter 2: International Economics and Competitive Advantage of Nations

Part I: Understanding International Economics

2.1 Introduction

For decades people have been writing about economics and the changing trends in the international economy. Many have tried to predict how the future of the world economy is going to turn out and what the future holds for us in terms of the new players in world market. The truth is that it is always not so simple a thing to decode the way in which the world economies would evolve and the unexpected problems that would be looming around the corner. Even at the stage where the world economy slows down and many economies face a recession, it is not exactly a foregone conclusion when and if this will happen.

Before understanding more about economics it would be wise to start by understanding what an economy is defined as. Wikipedea, the world’s most famous online encyclopaedia, defines an economy as the realised social system of production, exchange, distribution and consumption of goods and services of a country or other area. This is a very simple yet very accurate description of the word economy.

It further explains that an economy is a result of processes involving technological evolution, history of civilisation, social organisation, geography, resource endowment and ecology. These can be summarised as the basic factors affecting an economy but there are many different authors and experts who think that there are many other factors that have to be included. This chapter expects to list and explain some of the main factors affecting an economy according to some of the best authors in the field. One such person is Jeffrey Curry who explains these in detail in his book, ‘A short course in International Economics: Understading the dynamics of the International Marketplace’. The chapter will also explain the different Economic systems that have and are being used as well as look at the macroeconomic and microeconomic principles.

2.2 Defining Economics

According to the online source World Scientific, economics is a social science that studies how society chooses to allocate its scarce resources, which have alternate uses, to provide goods and services for present and future consumption.

The book from the same source breaks-up the definition into little fragments and explains each term to give a better idea of the word.

It starts by explaining that goods refer to anything that is used to satisfy a want. Production of goods is to serve just that purpose which is to satisfy the want of the masses. Goods mainly refer to the physical items and the intangible items are refered to as services. And therefore, goods and services pretty much refer to the same thing.

It then proceeds to explaining about resources. Resources are the input that is used for the production of goods. For any sort of production there is always the need for resources. Land, labour, capital and entrepreneurship are all resources. Land and labour need no further explanation. Capital is used by an economist not as a reference to money but to a resource. Of course, the main idea of the word capital is money, but it also represents goods that have been produced for use in the production of other goods. Consumer goods are the goods that are produced directly for the use of the consumer. They directly satisfy the need of a consumer. Capital goods on the other hand are produced not with the purpose of directly satisfying the want of a consumer but to be used for further production of other goods. Entrepreneurs are the ones who reap the benefit or bear the loss of their business of supplying goods and services.

Scarcity is another term that needs very little explanation. It is though, very important in deciding a market of an economy. It is a measurement of the demand and supply that is in progress. When goods are in huge demand and the production cannot match it, there arises the scarcity of the goods. This can drive the price of the good high in the market and make it less available to the poorer segment of the society. Fuel is always a good example of scarce goods. Even though there is enough fuel in the market today to meet the demand, it is a resource that is non-renewable and soon running out. A very good definition of scarcity according to the book is the unlimited demand for limited goods.

Scarcity leads to choice. In fact it forces choice. Where there is scarcity there should be a system to make choices in order to save the resources and to cater to the needs of the people. Society has to come up with a system to allocate the resources in the best way possible to satisfy the needs of the people. There have to be alternate ways to make choices so that it does not affect the future of the economy and not just satisfy the present needs.

2.3 International Economics

Trade of goods between nations have been going on for centuries. Even in the earlier days there was a system of satisfying wants by trading goods between nations to satisfy the scarcity of goods. The methods and amount of goods traded has changed since. International business has grown to the highest level ever seen in the 2oth century. The exchange of goods, money and culture and the movement of people between the nations have been at its peak. The scale of trade is so large that even the smallest of nations or economy has to look outside its border for products and profits. The chapter will later highlight on how the economies of the world are interdependent and how its effects can be monitored.

Henry Hazlitt(1946) was one of the first writers on the principles of economics and revealed the myth behind many policy decisions of national governments. Even though his work dates back to so long ago in time, it is still a very good guide to refer to. His work brought to light a lot of the internal issues of economics. He believed that the driving force behind most of the economics decisions is self-interest. He believes this is true in both the private and public sectors. Another important thing according to him is the effect a decision on an economic issue can have on that economy or the world economy.

The main reason behind the nations trading goods is to get goods that they themselves do not have or cannot produce. There are many reasons why one nation does not have a product that another nation does. Availability of resources, geography and expertise are just a few of the factors. A simple thing like the geography of a country has a say in what kind of products it can produce. Climate and the kind of soil are the main factors for agriculture. And this was the beginning of trade. One country may have crop ‘A’ in excess while it may not be enough in quantity for another country. The second country on the other hand may have crop ‘B’ in excess. Both the countries may therefore enter an agreement to share their resources and trade the goods to satisfy the needs of their respective economies. Trade is not done just for food. It extends to all parts of the society, including manpower and technology.

The trade policies followed by different countries are different. Some countries follow a more open style trade while others prefer a closed style market. China is a good example for the tight control it imposes on international trade. The government of France and Japan have a more controlling approach on the industries and investments within its border. Most of the Arab countries also follow a strict control over the state of affairs within their country. They also deny ownership of land and industry to foreigners. Countries like Russia and India are now decentralising the economy. United States of America is the best example of the open market. They had opened their doors to foreign trade and investments since many years.

Some economists divide economics into two sub-divisions. They are positive and normative economics. Normative economics tries to explain how economies are supposed to operate where as, positive economics tries to evaluate how economies actually operate. According to David Hume (1739), a positive statement is one that gives an answer to the question ‘what is’. There isn’t an indication of approval or disapproval. Normative statement is one that expresses whether a situation is desirable or not. It answers the question ‘what ought to be’. The reason economists find this positive-normative distinction useful is because it helps people with contrasting views about what is desirable to communicate with each other.

The other two main principles of economics are the macroeconomic and microeconomic principles. This will be discussed later in this chapter.

2.4 Economic Systems

There have been numerous economic principles that have helped in the formation of the global economics as we know it today. These principles have been developed over the years in different countries and different cultures. This section of this chapter will look at some of these principles that have been the base of political systems. Economic systems are never permanent. It always evolves according to the times and trends.

2.4.1 Feudalism

The economic, social and political system that is bound by a class structure is called feudalism. Here nobility comes on top of the system and the peasants right at the bottom. There were other classes that came in between these two extremes. The nobles and the kings were the ones who owned the land. The peasants or the villains were the ones who would toil on these lands and serve the higher class. The other two main classes in between were firstly the tradesmen, artisans and knights who were more like the freemen and secondly, the magistrates or the barons who were appointed by the nobles and were answerable to them. A simple graph below in Figure 2.1 gives an idea of this system.

In this system the King or Noble controls the land. The lower class live and farm on the land. They have to then pay a share, which was normally the majority, to the ‘lord’ assigned to their land. This lord was then responsible for the safety and security of those peasants.

This system was in practice at some time or the other in most of the major economies of today. The main time of its existence was in the medieval age which was around the 15th century. Even though this system ceased from existence in most of the countries by the late 19th century, there still are shades of it in countries like China and the Arab nations. It is interesting to notice that there were three main origins of this feudal system. The end result was pretty much the same in all of them. The main systems were the European system, Arab system and Asian system. Like mentioned earlier, all of these had a similar outcome and led to next common stage.

2.4.2 Mercantilism

This is a theory that the prosperity of a nation depends on its capital. It states that the volume of the world economy and the international trade is unchangeable. It is widely believed that the mercantile system was a predecessor to capitalism. The economic policies of governments are based on this system. The capital of a country is determined by the gold it holds or the bullion held by it. The capital is further improved by the wealth it gains through trade. According to this policy, the government should try to implement a policy where the country exports more value of goods than it imports so that the nation’s capital increases.

This thought of economics was the main system in practice during the era between the 16th and the 18th centuries. This time is also considered as the starting point for viewing economics as a discipline. Before this period there was no special recognition to economics as a subject. Now, the country started putting serious thought into the policies that were being made and the effects they would have. It was also the period where for the first time there were discussions and debates on economic policies.

Under this system, there was a new way of taxing the merchants and the working class according to their production. It was much different to the methods used during the feudal times. The merchants would have to pay a tax to the government to run their business and they would get the protection and permission of the government to do business inside and outside the national borders in return. It was a more relaxed system to what was in practice before.

This also led to the formation of more colonies. The colonies, both existing and the new ones, were used to provide profit to the controlling nation. These searches for new colonies resulted in the discovery of even new continents like the North and South America. Some of the policies created during these periods still exist in some economies. Under this system, the government had a lot of power and they could control most of the aspects of the economy. It could finance new businesses and could decide whether to allow or disband monopolies. They could impose tariffs on trades and could control the way the labour was being managed. The most important thing probably was that it had the right to deny a country, which could be a potential threat to its status, to function within its borders. Many of these policies can still be seen in effect in many countries. The Arab nations are among these.

Shipping was used as the main means of transporting goods. Given the technology and the conditions available during those days, shipping provided to be the quickest and safest way to export or import large quantities of goods between distant economies. This saw to the rise of new laws and regulations to control the flow of goods between nations using this method.

England used the Navigation Laws of 1650 to stop foreign vessels from trading on its coast. They made sure that all the imports to England came only on English ships or on ships controlled by English captains or those from colonies of theirs. Then again they introduced the Staple’s Act in 1663 which said that all the goods from the colonies had to come to England first and then be distributed to the European nations. This gave England the controlling power over much the global trade. Military had a great role to play in the controlling of exports. The merchants would fund the cost of the military protection, to secure their trade interests.

Policies during this time aimed at increasing the gold import of the country. A wealth of a nation depended on the gold it had in possession and the strength of its military. Gold helped in strengthening the military. The nations tried to acquire as much gold as possible to strengthen their respective militaries. To effect this, the stronger nations would try to produce all the goods so that they would not have to import anything but would be able to export their goods in exchange for gold. The last thing they would want was to export their gold to a competing nation in return for goods.

The main reason behind the decline of mercantilism was the wars that followed this period. The Napoleonic wars in the early 1600s had weakened most of the European nations who were the main players in the international market. This brought America into the International limelight and also made the nations aware that there are other ways of managing an economy that could also prove good and effective than what was being followed. The industrial revolution (1750 to 1850) changed the complete image of the international marketplace. England overwhelmed the whole world by the progress it made. It abolished the mercantile system and became the undisputed leader of both the industrialised world and seas. Even though England had lost the American colonies, they still had more than they required, continuing to stay as a world power. After the two world wars, the mercantile system changed in most of the world. Trading in currencies became the norm.

2.4.3 Capitalism

This is the most common kind of economic or social system that is present in the world today. It is safe to say that most of the countries follow this system. Here the means of producing and distributing goods are owned by a small minority of people. This minority is referred to as the capital class. The majority of the people come under the working class who have to work in return for a wage or salary. The main concept in this system is the private property ownership and entrepreneurship.

The working class are given their pay to produce goods or services. These then generate profit for the capital class. In one sense the capital class do exploit the working class as the latter have to do all the work and are made to buy goods at a price that give profit. The capitalists live off the profits they make and invest some of it back into the business to increase the output and generate more profit. This division of class does not mean that all of the working class are poor. They do get paid differently according their abilities. The only thing is that they all have to get paid by a capitalist.

The driving idea behind capitalism is to produce and sell goods to make a profit, not to satisfy the needs of the people. To make the profit they will have to produce the goods that the masses require. The goods are produced with the idea that they should sell at a profit. They are not made just to satisfy the people and generate loss for the capitalist. This is not a case of the capitalists being greedy but the nature in which the capitalist has to perform to survive in the business. Unless they get a return for their investment, it is not worth doing the business. To overcome their competitors they have to keep making profits to reinvest in their business and create new and better ways of making more profit.

Britain in the nineteenth century and the USA in the twentieth century saw capitalism grow to be the norm of the social system. The government would not provide much resistance to the growth or activities of companies. They were allowed to operate in a free way and to expand as feely as possible. Business monopolies were created and they were encouraged rather than being sanctioned upon. The divide between the working class and the capitalists grew. Labour was being treated with very little respect. Even women and children were exploited. The rich capitalists had enough say in the government and even in the military affairs to be able to suppress labour revolts.

On important fact that always is overlooked when talking about capitalism is that even though there was this large divide between the working class and the capitalists, the whole of the society did come up. There were lots of jobs created in these huge companies and more people were getting work. Before the industrialisation people still had to work had to get money. They had to toil hard in their fields. Even the women and children used to work all day in the fields. So, when industrialisation came into place the people had a fixed source of income and opportunities to get paid according to their skills.

There were a lot of problems involved in capitalism. Some of these were the crowding of people in the urban areas, pollution and spread of diseases. Due to these negative aspects people would overlook the benefits it provided. There was constant criticism against the system. Slowly the governments introduced more regulations and legislations. Monopolies were dismantled and workers were given more rights. There were also unions that were being formed. The great depression in the 1930s crippled the world economies. Just before this people were already asking their governments to take control over the activities of commerce. The economic system needed changes.

2.4.4 Socialism

Socialism is the economic system in which the onus is on central planning. All the control on the means of production is in the hands o the government. Unlike in the capitalist system, there will be no private ownership or entrepreneurship. The production is done by the government with the purpose of serving the needs of the people. Profit making is no the driving thought. Pricing and individual product demands do not decide the market. Ownership of land and businesses by private parties is disallowed or in most cases banned. Socialism is a very complex idea. Not all interpret it as the same. This difference in interpretation and implementation has led to many different kinds of social economies. They are as discussed below.

State socialism is the kind of system where the government is set up in a capitalist society. Here certain sectors of the economy are controlled by the state with a social objective in mind and not profit making. Utopian socialism is the idea where all the people are treated as equals. Here there will be no class divide. Each person works for the benefit of the whole group. No one is concerned with personal gain and all are selfless. It follows the principle ‘from each according to his ability to each according to his work’. This system has failed even at a lower scale and never been implemented on a national scale.

Anarchism is the society where small self-governing groups come together freely by association. This idea is similar to that of Utopianism but without a central government. There is more of a collective ownership of property and no private ownership. The level of production is decided by an association of producers and similarly an association of consumers decide the price of products in the market.

Marxian socialism gets its name from the ideas of Karl Marx. Many believe that he had little to do with this idea and the true recognition should go to Lenin. It is based on the idea of a continuous class struggle. Each successive economy is revolutionised by the classes that it oppresses. Private ownership is only allowed for the consumer goods and the centre owns the means of production. In this system there will be no effect on the economy by the factors such as rate of investment, profit and competition.

Syndicalism follows the idea of having central planning but which is not done by a government. It will be done by a federation of individual, autonomous industrial unions. Private ownership is completely abolished. Guild socialism is the kind that Britain is familiar with. All the economic policies are formulated by the state and then have to be followed by the trade guilds. There is an equal share and representation in the government between the producer and the consumer.

Most of the countries in the world have practiced socialism. Even the so called capitalist countries have had a degree of socialism in practice. Communist countries like China and the USSR had followed socialism even though they were known as communists. The main reason why this idea needed change was that socialism on its own cannot prosper a society. It needs the assistance of capitalists in the economy. Another main reason is the human behaviour. People tend to have different goals, ambitions, intelligence and motivational levels. These differences in traits of people were ignored in socialism. Socialism declined in the late 1980s when Mikhail Gorbachev implemented the policy known as perestroika (restructuring). In this system private ownership and competitive markets were introduced.

2.4.5 Monetarism

In this social system it is the amount of money in circulation within a society that determines its growth and wealth. The government maintains a steady supply of money into the economy which is equal to the actual growth of the economy. If the money supplied by the government increases compared to the growth of the economy, it results in inflation. On the other hand, if the money supplied is less than the growth then there is deflation, where the prices of goods are reduced. The rates of interest vary in the same proportion as the inflation. When both are high the value of the currency drops in the international money exchange market. The money supply has an immediate effect on the buying power of the economy. If the inflation rate is high and raw materials cannot be bought the output of the nation reduces and can lead to a recession.

This is very much a part of the modern day economics of all the nations. It is very important for an economy to keep the price stable. Nations compare currency to those of more stable nations to determine how their economy is doing.

2.4.6 Communism

This system follows the principle ‘from each according to his means to each according to his needs’. It is in contrast with the utopian principle. In this sort of economy there has to be an abundance of goods and all will have to be selfless in favour of the benefit of the society as a whole. Money will not be used as a mode of exchange in this system. Work is not considered as a requirement but as a service to the community. There will not be a central body as there is no need to control all the people who are selfless. The only reason why people should come together is administrate production.

This idea has never been implemented on a national scale yet. It has been implemented on a small-scale basis but has had a short life-span. This is due to the human nature where all are not selfless. In today’s world, the communist countries are socialists who are looking forward to implementing the communist system in their society at some stage in the future. Cuba, North Korea and Laos are probably the only countries that still believe this is possible.

2.5 Microeconomics

Way back in the older days economics was divided into two main groups known as the pricing theory and the monetary theory. In the post-war era the same are known as microeconomics and macroeconomics respectively. The former concentrates on the day-to-day economic decisions and the latter on a larger view of the world. Both are equally important and cannot survive without the other.

Microeconomics is the study individual economic units. Workers, consumers, landlords, businesses, investors, share-holders and service providers are all economic units. The main goal is to study how and why these individual units make their choices and decisions. It also studies how the individual units combine to form bigger units. All the nations perform a microeconomic role in the whole global market.

Microeconomics deals with both the positive and the normative concepts. The former concentrates on the realities of economic life, while the latter states how things ought to be in an ideal economy. Stated below are some of the key aspects of microeconomics.

2.5.1 Pricing

The strength and stability of each market is determined by the price of goods and services within itself with respect to the other established economies in the world. There are two ways of measuring prices. The nominal way of measuring prices is checking how much money or currency will have to be paid to purchase a something. The real term of checking price is comparing the price of a product with other goods in the market over a set period of time. The national governments use CPI (consumer price index) as a scale to track the price of goods. They use this to keep track of the prices of the essential commodities.

2.5.2 Supply and Demand

This method is not very relevant in the social economies. It can be found more in the capitalist economies where the factors come into play in determining the price. Market mechanism is used. This can be explained as the tendency for the price of goods and services to adjust until the quantity supplied and the quantity demanded are equal. There is always a fluctuation in the market. When the price of a product is high and it is not an essential commodity, there will be a drop in demand and vice versa. Equilibrium is the state when the quantity supplied meets the quantity demanded.

2.5.3 Elasticity of Demand

Price elasticity of demand is when there is a ratio of proportional change in demand created by a proportional change in price. When there is a certain percentage of change in demand, the percentage of change in price is not always the same. They vary in the four cases as below.

Elastic demand is when price changes by a certain percentage and this effects in a larger percentage change in demand. This is the case normally in non-essential items. When there is an increase or decrease in price of most goods, the demand for it in the market increases or decreases with a very high margin.

Inelastic demand can be seen in the case of essential goods. When there is a change in the price by a certain percentage, the change in demand is of a lesser percentage.

Unitary demand can be noticed in cases such as that of luxury goods where price really is not a controlling factor for demand. Here the change in percentage of price will be equal to that of demand.

Cross demand is in the case where some goods are sold in conjunction with other goods. When there is a change in the price of one item, there will be a proportional change in the price or demand of the other. The price of the related good can increase or decrease even id the price of the primary good falls. And example of this is when the price of VHS cassettes increased when the price of VCRs dropped and its demand increased.

2.5.4 Utility theory

It depends on the consumer behaviour which means that it is the consumer who decides how they should spend their wealth. The choice of the consumer depends on their perception of how much satisfaction they will get from the purchase. This level of satisfaction is called utility. This is the same in the case of any product or service. The rate at which the total utility changes, is called marginal utility. Marginal utility reduces as consumption increases.

2.5.5 Product substitution

This idea explains that the competition of a producer is not just with other producers who produce similar goods but also with all the other products in the market. The reason for this is that the consumer may reduce the purchase of one product and increase the purchase of another product at any time. Say for example, a rice producer may find themselves under less demand if the trend shifts to eating more breads.

2.5.6 Profit maximisation

The idea behind this is that the producer should get as much satisfaction in selling their product as the consumer gets in buying them. The satisfaction of the producer is measured in the profit they can obtain from the sale. Profit maximisation is the process followed by a company to gain maximum profit possible from their product.

2.5.7 Pricing scheme

There are different pricing schemes used by companies in different markets. The kind of product also makes them choose different pricing schemes. The main types of pricing schemes are as explained below.

Component cost pricing is the method where a single component of the cost is taken into consideration. This is normally the major cost factor, and then it is expanded by a larger percentage to give the selling price. This is not a very good method as different costs vary with time and that will not be reflected in the price of the product.

Cost plus pricing is the method where the producer adds a percentage as a profit to the total cost of one unit. The margin of profit remains the same throughout the change in the price of product due to production cost changes.

Average return pricing where a fixed amount of profit and not a percentage is added to the whole cost of production and then it is broken down into individual unit price along with the profit already included. The seller will have to wait till all the products are sold to meet the target profit.

Breakeven point pricing is where the producer sets a level of sales to achieve profit. If the level of sales is below the breakeven point, the company makes a loss and if the level of sales goes above this point, it is a profit.

Competitive pricing is where the market determines the price. Depending on the number of producers available and the demand for the product, the producer will have to set a competitive price.

2.5.8 Monopolies, Oligopolies, Monopsonies and competition

There are different kinds of competitors involved in a market. The market is divided on the basis of the strength of the producer in this market.

A standard market is where there are many numbers of producers for a given product in the market. The consumer has the choice to decide which product to buy. The producer has to convince the consumer to buy their product. They will have to market their product to make it attractive to the consumer. It is the producer and not the retailer who decides the price in this market. The customer does not have much chance of bargaining with the retailer.

A monopoly is where the producer has a huge control over the market. There are mainly two types of monopolies. A regulated monopoly is where the government decides that someone should have the monopoly in a particular sector for the benefit of the people. Competition is outlawed in this system. There will be regulators who set the prices and the producers get the profit. The customer does not have much choice. They have to decide either to have the product or not. Natural monopolies are where a company gains the monopoly by their own effort. They may capture the market by their innovative ideas or by driving out competition. The government normally brings out regulations to control this kind of monopolies and they last for a shorter time period.

Oligopoly is like monopoly but by more than one company. There will be a few companies who control the market. These can be companies who sell identical products or can be those who sell differentiated products. Differentiated products are those that are similar in nature or serve a same purpose but are differentiated in the minds of the consumers. Different models of cars, is a good example for this.

Monopsony is where there is only one customer for a particular product. There may be more than one producer but only one person to sell them all to. This is like reverse monopoly. The price is set by the buyer. The government is a good example for this as there are lots of things that only the government of a country is allowed to buy, like defence weapons.

Oligopsony is the reverse of oligopoly where there are just a few buyers for a given product. Again the price is determined by the buyer. The manufacturers of car spare parts for major car manufacturers are a good example of this.

2.6 Macroeconomics

Macroeconomics is the study and analysis of the behaviour of a market in aggregate as well as the behaviour of the central body that affect both national and international economies. It looks at the total employment, consumption, trade, and investments. It does not look at the effect of just the individual or company decisions.

There are two main approaches in macroeconomics. The first and main one is the Keynesian school of thought which states that not all the buyer and seller come to a conclusion rationally. The market force is not desirable or efficient. The main decisions have to be taken by the government in favour of the benefit of the people. The other more relatively school of thought is that of the New Classical Macroeconomics. This believes that the consumer and producer always act as radical agents. The only time when the government can intercede is when there is a serious market failure that has been found and if they can lead to its correction. They always question if the government can actually avoid doing more harm than good by their actions.

2.6.1 Business cycles

Every kind of economy experiences fluctuations in its activity. There are both boom phases and recession phases in every economy. The rates of cycles differ with the causes.

Trade cycles are the most common cycles in practice. There is a fluctuation in aggregate level of output and employment relative to long term trends. The output is measured by Gross Domestic Product (GDP). This is the amount of total goods and services produced by all companies operating within the country. It is very hard to predict the length of the cycles. The change in the duration severity of the cycle is based on the economic decisions.

Real cycles are also very hard to predict because they are caused by drastic causes. Economic shocks, technical developments and social upheavals or wars are some of the factors that bring this cycle into effect. Real refers to a wide variety of economic terms and denote less theoretical factors.

Political cycles are those that are effected by the government in power. All the economies have some input from their governments. There is a belief that many governments deliberately manipulate the economic cycles to maintain political domination. They make different decisions when they come into power and when they near elections. They then slowly retract the decisions well into their terms. Governments use political cycles to quell unrest.

2.6.2 Inflation

Inflation happens when the value or the purchasing power of a nation’s currency drops in the international market. This results in the continuous increase of prices. Countries use the CPI, GDP and a producer price index to measure inflation. The different types of inflation are as follows.

Sectorial inflation is caused due to the supply and demand irregularities. There is always fluctuation of prices of products with respect to the other products due to the supply and demand. Sectorial inflation is where the price of a particular set of products increases. This happens normally only in essential products. This has a short term effect and may happen due to sudden change in circumstances.

Cost inflation when the cost of the factors of production increases. The change is reflected on the economy. When the cost of raw materials increase or when wages for labour increase, it leads to cost inflation. It is very hard to manage as wages have to be increased as a result of cost inflation and this leads to a need for further inflation.

Demand inflation is very straightforward. When demand cannot meet supply, the price of the product in shortage, increases. It can happen regionally or sectorially. This can then lead to cost inflation which is then very hard to manage.

Hyperinflation is a larger scale of cost inflation. This happens due to wars or famines. Some countries may have an inflation rate of 50% per month. It reduces the value of the national currency to a very low level.

Inflation tax is informal tax applied by the government over the already present tax. When inflation reduces the value of money, the value of government debt increases. Inflation tax is used to reduce this condition.

2.6.3 Savings

The amount of money people have to put aside after they spend on consumables is called savings. This can be used in a time of need. Savings is done normally with banks. The public get interest on their savings in most economies. The rates of interest differ according to different factors. Life savings, small savings, savings account, contract savings and national savings are different forms of savings.

2.6.4 Recession

Recession is the worst state for an economy to be in. This happens when there is a low demand in the economy. The low demand causes the output to be low. The employment level drops as a result. Recession is declared when this state of affairs continue for two financial quarters. Recession within an economy can be tackled by the government, bankers and private enterprises.

2.6.5 Unemployment

The actual measure of unemployment is how many people who are old enough and capable to work, is unemployed. Different people use different methods to measure unemployment which are not right. The main mistake is that they look at the number of people they know who are seeking job. This is not the right representation for unemployment. There are different types of unemployment and they are as below.

Demand deficiency or Keynesian unemployment happens when there is an all around lack in demand for goods and services. The only way to tackle this is for the governments and private companies to create more jobs so that people feel happy to spend.

Classic unemployment is where the high wages, labour regulations and lack of productivity of employees stop the company from being able to employ more people. Only if the wage is lowered or labour laws are relaxed or the existing staff improve their production will this issue be solved.

Structural unemployment happens when there is a shortage of skill. The people available are not suitable for the jobs available or are too far away to commute. In this case the unemployed can be trained to gain new skills.

Frictional unemployment happens when the people are looking for better jobs to match their skills. They are ready to wait till they find the right job. This can be tackled by having recruitment centres.

Impaired unemployment is when people are kept out of jobs due to reasons other than their skills. Reasons like discrimination come under this. It can be controlled by punishing firms that follow such methods and bringing in more regulations.

Underemployment is when people are working in jobs that are far lesser than their educational qualifications or skill levels. This also includes the part-timers. The full potential of the people are not used and so the economy loses what it may have got otherwise.

To summarise, once again it is worth mentioning that macroeconomics and microeconomics are always co-existent. One needs the presence of the other. Governments concentrate on the macroeconomic issues but also think about its effects on the micro level for the individuals.

Part II: Competitive Advantage of Nations

2.7 Introduction

The most notable writer on the topic of Competitive advantage is the Harvard Scholar, Michael E. Porter. For almost two decades now, it is his Diamond framework that has been used as the main tool by the nations to define what their competitive advantage is. He had refined his earlier work and come out with a book called ‘The Competitive Advantage of Nations’ in 1990. This part of the chapter will study Porter’s Diamond framework and it’s implication to the competitive advantage of nations.

Porter contradicts the traditional theory of economics which looks at the common variables as the most important factor to determine an economy when he says, ‘national prosperity is created, not inherited’ (Porter, 1990). The old theory (Ricardo, 1928) that the other variables like the labour and interest rates are the main factor deciding the economy conclude that national advantage is inherited and cannot be created. There are lots of things that need to be understood to get a better idea of what Porter was implying. Different firms follow different methods that allow them to have a competitive advantage over others. In the global economy, one can consider nations to behave like these companies that are trying to get an advantage over the market. This leads to the quest for national competitive advantage.

According to Porter (1990), innovation includes both improvement of products and the development of completely new products and production methods. He says that innovation is just not the end result where something substantial is obtained but is also all the steps and efforts included in the whole process. Everything leads to new knowledge and improved methods of doing things and new ways of doing things better. In today’s world, improvements are made to products at almost a daily basis. Such is the rate at which the competition improves. Any advantage a firm has may be nullified by a competitor the very next day. Countries encourage companies to come up with innovative ways so that the result will be the competitive advantage of the nation as a whole. Those who stay a step ahead of the competition and try to explore different new possibilities are the ones who generally get the competitive advantage over the ones who actually have better technologies. Some firms come up with ideas never thought of that can actually change the whole set-up of the competitive structure. This chapter will discuss Porter’s Diamond framework, the determinants highlighting a nation’s economy according to the Diamond and some drawbacks of the Diamond.

2.8 Porter’s Diamond Framework

The diamond framework, as mentioned earlier, is the main framework used by the industry to analyse the nation as a whole unit. It allows the nation to look whether it is providing the facilities available for the industries operating within its border to grow in a way that it creates an effect on the global market. The Diamond framework gives a clear idea whether the firm’s competitive advantage, if any, is good enough to make it a main international player.

There are six main determinants under the Diamond framework for the country to measure its competitive advantage. These are factor conditions, demand conditions, related and supporting industries, firm strategy, structure and rivalry, chance and government. These are the determinants that form Porter’s Diamond framework. In this formation, the effect of one of these determinants reflects on the others. Again Porter (1990) says that there are two main factors that are very important to the Diamond formation which are domestic rivalry and geographic closeness. Perhaps, domestic rivalry is the most important factor as that is what makes the nations to compete with each other and come up with better and more efficient ways of production. Geographic closeness is also important as this gives the companies the same kind of laying field and they can benefit by seeing the progress of their competition.

Porter (1998) explained the effect of the determinants as very important to the competitiveness of nation when he said, “the availability of resources and skills necessary for competitive advantage in an industry; the information that shapes what opportunities are perceived and the directions in which resources and skills are deployed; the goals of the owners, managers, and employees that are involved in or carry out competition; and most importantly, the pressure on firms to invest and innovate.”. What he said can be explained in simple words that the environment within the country is what is most important. Only when it favours the growth of the company will it create an international competitiveness.

Figure 2.2: Porter’s Diamond Framework. Source: Porter, 1990

It is probably impossible for a nation to have advantage in all the determinants of the diamond, but it is important that they have more than one. More the number of determinants that a nation has an advantage in, the better will be its competitive advantage. According to the Diamond framework, there are three conditions which allow competitive advantage for companies. Firstly, if the nation does not restrict the amount of wealth and skills the company can gain. Secondly, the nation has to develop overall so that the companies have the ability to find new techniques. Lastly, if the companies stick to their policy of growth and the investors stay loyal to the cause.

2.8.1 Factor Conditions

According to Grant (1991), factor endowments lie at the centre of the traditional theory of international comparative advantage. This is uses to determine where the nation stands in-terms of the factors of production. All the different factors like the kind of labour available, the infrastructure and the other related costs come under this. According to Porter, the advanced and specialised factors are more important to the model. These are the highly skilled and educated labour and other important factors that are key for the industry. What he believes is that just having educated people is not enough for a nation’s competitive advantage but also there has to be the facilities available that are specifically suited for an industry to prosper. And, these can be only obtained if there is a good and steady investment available.

For a nation to have a competitive advantage, it’s not enough that the factors required are available but, there has to be means by which the factors can be improved or created. There have to be institutions where the factors required for the industry are created and improved continuously. Local rivalry helps achieve this as a by-product. The other parts of the Diamond have to be in favour if this has to work out well.

2.8.2 Demand Conditions

Demand condition is the term used to determine how demand for a good product produced by a country within itself, can improve its competitiveness. Porter (1998) says that it is the demand of the products within the country that helps the organisations to better their products and to know what to expect. When the home-market is very sophisticated in its demands, it helps the country to develop as the companies in it try to better their products in comparison to those outside. Therefore, it is not the quantity of demand that counts but the quality.

If the improved products stay within the country, there is little use for the nation with the advantage it gains. The company will have to promote the reasons for which they needed the better products, so that there will be a global interest in it. The nations will have to export their values and tastes through the media or their foreign relations. This will help both the home-market of small economies who cannot sell more than a limit within its borders and also large economies where they can increase production and improve the economy.

2.8.3 Related and Supporting Industries

Just having one main great industry that is superior in the global market cannot make a country have a competitive advantage. There have to be other good supplier industries and related industries that can complement the main industry. These related and supporting industries have to be as good as or better than the international standard. If this is not the case then they will just pull the other industry that is growing at a good rate. In most nations, the leading industry tries to improve the ones linked or supporting them so that it can have an effect on their operation. There also has to be a good flow of communication between these industries to keep helping each other.

The best advantage for a nation is when these supporting industries are also global competitors. This means that the nation and its main industry will have to spend less time and effort into developing them. When the supplying industry competes at a global level, they also will continuously try to develop and improve their factors so that they can then supply in the global markets. Having a global market for the suppliers helps them to stay steady even at times of a downturn in the home market. This is similar in the case of the related industries where there will be new methods being created and improved.

2.8.4 Firm Strategy, Structure and Rivalry

Firm strategy, structure and rivalry is made up of the framework in which the firms are fashioned, ordered and managed and also the rivalry at the national level. The aims of the owners, management and employees contribute to this. Organisations have to be in sync with the national goal of competitive advantage. Industries have to be set up in that context and the style of management has to be adaptive to the nation’s preference. Porter (1998) gives an example where engineering and technical background of senior executives has increased the appeal for methodical product and process improvement.

It is important for a nation to have the employees of its industries motivated and to improve the skills base. Different methods of appraisals are used for it. Nations have to keep looking at ways to recognise and retain the talented people they have before another nation takes them. This is very important when the nation is looking to have a competitive advantage.

As mentioned many times earlier, domestic rivalry is a key part to having a competitive advantage. Porter (1998) strongly believes that the domestic rivalry is not only when it comes to the prices but, the main contribution is better quality and services and innovation. A very good example of this is when a firm will not just relax when they have a new technology innovation but, try to improve it in fear another competitor may do it before them.

2.8.5. Chance and Government

Porter sees these as the two external factors. This does not mean that these two external variables are not important to the Diamond framework.

Chance events are those that are not directly under the control of the firms. Events like a new invention, wars, and sudden changes in global demand, external political developments and breakthrough in basic technologies are some of these chance events. These are factors that actually cannot be controlled by a firm or nation and may upset the whole structure that was in place, and give another nation the competitive advantage.

The decisions made by governments can make or break a nation’s competitive advantage. All the policies made by the government have an impact on the industry at some level. The government has to have proper consideration of how their policies may affect each factor of the diamond before passing them. Only if the government stays clever will the nation be able to have a competitive advantage.

2.9 Shortcomings of Diamond Framework

Even though Porter’s Diamond framework is considered to be effective by many countries, it is not free from criticism. According to Rugman and D’Cruz (1993), the framework is developed with MNEs originating in US, Japan and Europe blocks in mind, leaving MNEs in small economies without a proper analyzing-tool. According to them only these MNEs have the capabilities of creating the resources. Bartlett and Ghoshal (2004), state that MNEs are becoming less depending on one nation. They say that they use the Diamond framework to use different countries for different parts of their operations. Dunning (1993) also agrees that nation is not the main factor to decide the competitiveness of MNEs. Rugman and D’Cruz have come up with alternate models.

E-commerce is the new trend for the international consumer. According to Laudon and Laudon (2003) and Parsons and Oja (2006) e-commerce includes internet activities like shopping online, e-auctions, ordering tickets online, online banking and stock trading and online education. The ease of shopping, the wide selection and the home delivery system has made online shopping very popular. There is again the issue of national boundary (or lack of it), when it comes to e-commerce. If someone has a credit card and an internet connection, it does not matter which country they are in to shop online. Porter (2001) dismissed e-commerce from having a great impact on the world economy. He did not see the e-commerce industry as a separate entity that it has now become.

Chapter 3: Overview of the Indian Economy and Indian IT Sector

Part I: India and Its Economy

3.1 Introduction

India – the largest democracy in the world, the second most populous country in the world, the seventh largest country in terms of geography and now, since recently, the second fastest growing economy in the world.

Indian economy has been on the rise since recent years. The attention of the world has been on the speed of the rise of the Indian economy. India is continually trying to overcome challenges like inflation and other complexities involved in managing such a large economy. The economy has grown by 9.2% in 2007, which was a little below the growth rate of 9.6% in 2006. There have been different reasons that have contributed to this rise of India. There have been many market reform, foreign investments, increasing foreign exchange reforms and flourishing capital markets have all played its part in this growth.

2008 has been a testing time for all the economies in the world. India also faces similar problems. Even though the inflation rate set by the Reserve Bank of India was 4%, the actual inflation by the mid of this year was around 11%. This is the highest level of inflation seen for more than ten years. The cost of oil and food increasing in the world market and the price increase for raw materials needed for construction are the main reasons for this.

The interest to invest in India by the foreign countries and Indians residing outside India is still on the rise despite these issues. There are many foreign countries setting up operations in India and many mergers and acquisitions going on. This trend is expected to rise or remain steady as many investors want to grab the opportunity of what they think is an undervalued economy. Indian companies are giving hope to the economy by flourishing not only in the domestic market but also expanding abroad. There are now four Indians the top ten of the Forbes’ Rich list. This is more than any other country and the largest contribution in the last four years to the Forbes Global list has been from India than any other country.

This chapter will look at the current trends in the market and look at reasons why the economy has grown to reach its current position.

3.2. Recent Trends in the Growth of the Indian Economy

The growth of the Indian Economy has been above 7% for the past ten years and it has stayed consistently above 9% in the past three years. Only China has had a better growth rate than this for the past few years. Over half of India’s population use agriculture as their source of income. Natural causes like floods and droughts keep the poverty level in India’s population high. The growth of the economy has seen the poverty level reduced by as much as 10%, but considering the population of India is over a billion, povert