SELECT: What is the current size of the outsourcing market? What percent of U.S. software development, call centers, etc., have already moved to developing nations? Is the amount of outsourcing still increasing?

Dossani: To provide some perspective, although the off-shoring of services has been going on for mans Nears, technology led by the widespread use of the Internet has changed things. The resulting new twist in the provision of services is that the required interaction between the seller and the consumer has been substantially limited. The advances in information technology made possible the parsing of the provision of certain services into components requiring different levels of skill and interactivity As a result, certain portions of the serviced activity that might or might not be skill-intensive, but required low levels of face-to-face interaction could be relocated offshore. The sequence of events that enabled this process is the following:

First, the digital age allowed (or, at least, revolutionized) the conversion of service flows into stocks of information, making it possible to store a service. For example, a legal opinion that earlier had to be delivered to the client in person could now be prepared as a computer document and transmitted to the client via e-mail or, better yet, encoded into software. Easy storage and transmission allowed for the physical separation of the client and vendor as well as their separation in time. It also induced the separation of services into components that were standardized and could be prepared in advance (such as a template for a legal opinion) and other components that were customized for the client (such as the opinion itself) or remained non-storable. Taking advantage of the possibility of subdividing tasks and the economies that come with the division of labor, this reduced costs by offering the possibility of preparing the standardized components with lower-cost

labor and, possibly at another location.

The second fundamental impact of digitization was the conversion of non-information service flows into information service flows. For example, the sampling of tangible goods by a buyer through visiting a showroom is increasingly being replaced by virtual samples delivered over the Internet. Once converted to an information flow, the service may also he converted into a stock of information and subjected to the above mentioned forces of cost reduction through standardization of components and remote production.

Third, the low-cost transmission of the digitized material accelerated the off-shoring of services. Services such as writing software programs which were off-shored to India in the early 1970s were enabled by digitized storage and, in the 1980s, by the standardization of programming languages. Still later, as digital transmission costs fell in

the 1990s (just as digital storage costs had fallen earlier), even nonstorable

services, such as customer care, could he handled offshore.

The offshore services outsourcing market (excluding software development) is still small and will probably be approximately $10 billion for 2005. It employs about 500,000 people, two thirds of whom are located in India. The rest are widely distributed, with developing Asia and Ireland accounting for most of the remaining employment. About 60% of the employment is in call centers. The U.S. and U.K. call-center industry together employ about five million people, so the percentage of offshore jobs is still small. It is even smaller for other services.

Offshore software development employs approximately another 500,000 people. This compares with U.S. employment of about two million. This is a larger percentage of the total software development labor market. although most of the outsourced work is programming, while work such as systems integration and design continue to be done in the U.S.

The growth rate is still high and there are concerns about whether or not this rapid growth rate will hurt the quality of work done. However. this rate will still likely he in excess of 30% in 2005 and 2006. The reason for this is the massive wage differential.

Clearly there have been massive failures as well as outstanding successes in outsourcing. What are the critical success factors for making outsourcing work?

The infrastructure (telecom. finance, power) has all been standardized, although the solutions might not he the same as in developed countries. The critical success factors are two: the quality of labor and supervision; and managing growth. Unbelievable there is a growing shortage of labor. The result is that the quality of work is declining. Project supervisory skills are also in short supply. Managing growth, especially keeping attrition

under control, training, developing new vertical skills, moving into back-office work, and offering the client turnkey packages are some of the critical managerial factors for success.

Short of being willing to work for $15,000/year, what can western IT professionals do to provide sufficient value to prevent their functions from being outsourced?

The U.S. educational system still turns out a good product. It is sufficiently ahead of the comparable Indian product so that a recent computer science/computer engineering graduate from the average U.S. university can earn a premium of at least 100% over his Indian counterpart from a good university such as the IlTs, with substantially higher premiums for graduates from schools such as MIT and Stanford. The problem occurs more with mid-career professionals. Those with older skills are unable to compete with freshly trained graduates from India. Therefore, they need to update those skills regularly and take advantage of opportunities to globalize and convert them into managerial skills. This may have to he mandated at some point, as has happened in the financial sector, where stockbrokers need to regularly sit for exams to renew their licenses.

That said, most of the offshore jobs are relatively low-skilled. For example, the single largest category of offshore services is outbound calling for the financial services industry for selling mortgages or collecting overdue receivables. The work is routine, based on scripts that pop-up on the computer screen in response to prompts.

Do these findings suggest that developed countries are likely to be only marginally threatened by the globalization of services? Even if high-end work is stays within developed countries, as has happened in the software industry, the problem is that not everyone in developed countries can readily shift to high-end work. Since the 1960s, the shift in the economies of developed nations towards service-based economies certainly increased the number of highly-skilled service workers, but there was an even greater swelling in the number of other less-skilled service workers. This is partly a consequence of the nature of many services as linked, inseparable sets of activities with different

skill levels, combined with a pyramid of labor requirements, i.e., there is more demand for lower-level work than for high-end work. In manufacturing. the unemployment created by the reduction in demand for blue collar labor in developed countries was offset by the absorption of much of the surplus labor into service industries, often with minimal training. But the shift of low-end service workers to high-end workers will require a longer period of re-education and may have significant interim consequences on unemployment rates.

The threat to developed countries is increased by the fact that, apart from software, the largest growth in off-shoring is happening in business services. These are also the sectors with the largest growth in U.S. employment.

Further, there is evidence that even higher skilled functions can be moved offshore or might evolve on their own. For example, interviews with people at a firm earlier this year revealed that they had initially been contracted by an American firm to call its clients with overdue credit card payments. The offshore company eventually purchased the receivables from its client and assumed the collection risk itself. Another firm, Wipro Spectramind, managed the radiology services of Massachusetts General Hospital for its second and third shifts. Thus, American radiologists, who earn an average of $315,000 a year were replaced by Indian radiologists, who earn $20,000 a year on average.

I understand that there is a whole subculture in Pakistan and India of people who go to work in the late afternoon or evening and then work a full day on U.S. time. What effect has outsourcing had on the cultures of the countries that are recipients of much of the outsourced work? Have labor rates dramatically increased? Is it difficult for local companies in India and Pakistan to get quality IT talent?

Indeed such a subculture now exists. It is viewed as very stressful work and not suitable for a long-term career. Companies that do such work try to ameliorate the stress by hiring psychiatric counselors to provide free counseling to stressed-out employees. They also provide free meals and transportation, sports facilities, etc.

However, labor rates have increased only, a little. This is more than offset by

the rise in productivity of this labor over time.

Outsourcing is clearly a temporary solution. As labor rates equalize, the benefit of outsourcing decreases. In Pakistan and China, there are still huge differences in labor costs, but in Turkey, rates are closer to what they are in the 11.5. and other Western states. Realistically, how long can we gain a significant benefit form outsourcing?

India and China, and to some extent, Pakistan, have large labor pools. That is why, in manufacturing, Chinese wage rates have not changed despite massive employment growth over the past three decades. I think that wage rates in India will actually fall because of increasing supply, which is being drawn into outsourcing. This would mean several more decades of benefit from outsourcing.

One way in which developed countries may retain value is if their firms control the work done, either through providing the risk capital or through subsidiaries. While it is difficult to predict which organizational types will dominate, a number of firm-specific factors that influence the liability of off-shoring and organization structure are summarized here:

The knowledge component of the activity. A higher knowledge component makes the firm more concerned about whether the quality of the service will change due to a location change or the transfer process.

The interactive components of the process.

The ability to modularize the process

Savings from concentrating an activity in one location, leading to

benefits of scale and scope.

Reengineering as part of the transfer process. To transfer a business process, it is necessary to study it intensively and script the transfer. In the process of study, often there will he aspects of the current methodology for discharging the process that do not add value. Very often these aspects are legacies of earlier methodologies that were not eliminated as the production process evolved. During the act of transfer these are easier to abandon than at an existing facility' where they have become a "natural' part of the daily routine. Our interviews identified other unexpected benefits that go beyond the efficiency effects. Simply examining the business processes may reveal previously undetected inefficiencies. During the transfer process, these inefficiencies can be addressed without disrupting work patterns. Workers in the new location then use the reengineered process which is usually more efficient.

The time-sensitive nature of the work.

SEOUL, Korea - The visit last month of North Korea's diminutive dictator Kim Jong Il to China is still making waves here in the South Korean capital.

The Chinese rolled Kim through showcases of their market reforms. The North Korean leader, who once denounced the Chinese for retreating from socialism, responded with dutiful words of praise for the Chinese model.

South Koreans applaud any evidence that Kim may be headed down a Chinese-style path. Like the Chinese, most South Koreans believe this may be the only way to ultimately persuade the North to abandon its nuclear weapons program.

But in conversations here with senior South Korean officials and others closely involved with North Korea, I detected unease, even alarm, at the growth of China's influence and presence in the North. Some talked darkly about a Chinese "takeover'' of the North.

South Korean mixed feelings about China are not new. But the Kim visit comes on top of a rapid broadening of Chinese economic ties to North Korea, described in detail in a new report issued by the International Crisis Group. Chinese trade and investment in North Korea has reached $2 billion annually. Bridges and highways in and out of North Korea are being built, making it easier to ship iron ore and other raw materials out.

Hundreds of Chinese firms are investing into North Korea, in some cases grabbing deals away from South Korean companies.

Is China willing to use this expanded influence to compel Pyongyang to give up nuclear weapons? Some in the Bush administration still cling to that hope. But the report argues strongly against that happening.

China may again drag Pyongyang back to the stalled six-party talks that it hosts. And it will move quickly to curb any North Korea provocation, such as a nuclear test, that could lead to war.

But China has an overriding interest in stability as well, opposing any attempt to destabilize the Kim government. The Chinese will cooperate to curb Pyongyang's laundering of counterfeit money through their banks, the report says, but will not shut down the North's banking operations in China.

South Koreans don't differ with China on the need to engage the North. Their own economic ties with the North are deepening. And Seoul too is consumed with the danger of triggering a war by trying to cut off the North's economic lifeline.

But South Koreans now also worry that China's deepening stake in the North will only perpetuate the division of the Korean Peninsula.

A South Korean businessman who is deeply engaged in dealings with the North argued to me privately that the North Koreans are unhappy with their dependence on Beijing and eager for an alliance with the United States. By refusing to deal directly with Kim Il Jong, he argued, "the Bush administration is pushing North Korea into the camp of China.''

We should explore such claims with a healthy dose of skepticism. The North Koreans are masters at playing the Chinese and South Koreans against each other, as they did with the Russians and Chinese during the Cold War.

More important, South Korean nervousness about China comes together with renewed interest in shoring up the strained alliance with the United States. This is partly behind a decision to negotiate a free-trade agreement (FTA) with the United States this year.

A free-trade agreement between the United States and Korea, one of the largest economies in the world, would be good for both economies. It should open more markets in Korea, removing a host of barriers such as restrictions on foreign investment. Korean officials, led by a young and ambitious American-trained trade minister, believe an FTA will spur a new round of needed internal reform and a jump in growth.

Anti-FTA protests were already taking place as I was discussing this with Korean officials. More are sure to come from those, such as farmers, most threatened by more open markets. But officials say the president and his government are committed to pushing this through.

Privately, Korean officials hope the FTA will also remind Koreans and Americans of the value of their alliance. It gives both sides something to talk about other than to dwell on their differences over North Korea. We should push hard from both sides to quickly finish an FTA deal -- and continue to talk quietly about our shared interests in maintaining a strategic balance in Northeast Asia.

What is South Korea's strategic posture in East Asia?

After the Korean War ended in 1953, South Korea and the United States established a political and security alliance that has lasted more than half a century. "For a number of decades, South Korea primarily defined itself as a U.S. ally, with the enemy to the north," says Donald Gregg, president of the Korea Society and a former U.S. ambassador to Korea. However, South Korea is now trying to create a new role for itself in Asia. Seoul is exploring a growing economic relationship with China--which passed the United States in 2003 to become South Korea's largest trading partner--and its policy of engagement and growing cooperation with North Korea is pulling it away from the United States. "All we know for sure is that South Korea's role is no longer junior partner to the U.S.," says David Kang, a visiting professor of Asian studies at Stanford University. "The days when they would just unquestioningly follow the U.S. are over."

Kang and other experts say Seoul is beginning to shift its focus towards increasing regional ties with its Asian neighbors. The U.S.-South Korea relationship, while still strong, is not as exclusive as it has been in the past. "South Korea is still an ally of the United States ... nevertheless, it has been the most active country in promoting East Asian cooperation and integration, and will probably continue to do so," says Charles Armstrong, professor of history and director of the Center for Korean Studies at Columbia University.

What are South Korea's biggest foreign policy challenges?

Dealing with North Korea while preserving its relationship with the United States, maintaining relations with Japan, and addressing potential long-term military or economic threats from China, experts say. But "the major issue for Seoul is overwhelmingly North Korea, and everything else gets filtered through that lens," Kang says. South Korea looks to its northern neighbor with the goal of eventual reunification, and therefore seeks economic cooperation and political engagement to smooth relations and slowly move down that path. The United States, on the other hand, is primarily seeking to prevent North Korea from gaining nuclear weapons, and has refused to engage with Pyongyang until that issue is resolved.

Other experts see a disconnect between how South Korea views its role in the region and how other nations see it. South Korean officials talk of playing a "balancing" or mediating role in regional disputes, including tensions between China and Japan and the nuclear standoff between the United States and North Korea. But South Korea's "actual ability to mediate and balance is limited," says Armstrong. And while South Korean President Roh Moo-Hyun has expressed hopes of building Seoul into a logistics and business hub for the region, existing tensions on the peninsula--including international fears that North Korea is amassing a nuclear arsenal--cloud any long-term economic plans. As things stand, South Korea has the world's 11th largest economy, but not a corresponding level of political clout.

How is South Korea dealing with North Korea?

Through a policy of active engagement. In 1998, Former President Kim Dae-Jung introduced the "Sunshine Policy" aimed at improving ties with North Korea while assuring Pyongyang that Seoul is not trying to absorb it. Since then, "the degree of economic interaction between south and north has substantially increased," Armstrong says. Kim and North Korean President Kim Jung-Il met at a historic summit in 2000, and increasing progress has been made on a range of issues, from economic--increased rail links and joint projects like the Gaesung industrial complex--to social and symbolic, including cross-border family visits and Korean athletes marching together under a single flag at the Olympics. Trade between the two countries reached $697 million in 2004, and South Korea is now Pyongyang's second-largest trading partner after China.

South Korea sees engagement with North Korea as yielding far more benefits than confrontation. "South Korea is reorienting itself toward reconciliation and eventual reunification of the peninsula," Gregg says. South Korean officials say reunification would reduce the burden on each side of maintaining huge armies, help improve living standards, draw international investment, create employment, and help avert the worst possibility: open war on the Korean peninsula.

What is South Korea's relationship with China?

South Korea is developing increasingly warm relations with its giant western neighbor. "There is a real fascination with China in South Korea, and the flow of investment, exports, students, tourists, and businessmen going to China from South Korea has exploded in the last several years," Armstrong says. Bilateral trade between Seoul and Beijing reached $90 billion in 2004, a 42 percent increase from 2003. The two countries also agree politically on issues ranging from opposition to Japanese Prime Minister Junichiro Koizumi's visits to the Yasukuni war shrine, to accord on how to deal with North Korea's nuclear ambitions. China is also choosing the path of engagement with North Korea, and helping Pyongyang find a "Chinese way" to develop: that is, increasing economic openness without sacrificing political control. "On the whole, [South Korea and China] see pretty much eye to eye on the major geopolitical issues," Kang says.

Beijing, like Seoul, is investing in North Korea, which has ample natural resources--including coal, iron, and gold--and a low-cost labor force. In 2003, Chinese investment in North Korea was $1.1 million; in 2004, it ballooned to $50 million; and in 2005, it was expected to reach $85-90 million. The volume of trade between China and North Korea reached $1.5 billion in 2005, making Beijing Pyongyang's largest foreign trading partner. North Korean leader Kim Jung-Il, who rarely travels, emphasized Beijing's importance to his country by visiting China in January.

South Korea is positioning itself to be closer to an ascendant China, but trying to do it without jeopardizing existing ties with the United States. South Korea's biggest worry, experts say, is being pulled into a conflict between the United States and China over Taiwan.

What's the relationship like between South Korea and Japan?

"Very bad at the moment in terms of public diplomacy and popular opinion," Columbia University's Armstrong says. South Korean wariness of Japan dates back at least to 1910, when imperial Japan invaded Korea and ruled it as a colony for thirty-five years. During the occupation, Japanese efforts to suppress Korean language and culture earned Korean enmity. During World War II, the Japanese practice of using "comfort women"--women from occupied countries, mostly Korea, who were forced to serve as prostitutes for the Japanese army--increased the anti-Japanese feeling.

South Koreans, and others across the region, are also infuriated by Koizumi's annual visit to the Yasukuni shrine. The site honors more than two million Japanese war dead, but includes the remains of more than a dozen convicted war criminals. South Korea also has disputes with Japan over territory. Both countries claim a group of islands--and the fishing and mineral rights around them--in the Sea of Japan that the Koreans call Dokdo and the Japanese call Takeshima. And many critics in South Korea and across Asia accuse Japan of whitewashing its wartime atrocities in its grade-school textbooks.

But much of the South Korean conflict with Japan may be for domestic political consumption, some experts say. "Under the surface, I would say the degree of interaction [between Seoul and Tokyo] remains high and, in the economic realm, is rather good," Armstrong says.

How is South Korea dealing with the United States?

While experts say most South Koreans still consider the U.S.-Korean alliance the backbone of their security relationship, time has passed and attitudes are shifting. A new generation of South Koreans, assertive and nationalistic, are less mindful of the Korean War--and less grateful for American intervention in the conflict that left nearly three million Koreans dead or wounded--and more resistant to what they see as a U.S. attempt to impose its values and Washington's singular focus on terrorism. The United States has opposed South Korean engagement efforts with North Korea, and has also moved to increase its ties with Japan. The Bush administration's foreign policy, including the war on terror, its punitive stance toward North Korean nuclear weapons, and particularly the invasion of Iraq, is highly unpopular in South Korea, according to opinion surveys there.

South Koreans are also increasingly demanding more control over their country's military and political affairs. In 2004, the United States returned several military bases to Korean control, and agreed to withdraw 12,500 of the 37,500 U.S. troops currently stationed in Korea by 2008. U.S. officials, including Defense Secretary Donald Rumsfeld, had been pushing for South Korea to take more of a role in the defense of the Korean peninsula, to free up U.S. forces for deployment elsewhere. But, all differences aside, Seoul is still eager to cooperate with the United States. South Korea, with some 3,000 troops in Iraq, is the third-largest member of the U.S.-led coalition there, behind the United States and Britain.

What is the recent history of the region?

Poised between China and Japan, fought over by the United States and Russia, the Korean peninsula long has played a central role in Asia's geopolitical affairs. After World War II, Japanese colonial rule gave way to U.S. and Soviet trusteeship over the southern and northern halves of Korea, respectively. The peninsula was divided at the 38th Parallel. In 1948, the southern Republic of Korea and the northern Democratic People's Republic of Korea, under Kim Il-Sung, were established.

In 1950, North Korean forces invaded South Korea, starting a conflict that brought in China on the North Korean side and a U.S.-led UN coalition on the South Korean side. While an armistice was agreed to in 1953, a formal peace treaty was never signed. In 1954, the United States agreed to help South Korea defend itself against external aggression in a mutual defense treaty. U.S. troops have been stationed in Korea since then. In addition to this important security relationship, shared interests in the last fifty years have included fighting communism and, since the 1980s, establishing a strong democracy and fostering economic development. However, in recent years strain has emerged on a range of issues, none more important than how to handle Pyongyang.