US Could Kill Indian Outsourcing

Mumbai: George F Baker professor of economics at Harvard University, Martin Stuart Feldstein, 70, has been heading the US National Bureau of Economic Research for 25 years. Feldstein has also advised US presidents on the economy, his latest role being a member of Barack Obama’s economic recovery advisory board.
The economist was in Mumbai and spoke with Mint on a variety of issues, including the latest bailout plan of the US treasury, his worries and how planned curbs on Wall Street could impact outsourcing.

On the latest US bailout plan.

Raising concern: Martin Feldstein. Ashesh Shah / MintIt’s an ingenious plan. There are a lot of positives to be said about it. It’s goal is ambitious—take a large part of impaired assets away from banks; keep them in private hands rather than under government management; avoid nationalizing the banks, protect taxpayers in the sense that they will have some potential positive gains if things work out well (with the plan).

On his worries about the plan

One issue is: Is it enough? A trillion dollars is a lot of money even in the US. By contrast, banks have more than $10 trillion balance sheets and they have residential mortgages of $3 trillion. They have mortgage-backed securities on top of that and commercial mortgages of $2 trillion...And if this new treasury plan—the private-public partnership—doesn’t take away most of the impaired assets, then what exactly does it accomplish? It will still not put the banks in a position where...they can lend.

There’s also a question of whether the banks will actually sell the mortgages. When you are a bank looking at several hundred millions of mortgages, would you want to write them down and sell them 50 cents to the dollar?

On excess liquidity leading to inflation.

Most of the money pumped in is going directly to the Federal Reserve. The Fed’s balance sheet expands; the reserves expand; and the bank’s balance sheets expand. But they are not lending this money, they are depositing this at the Fed. And the Fed pays interest on those deposits.
I think there is a potential for inflation. It is not this year’s worry, but I think it is something that could come along. If there is $2 trillion or more excess reserves in the banks, they will have every reason to want to use those reserves to make loans. That would push up demand and could be inflationary.

Beyond what they want, the Fed can normally go into open market operations. But it doesn’t have $1 trillion or $2 trillion of assets with which to conduct open market operations. All they got is junk—for lack of a better name. And it is not clear, when the time comes, they will be able to persuade the banks to take the junk back.

On the possibility of Asia’s export-led growth model collapsing as US consumers start saving.

It won’t collapse. I think it will be less when the dollar comes down, as I think it will, and there will be more demand from the US consumers for US-made goods and services.
On outsourcing.

Well, I read in the Wall Street Journal today that IBM is laying off people in the US and expanding in India. The US companies are under financial pressure; it becomes a question of more incentives. When you need to save money, those things (a call centre or accounting back office in India or China) look attractive.

On curbs on the financial sector in the US and its impact on outsourcing in India.

It’s scary. It’s a frightening thought. What I don’t know is whether they will actually try to
enforce that and if they do, there will be indirect ways of going around it. Because of the British tradition, the English language and the quality of secondary education, India has an ability to be competitive in outsourcing.
Could we kill it unintentionally or intentionally? Yes, the US could and that is a real danger.