The Indian Software Industry:

the Human Capital Story

Ashish Arora & Surendrakumar Bagde
Heinz School of Public Policy and Management
Carnegie Mellon University
Pittsburgh PA 15213
{ashish, sbagde}@andrew.cmu.edu

Abstract: The Indian software industry has been widely studied. Previous studies have
recognized the role of skilled labor in the growth of the industry, but have not empirically
investigated the role of skilled labor. In this study we focus on the role of human capital in the
regional location of the software industry. Specifically, we study the effect of the engineering
college capacity for undergraduate engineering studies in different Indian states on the regional
growth of the software exports industry between 1990 and 2003. We find significant effect of
human capital on the growth of software exports even after controlling for other relevant factors.
In addition the initial as well as current size of electronics hardware industry also plays important
role in the regional growth of the software exports industry.
Introduction
The Indian software industry, which was almost non-existent till late 1980s, grew at
tremendous pace after early 1990s. The Indian software industry's export was about US$128
millions in 1990-91 and grew to US$485 millions in 1994-95. By 2003-04 the software exports
had increased to US$ 12.2 billions. The bulk of Indian software industry is concentrated in a
few clusters; indeed Bangalore has often been branded as the Silicon Valley of India in press
accounts.
Some scholars have highlighted the role of policies adopted by federal and state
governments. The infrastructure initiatives of the federal government, especially Software
Technology Parks (STP) scheme 19912, provided reliable internet connectivity and single
window clearance for various government permissions to software export firms. In 1990s many
state governments have provided suitable infrastructure by setting up information technology
(IT) parks (see Nasscom, various years).
The importance of availability of skilled manpower in the success of Indian software
exports has been recognized by several research studies (e.g., Lakha, 1994). A noteworthy
feature of Indian software industry is predominant share of engineers amongst software
professionals in India. Arora et al. (2001) have argued that large share of south and west region
in engineering engineering college capacity, spurred by the growth of private (not publicly
funded) engineering colleges, was one of main reasons for growth of software industry in those
regions. However, these claims have not been systematically tested.
In this paper we empirically investigate how software exports by the fourteen major
states of India are influenced by local levels of human capital. The simple point of the paper is
that some states were favored locations for software because they had higher stocks of human

2
Software Technology Parks of India (STPI) is a society set up by the Department of Communication &
Information Technology, Government of India in 1991, with the objective of encouraging, promoting and boosting
the Software Exports from India. The software companies are given tax incentives and have duty free imports for
some of their equipment and they register themselves with STPI for availing such benefits. There were other
schemes like export processing zones which offered similar incentives to firms locating in such zones. However,
STP scheme offers much higher level of flexibility to firms in their location choices and was targeted to software
export firms. Firms could locate anywhere and were required to register with designated STP office to avail various
incentives.
5
Uttar Pradesh and Madhya Pradesh reflect the geographic boundaries as in 1990 and not the current boundaries.
capital, and they had higher stocks of human capital because they allowed private engineering
colleges to operate earlier than other states.
There are empirical challenges in such research. First, there may be unobservable state
characteristics that are correlated with software industry and engineering education capacity.
We address this potential source of bias by using a panel dataset and controlling for state fixed
effects. Second, there is issue of endogeneity of engineering college capacity. We address the
issue of endogeneity in two ways. We estimate effect of engineering college capacity before the
birth of the industry on software exports. We also instrument for engineering college capacity.
The instrument, discussed in greater detail below, is based on the policy on private, non-granted
engineering colleges, of neighboring states.
Our research covers fourteen states of India, for the period 1990-20035. According to
official statistics, these fourteen states’ population share in country’s population was 83.47
percent in 2003, have 78 percent geographic area of India and share in net state domestic
product in 2001-02 was 79.2 percent7. As well, the available data require that our measure of
software exports is a broad one, including not only the export of software, but also affiliated IT
services, including the so-called IT enabled service. IT enabled services are relatively
unimportant in terms of revenues for much of our sample and only become significant after the
turn of the century. As well, such services, particularly low-end services such as call centers
rarely employ engineers. Their exclusion would therefore only strengthen our results. These,
and other issues related to our data are discussed in more detail in the appendix.
This research is contributes to the literature on the globalization of the software industry
(Arora and Gambardella, 2005). It is also related to a recent literature that examines inter-state
variation in institutions and policies. Bhaumik et al. (2006) analyze inter-state variation in firm
entry into 3-digit industry between 1984 and 1997. They conclude that during the 1980s
industry level factors largely explained the variation in entry rates, but post-1991 reforms,
variation in entry rates during 1990s were explained largely by state level institutions and legacy
factors. Aghion et al. (2006) study the impact of delicensing and state labor market regulations
on the performance of manufacturing industry. Intriguingly, they find that only states with
relatively pro-employer policies benefited from de-licensing. Thus there was reallocation of
industrial production from states with pro-worker labor institutions to states with pro-employer
labor institutions. Kochar et al. (2006) conclude that state level institutions and policies have

7
The source for population and area share is the Census of India, and for the GDP share is Government of India,
Ministry of Ministry of Statistics and Programme Implementation (http://mospi.nic.in/9_nsdp_const_9394ser.htm)
become more important determinants of industrial production and growth than was earlier the
case. As in these studies, we find that state level policies, specifically regarding the entry of
private engineering colleges, appear to play a very important role in the location of the Indian
software industry. Unlike them, we focus on a single industry, albeit one that has become very
visible in recent years, and one whose impact upon the Indian economy arguably far exceeds its
share in GDP or employment (cf. Arora and Gambardella, 2005).
Finally, this research is also related to the literature on human capital and regional
growth. Many studies have found that the city’s later growth is influenced by the initial level of
human capital. Glaeser et al. (1995) find that human capital level in 1960 influences growth of
the cities between 1960 and 1990. Similarly, Simon et al. (2002) found that cities that have
higher level of human capital initially grow faster in the long run. The higher level of human
capital may enhance the regional growth through direct as well as indirect channels (Mathur,
1999). For example, the existing stock of knowledge influencing creation of new knowledge
(Simon, 1998). Regional differences in level of human capital also explain geographic
differences in firm formation rates with regions endowed with higher level of human capital
having higher firm formation rates (Acs, 2003). Our focus is not on regional growth per se, but
on the growth of a particular industry, albeit an industry which is especially human capital
intensive. As well, we do not explore mechanisms such as knowledge spillovers or new firm
formation.
Finally, this research is also related to the literature on industry agglomeration.
Agglomerations can be resource-based or interaction-based (Wolter, 2004). Firms may gravitate
towards a region or city if they have access to scarce resource (e.g. trained engineers, a key
input for Indian software companies) and some firms may cluster to take advantage of
technology transfers from the academic and research institutions. Individual firms may benefit
from information spillover due to proximity to other firms within an agglomeration. However,
Arora et al. (2001) find inconclusive evidence of agglomeration economies in Indian software
industry though they recognize the possibility of it arising due to a thick labor market or good
infrastructure. Our results support this possibility.
The remainder of this paper is organized as follows. Section 2 describes the character,
size and regional spread of software exports industry. Section 3 describes the size, growth of
technical education in India, its regional dimension and importance of private sector. Section 4
describes the role of human capital in regional development and model of labor supply is
developed. Section 5 develops empirical model. Section 6 presents summary statistics. We
present results in section 7, and discuss important findings of paper in section 8.
II. The Indian Software Industry:
Indian software exports were a mere US $4 millions in 1980 and rose to US $27.7 millions in
1985 (Heeks, 1996). The industry grew very rapidly in the decade of ‘90s and exports reached
US $128 millions in 1990 and US $12200 millions in 2003-04.
A key factor in the success of the Indian software industry is its absolute advantage in
supply of skilled software professionals. Table 1 shows comparative salaries for software
professionals in 1997. “The estimated wage costs in India were about 1/3rd to 1/5th of the
corresponding US levels for comparable work” (Arora et al., 2001). The cost advantages are
smaller for onsite work (done on the client’s site overseas) but there is nonetheless potential for
lower labor costs. The wages of an Indian employee working on client’s site would be 20-25
percent lower than wages of similar US employee9. The projects executed in the offshore
development center offer even greater cost savings to clients. The Indian firms have also
succeeded in executing large projects, which has helped transition from mostly onsite work to a
favorable mix of onsite and offshore work (Athreye, 2005b).
Table 1:Software professionals: comparative salaries, 1997, US $ per yeara
Designation United States Indiab
Programmer 32500-39000 2200-2900
System analyst 46000-57500 8200-10700
Programmer analyst 39000-50000 5400-7000
Network administrator 36000-55000 15700-19200
Database administrator 54000-67500 15700-19200
Help-desk support technician 25000-35500 5400-7000
Software developer 49000-67500 15700-19200
Source: INFAC (1998), Mumbai, cited in Arora et al., 2001.
a
Figures are starting salaries for large establishments employing more than 50 software professionals.
Salaries for a particular designation would vary due to factors such as educational and experience profile of
the professional, platform of operation, nature of assignment (contract/full-time), location of the employer
and additional technical/professional certification.
b
Converted at exchange rate of Rs. 41.50/US$.

The growth in software exports revenue has been due to increase in revenue per
employee as well as growth in the number of professionals (see Table 2). The number of

9
Interview of Phiroz Vandrevala, Executive Vice-President of Tata Consultancy Services (TCS) in Business World
(http://www.businessworldindia.com/innerSections.aspx?SectionId=187&ArticleId=332
15
Source: http://www.ti.com/asia/docs/india/about_tii.html accessed on 11/06/2005 at 6.51PM.
professionals (including IT enabled services and call centres) was merely 6800 in 1985 and
increased more than ten fold times in the next five years to 80,000. The growth was at smaller
pace in next decade and number of professionals rose to 841,500 in 2003. The number of
professionals in the software exports sector has increased more slowly in recent years in
comparison to those in the IT enabled services sector (ITES-BPO), from 110,000 in 1990 to
270,000 by 2003.
Table 2: Growth of Manpower Employed in Indian Software Industry
1985- 1990- 1995- 1999- 2000- 2002- 2003-
86 91 96 00 01 03 04
Software-export sector 110,000 162,000 205,000 270,000
Software-domestic sector 17,000 20,000 25,000 28,000
Software- in-house captive staff 115,000 178,114 260,000 290,000
ITES-BPO 42,000 70,000 180,000 253,500
Total 6800 56000 140000 284,000 420114 661000 841,500
Source: NASSCOM's Strategic Review of 2003, 2004, 2005

An important feature of the Indian software industry is preference for engineers. Arora et
al., 2001, for instance, find that in 1998, over 80% of those employed by Indian software firms
had engineering degrees. This is not just electrical or computer engineers but engineers in any
discipline with a 4 years of undergraduate degrees, though often followed by specialized, non
degree training in software tools. There are some important reasons why firms prefer
undergraduate engineers. First, the high competition for admission to engineering colleges
implies selectivity and the higher quality (Arrow, 1973). The undergraduate engineering degree
thus acts a screening device. These engineering graduates also get good exposure to
fundamentals of computers and also learn basic programming and some even master advanced
programming language during the course of their studies thus reducing need for longer duration
training. As well four years of “engineering education imparts a set of problem solving skills,
methods of thinking logically and learning tools that help quick adaptation to changes in
technology, domains and tasks” (Arora et al., 2001). Perhaps equally important, initially the bulk
of software exports consisted of software professionals working on client’s site in the US on
temporary work permits, or H-1 B visas. US visa requirements meant that it was (and is) easier
for engineers to qualify for H-1 B visas.

Uneven regional growth of the Software Industry:

In the very early period the software industry was mainly concentrated in Mumbai, the
capital of the state of Maharashtra (Heeks, 1996) and as size of the exports grew industry
started spreading to other cities and states. Bangalore attracted many multinational companies
after Texas Instruments set up its development center in 1985.15 By 1990 the states of
Maharashtra (Bombay), Karnataka (Bangalore), Tamil Nadu (Chennai) and Delhi were the ones
with large share of exports and states of Uttar Pradesh (NOIDA), Andhra Pradesh (Hyderabad)
and West Bengal (Kolkata) also had software exports, albeit at lower levels, and were later
jointed by the other states included in this study (see figures 1-3, and table A1).
Initially, software exporting companies grew by expanding their operations in current
locations. Many multinational companies (MNCs) set up their subsidiaries after foreign
investment norms were liberalized by the federal government in 1991 (Athreye, 2005a). These
MNCs’ locations were typically in the leading software centers such as Bangalore, Hyderabad,
Chennai, Bombay and Delhi-NOIDA. Therefore the states which had head-start continued to
grow rapidly in 1990s. This resulted in very heavy regional concentration of industry. Seven
states contributed 95% of total software exports in 2002-03, but only 48% of the country’s
population, 47% of the net state domestic product (NSDP) and 57% of the industrial production
in the country. In the other seven states software exports are growing very rapidly as new firms
and established large firms set up their development centers in these states. However, despite
high growth rates the absolute size is still small.

III. Undergraduate Engineering Education in India:

In this section we discuss how India’s undergraduate engineering education sector has
evolved in past couple of decades. There are three main points. First, there is substantial
regional variation in engineering college capacity, especially at the birth of the software export
industry in the late 1980s. Second, this regional variation is due to differences in private
engineering colleges. Finally, the differences in private engineering college capacity are due
mainly to when the private colleges were allowed in the state.
In India, higher education, particularly technical education, had been provided mostly by
the government run institutions, except in last two decades. The majority of the institutions were
set up and funded by various state governments. The number of institutions offering
undergraduate degree in engineering has increased over the years as also the total intake
capacity of these institutions16. Table 3 shows the growth in intake capacity in undergraduate
engineering colleges between 1951 and 2004. In 2004 the engineering college capacity was 91

16
The engineering college capacity of a college/institution is the number of students it can admit in a given
academic year in all the disciplines. There are discipline-wise upper limits fixed for each academic year by AICTE.
Any increase in the engineering college capacity requires approval of AICTE. The All India Council for Technical
Education (AICTE), set up in 1945 as an advisory body, was given statutory status in 1987 through an Act of
Parliament. The AICTE grants approval for starting new technical institutions and for introducing new courses or
programs.
times that of 1951. Even accounting for population growth, Table 3 shows the engineering
college capacity per million of population grown from 13 in 1951 to 405 in 2004.

Table 3 : Undergraduate capacity in Indian engineering colleges, 1951-2004

Population in Engineering Engineering college capacity per
Year millions college capacity million of population

1951 361 4788 13

1985 765 45136 59
1995 928 105000 113
2004 1086 439689 405
Source: Ministry of Human Resources Development, Government of India, AICTE, NTMIS.

Regional Variation in engineering college capacity

Table 4 shows the sanctioned intake capacity (for undergraduate engineering degree
programs) by state. There are two important points to be noted about this table. We see a large
inter-state variation in capacity. In fact share of four states of Andhra Pradesh, Karnataka,
Maharashtra and Tamil Nadu was almost 75% in 1990-9119 as compared to 29% of the
population. As other states added capacity, the share of these states has declined, but
continues to be around 63% in 2003.
As table 4 shows, the growth in capacity has varied over time and across states.
Consider the period from 1990 to 1993. Only three states, Karnataka, Maharashtra and Tamil
Nadu were adding capacity. In other states the capacity did not increase perceptibly during
these years. Also some states have experienced a sudden jump in the capacity, albeit in
different years.
Role of private self-financed colleges:
The inter-state disparities in engineering college capacity are mostly due to differences
in the timing and growth of the private sector colleges. Engineering college capacity in a state
can increase by two ways: either by expanding capacity in existing institutions or by opening
new institutions. The new institutions can be in the public sector or the private sector. Much of
the actual increase has been through new private colleges.

19
Their contribution to engineering college capacity was similar even in 1987-88.
 Table 4 : Sanctioned intake capacity in undergraduate technical institutions

Year AP Delhi GJ HR KA KL MP MH OA PN RJ TN UP WB
1990 58 9 33 5 170 27 17 192 11 5 11 92 31 23
1991 55 10 33 6 180 28 19 199 11 5 11 92 32 23
1992 55 10 34 8 188 29 19 238 11 5 13 94 33 23
1993 55 11 36 8 172 30 19 256 11 11 14 118 33 23
1994 56 10 38 8 193 35 19 280 12 11 14 141 33 24
1995 80 13 44 9 202 45 32 309 12 19 14 185 37 25
1996 86 12 50 9 203 47 34 333 17 19 15 222 44 26
1997 130 13 54 33 238 49 48 344 33 22 15 238 49 26
1998 196 16 64 33 244 51 43 397 45 22 20 273 68 40
1999 241 21 73 47 262 67 71 429 62 22 27 366 85 45
2000 277 23 91 67 282 88 102 429 62 34 50 505 153 52
2001 440 30 106 86 356 113 109 446 88 44 63 655 213 62
2002 624 34 106 98 381 183 160 470 88 86 82 702 231 107
2003 658 35 103 101 389 199 194 475 107 107 115 707 242 107
AP: Andhra Pradesh, GJ: Gujarat, HR: Haryana, KA: Karnataka, KL: Kerala, MP: Madhya Pradesh,
OA: Orissa, PN: Punjab, RJ: Rajasthan, TN: Tamil Nadu, UP: Uttar Pradesh, WB: West Bengal

In 1981, the vast majority of institutions were in the public sector, as was also true of
engineering college capacity. Tuition fees were very low and the vast bulk of the expenses were
met from the budgets of the respective state governments, with the exception of the few
institutes and colleges directly supported by the central (federal) government. Budget
constrained state governments faced severe limits on increasing capacity. Therefore capacity
expansion in the public sector has been infrequent, and mostly limited to accommodating new
disciplines such as computer science in 1990s and information technology in early 2000s.
Furthermore, capacity expansion in existing institutions requires approval of All India
Council for Technical Education (AICTE). AICTE limits intake capacity of a college right from its
inception. For example the maximum capacity per discipline is 60 and college can have
maximum of 4 disciplines in first year of its operation. The total capacity can increase by 60 to
300 in the second year and finally to a maximum of 420 in the fourth year. Any increase beyond
420 requires that an institution meets stringent quality standards.20.
The effect of regulation on capacity expansion combined with states’ (public sector)
constraints in adding capacity means new private colleges have been the main source of
growth. Analysis of college-level data between 1981 and 2004 support this conclusion. The
number of colleges in the entire country increased from 246 in 1987 to 353 in 1995 and over
1100 in 2003.. Eighty percent of new colleges added between 1987 and 1995 were in the
private sector and the share of private colleges was even higher at 94 percent for colleges
added between 1995 and 2002.
20
Source: AICTE Handbook for Approval Process, 2003-04 and 2004-05.
 Karnataka was among the first state to permit the private sector in undergraduate
engineering education. The first such college opened in Karnataka in 195721. Thereafter one in
1962 and two in 1963 started their operation in the state. Then a large number of private
colleges entered, beginning 1979, with nine colleges opening in 1979 and eleven in 1980. The
first private college started in 1977 in Andhra Pradesh and in 1983 in Maharashtra after the
government introduced policy permitting such institutions to operate. By 1986, only six states
had such institutions.
As a result, Andhra Pradesh, Karnataka, Maharashtra and Tamil Nadu accounted for
almost 75 percent of total engineering college capacity in the entire country in 1990. Beginning
in 1992, other states began to allow private self-financed institution and by 1999 all fourteen
states had allowed private engineering colleges. As a result the share of private colleges has
steadily increased over the years, from 62% in 1995 to more than 82% in 2002.

IV. Regional Development and Human Capital:

Many studies have found that a region’s growth is influenced by the initial level of human
capital. Glaeser et al. (1995) find that human capital level in 1960 influences growth of the cities
between 1960 and 1990. Similarly, Simon et al. (2002) found that cities that have higher level of
human capital initially grow faster in the long run. Thus initial level of human capital seems to be
advantage cities and regions, perhaps by attracting knowledge-intensive industries. The
regional differences in level of human capital also explain geographic differences in firm
formation rates with regions endowed with higher level of human capital having higher firm
formation rates (Acs, 2003). This is one mechanism through which initial differences in human
capital can affect industry growth. We now develop a simple model of a two region economy
that illustrates how local supply of human capital conditions the location of the software industry.

Model of supply of engineers and size of industry:

Let N 1 and N 2 be the engineering stock in region 1 and 2 . We assume that everybody

joins the labor market and is willing to work at prevailing wages, w1 in region 1 and w2 in

region 2 . We further assume that the utility for engineer i from region 1 if they work in region 1
is w1 . The utility in region 2 for i would be w2 − C i , where C i is the migration cost (the

migration cost includes whatever utility loss there is from moving). Similarly, for engineer
j educated in region 2 , the utility is w2 when working in region 2 and w1 − C j when working in

21
Manipal Institute of Technology (http://www.manipal.edu/mit/aboutus/overview.htm).
region 1 . We assume that Ci and C j are all drawn from a distribution F. We do not specify lower

bound for C and it can take negative values as well. Then, the fraction of people moving from
region 1 to 2 is F ( w2 − w1 ) , and the fraction moving from 2 to 1 is F ( w1 − w2 ) . Let x = w2 − w1 .

So, total labor supply in region 1 is N1 (1 − F ( x)) + N 2 F ( x) , and N 2 (1 − F ( − x)) + N1 F ( − x) for

region 2 .
Labor demand: There are M firms, which are price takers. We assume that firms can
locate anywhere they want. We also assume free transport of output. They have some
production function Q(L) . It is immediate that with price taking firms, we must have w2 = w1 in
equilibrium. The way labor demand and supply will be equilibrated will be through the percent of
firms in each region. So, total labor supply in 1 is N1 (1 − F (0)) + N 2 F (0) . If y percent of firms

locate in region 1 , and if we normalize the price of the output p to 1, then each firm employs

m(w) workers, given by Q' (m) = w / p = w (Recall w is same in each region). The labor demand
is Mym in region 1 and M (1 − y )m in region 2 . This yields two equilibrium conditions for the
labor market to clear in both regions:
Mym( w) = N1 (1 − F (0)) + N 2 F (0) (1)

M (1 − y )m( w) = N 2 (1 − F (0)) + N1 F (0) (2)

By adding (1) and (2), we get
Mm( w) = N 1 + N 2 (3)

Equation (3) gives total demand. Substituting for Mm(w) in (1), we get

N1 (1 − F (0)) + N 2 F (0)
y= (4)
N1 + N 2

If we let N1 = θ * N 2 , then (4) becomes

(1 − F (0)) * θ + F (0)
y= (5)
1+θ
In order to understand how share of firms, y respond to changes in capacity imbalance

in two regions we differentiate (5) w.r.t. to θ , which equals

dy 1 − 2 F (0)
= (6)
dθ (1 + θ ) 2
This means
dy
>0 if F (0) < 1 / 2 (7)
dθ
 The regional variations in employment opportunities, career growth prospects and cost
of living differences, etc. may result in distribution of C i being different for each region. Let C i is

distributed F (.) in region 1 and G (.) in region 2 . In the equilibrium, the wages in two regions

dy 1 − ( F (0) + G (0))
are same. Thus, = , so that
dθ (1 + θ ) 2
dy
>0 if F (0) + G (0) < 1 (7’)
dθ

It is obvious from (7’) that holding F (0), G (0), N 2 constant, an increase in N 1 would increase the
share of firms y in region 1 provided G (0) + F (0) < 1 respectively.

V. Empirical Specification and Results

This simple model suggests that as long as there is some “stickiness” in the labor
market, local endowments of human capital attract software firms. Engineers being the key
input for software, the size of a state’s engineering college capacity would be an important
determinant in the location decisions of firms. In other words, it suggests that we specify a
model with software exports as a function of the stock of engineers. We lack a measure of the
stock of engineers in a state over time. However, our measure of engineering college capacity
is arguably closely related to changes in the stock. Specifically, if there were limited mobility of
engineers across states, then the growth in the stock of engineers in state i would be equal to
the lagged engineering college capacity in the state. Since available anecdotal evidence
suggests that such mobility is in fact small, we use this as a proxy for a change in the stock of
engineers. To the extent that there is mobility, we have measurement error. As discussed in
greater detail below, we also instrument for engineering college capacity to address biases due
to measurement error, as well as problems posted by potential endogeneity. In other words, if
Sit are software exports in year t for state i, and Kit is the corresponding stock of human capital,
we have
Sit = ait + gt + βKit + εit . (8)
By taking first differences over time (represented by ∆) we have
∆Sit = ∆ait + ∆gt + β∆Kit + ∆εit (9)
Note that (8) allows for each state to have a different time trajectory for exports, so that the state
effect varies by time. For feasible estimation, we assume that ∆ait = αi i.e., states differ in both
the level and change in their exports. However, the change in exports per year (for a given
state) does not systematically vary over time. Letting ∆gt = γt yields
∆Sit = αi + γt + β∆Kit + ∆εit (10)
In other words, the annual increase in software exports are equal to a state fixed effect,
a year effect and β times the engineering college capacity. This is our benchmark specification.
However, we also estimate a related specification where we use as the dependent variable the
level of software exports rather than the change. Although this specification is not theoretically
as well grounded, it is plausible that with rapidly growing demand, local of firms should depend
not merely on the level of human capital stock but also its growth. Both specifications find
support in the data, as discussed below. Also, in both specifications, we exploit the variations in
state policy allowing private engineering colleges to develop an instrument for engineering
college capacity.

Data
We obtain data on engineering college capacity from the “Annual Technical Manpower Review
(ATMR)” reports published by National Technical Manpower Information System NTMIS. These
reports are prepared by a state-level nodal center of NTMIS and give details of sanctioned
engineering college capacity and outturn for all undergraduate technical institutions in the state.
The Handbook of Engineering Education, a publication of the Association of Indian Universities
has also been used as a supplementary source.23 Data on software exports are obtained from
the Electronics and Comptuers Software Export Promotion Council (ESC), which is the apex
government trade promotion organization for this sector, for the years 1998-2003. For earlier
years, ESC does not provide state level export data. Accordingly, we used export revenues by
NASSCOM member firms, allocating the export revenues of each firm to the state where its
headquarter is located. Till 1995, virtually all firms were located in a single state. Thus, this
approximation is a reasonable one. As further described in the data appendix, we verified
NASSCOM figures where possible from Dataquest, a trade magazine that covers Indian IT firms
and provides data on sales, exports and employment for the leading firms, since 1982. For a
couple of leading firms which operated in multiple states, we were able to obtain data on
employment by state and allocated export revenues in proportion. Exploratory analysis does
not indicate that that these two data sources yield different results, with the possible exception

23
In a few cases, the data from these reports are inconsistent, typically involving decreases or large increases in
capacity or where capacity is markedly inconsistent with the number of graduating engineers. In such cases the other
sources have been used to arrive at the acceptable figures of sanctioned intake.
of the switchover period where the change in software exports between 1998 and 1997 yields
odd results for some states. Although the STPI is another potential source of state level export
data, for the earlier years only a small fraction of software exports appear to by companies
registered through the STPI, although towards the end, exports through the STPI are about over
90% of the software exports.
Carrying out the analysis at the level of the state raises some additional issues. In
particular, Delhi is bordered by the states of Haryana and Uttar Pradesh. Software exports from
the latter two are concentrated very near their border with Delhi, in Gurgaon and Noida
respectively. Since firms can move across the three locations, this results in large jumps and
dips in software exports. We chose not to smooth the jumps and dips.
Data on control variables like population, per capita power consumption, industrial
output, teledensity, per capita income and number of students passing 12th grade is obtained
from various publications and websites of concerned departments of Government of India as
detailed in the data appendix. Table 5 shows the descriptive statistics for the variables used in
the regressions. Software exports, industrial output and per capita net state domestic product
(NSDP) are in constant 1993-94 prices.

Table 5: Summary Statistics

Mean Std Dev Min Max
Software export (Rupees Million, 1993-94 constant prices) 6662 14422 0 107598
Change in Software export (Rupees Million, 1993-94 prices) 1724 4081 -9654 25764
Intake Capacity (number) 11507 14462 525 70660
Outturn (number of graduating engineers ) 4923 5731 235 28107
Population (‘000s) 57017 36867 9082 183205
Teledensity (no. of telephone lines/100 persons) 3.69 4.78 0.235 41.79
Per Capita Power Consumption (Kilo Watt hours/year) 429 197 148 921
Per Capita Incomea (Rupees, 1993-94 prices) 7692 3161 3752 17682
Industrial Outputb,c (Rupees Million, 1993-94 prices) 53608 48285 5739 269843
Electronics Production (Rupees Million, 1993-94 prices) 11426 11455 238 47633
No. of Students Graduating 12th Grade 173213 150213 4521 799916
N = 196. (14 states x 13 years. Some states have missing observations.)
ab
Lagged by four years.
c
Net value addition by all manufacturing units in a given state for each year.

Results
We begin with some simple descriptive relationships. Figure 1, which shows the log of software
exports by state for three years, points the persistence of export leadership: states which were
the early export leaders retain their leadership even after nearly a decade and a half. Figure 2
shows the relationship between software exports and engineering college capacity. For all each
of the three years, we see a positive correlation between a state’s engineering college capacity
and its software exports (in logs). Finally, figure 3 shows the change in software exports by
state in various years against the year in which the state first allowed private engineering
colleges. As can be seen, states which allowed private colleges to enter earlier are also those
where the software exports have increased the most.
These figures suggest that states which allowed private engineering colleges to enter
early, were also favored early destination of software exporters, and their advantage appears to
have persisted even as engineering college capacity in other states has rapidly expanded.

Figure 1: Software exports by state, 1990, 1995, 2003..

Log of Software Export (Rs BN of 1993-94)
10 15

1990
1995
2003
0 5
Karnataka

Tamil Nadu

Maharashtra

Andhra Pradesh

Delhi

Haryana

Uttar Pradesh

West Bengal

Orissa

Kerala

Madhya Pradesh

Gujarat

Punjab

Rajasthan

State

Figure 2A: Software Exports and Engineering college capacity, 1990 -1996
 1990 1996
Log of Software Exports (BN of 1993-94 Rupees)
12

mh
ka
dl tn
8

mh ap
up
ka hr wb
tn
dl
wb ap
up
kl
4

gj
oa

kl
0

hr
pn
oa
rj mp
gj pn
rjmp

0 10 20 30 0 10 20 30
Lagged Engineering Intake Capacity (in thousands)
Graphs by year

Figure 2b: Software exports and engineering college capacity, 2002.

2002
Log of Software Exports (BN of 1993-94 Rupees)
12

ka
tn mh
dl hr up ap

wb
8

oa
kl
mp gj
pn
rj
4
0

0 10 20 30 40
Lagged Engineering Intake Capacity (in thousands)
Graphs by year

Legend: ap: Andhra Pradesh, dl: Delhi, gj: Gujarat, hr: Haryana, mh: Maharashtra, mp: Madhya Pradesh, ka:
Karnataka, kl: Kerala, oa: Orissa, pn: Punjab, rj: Rajasthan, tn: Tamil Nadu, up: Uttar Pradesh, wb: West Bengal
Fig.3: Change in software exports 2003- 1990, by year of policy change allowing private
engineering colleges
Log (Software Export 2003 - Software Exports 1990) (Rs BN of 19
12

KA

MH
TN

AP HA
10

DL UP

WB
8

OA
KL
PN
GJ
MP
6

RJ

1957 1984 1983 1977 1999 1995 1995 1996 1986 1992 1986 1995 1993 1998
Year of Policy Change

Fig.4: Log of software exports for 1990, 1995, 2003, by year of policy change allowing
private engineering colleges
15
Log of Software Export (Rs BN of 1993-94)
10

1990
1995
2003
0 5
1957 (KA)

1984 (TN)

1983 (MH)

1977 (AP)

1999 (DL)

1995 (HA)

1995 (UP)

1996 (WB)

1986 (OA)

1992 (KL)

1986 (MP)

1995 (GJ)

1993 (PN)

1998 (RJ)

Year of Policy Change

 We further explore these patterns through regression analysis. Consider first the long
term impact of initial engineering college capacity. In table 6 we show the impact of engineering
college capacity in 1987 on the level of software exports and also on the increase in software
exports between 1990 and 2003. It is worth pointing out that the total software exports in 1987
were $54 million dollars (Athreye, 2005b) and therefore engineering college capacity in a state
in 1987 was unlikely to be influenced by software exports industry.
We control for several other factors that might have facilitated growth of the software
exports in the state. Electronics production in 1990 reflects the size of hardware electronics
industry before software industry achieved significant size. We include it our regression as it has
been argued that in the initial years software industry also relied on experienced professionals
working in the electronics industry to meet its manpower requirement (Lateef, 1997). This also
controls for a variety of other influences. For instance, Klepper has argued that related
industries are more likely to spawn successful firms. However, firms in many sectors, such as
Banking, Finance and Manufacturing are also significant producers of software (primarily for
their own use), this factor may not be as salient. Accordingly, we control for industrial
production as well.

Table 6: Initial differences in engineering college capacity and software exports

Effect of Engineering Capacity in 1987 on Difference in Software Export in 2003 and 1990
Log (Software Exports Software exports 2003 –
2003) Software exports 1990
Eng. Coll. Capacity 1987 5.96
(1.00)
Electronics Production 1990 0.97
(0.50)
Lagged Industrial Output 1987 -0.56
(0.15)
Constant 6096
(4956)
R2 0.90
No. of obs. 14.
As table 6 shows, initial levels of college capacity in the state have a significant and
sizable effect upon software exports in 2003, nearly a decade and a half later. The limited
number of observations makes it difficult to use more controls, and it is possible that this long
lasting influence is merely a reflection of unobserved state characteristics. Accordingly, we
exploit the within state-variation in capacity over time in table 7, which use both year and state
fixed effects. In addition, we control for per capital income, and teledensity, and use the state’s
population to control for size effects.
Table 7 reports on the specification implied by equation (10). Note that we lag engineering
college capacity by four years as it takes four years to complete undergraduate engineering
degree. This makes it unlikely that our effects reflect the feedback effect of software growth,
except possibly towards the end of our sample period. Other controls such as electronic
production, industrial output, per capita income and teledensity are also lagged, albeit by one
year. Further, the standard errors are cluster corrected to account for the non-independence of
errors within a state.
Table 7 shows two specifications, with and without time varying state characteristics
such as per-capita income, population and electronics and industrial production. Although
controlling for time varying characteristics reduces the impact of engineering college capacity on
software exports. In specification 1, a unit increase in capacity increases exports by Rs 340,000
or about $8,000. To put this in perspective, average revenue per employee in the software
industry in India in the mid 1990s was of the order of $15,000. If one takes into account the less
than full capacity utilization, attrition, movement into non-software activities and migration to
other states, the quantitative impact is even more plausible.
Table 7: Dependent Variable: Annual change in software exports, in Rs millions, constant
1993-94 prices
(1) (2)
Lagged Eng. Coll. Capacity 0.34 0.20
(0.1) (0.07)
Lagged Electronics Production 0.40
(0.24)
Lagged Industrial Output 0.007
(0.023)
Lagged Per Capita Income -0.55
(0.61)
Population -0.28
(0.16)
Constant -371 22981
(1308) (11914)
State-fixed effects Yes Yes
Year-fixed effects Yes Yes
2 0.49 0.54
R
Note: Cluster corrected std. errors in parenthesis. No. of obs. 182.

Despite the state fixed effects and despite the four year lags, it is possible that capacity
is endogenous. A growing software industry may create the expectation of growth in future
demand for engineers. This will bias our estimate upwards. On the other hand, it is likely that
capacity is an imperfect measure for the change in the state level stock of human capital, which
would imply an attenuation bias to zero. To address both issues we therefore use instrument
for engineering college capacity. Our instrument is based when neighbouring states first allow
private engineering colleges to operate. Specifically, we create a dummy variable, “policy”, for
each state, which is one if private engineering colleges are operating in that state in that year,
and zero otherwise. Our instrument is the average of “policy” for neighbouring states. This
identification strategy assumes that when neighbouring states allow private colleges to operate
may depend upon anticipated demand in that state, it is independent of the anticipated demand
in neighbouring states. Put differently, we assume that although state governments may
respond to local software firms, they are not responsive to software firms in neighbouring states.
However, they do respond to policy changes in neighbouring states.
It was not until the 1990s that Indian states actively began to compete to attract
businesses to locate. Before that, states frequently viewed private business with some
suspicion. More business friendly states might, prior to the 1990s, have offered tax concessions
or regulatory relief, they were extremely unlikely to offer to make significant policy changes to
address business concerns. Thus, this is a plausible instrument.
Table 8a shows the results of the first-stage regression of college capacity on average
neighbour policy, with state and year fixed effects, with and without time varying controls.
Though the neighbour policy measure is significant, the F statistic is only around 4.5 with time
varying controls, and around 6 without them, although these are after cluster correction.

Table 8a: First-stage Results Dependent Variable: Lagged Eng. College capacity
(1) (2)
Average neighbour policy -6713 -5144
(2618) (2429)
Lagged electronics production 0.37
(0.18)
Lagged industrial output 0.06
(0.03)
Lagged per capita income 0.1
(0.82)
Population -0.24
(0.11)
Constant 24204 33081
(4918) (11098)
State-fixed effects Yes Yes
Year-fixed effects Yes Yes
F-statistic 6.33 4.49
R2 0.89 0.93
Note: Cluster corrected std. errors in parenthesis. No. of obs. 182.
Table 8b: Two Stage Least Square Results
Change in Change in Software Software
Software Exports Software Exports Exports Exports
(2SLS) (1) (2SLS) (2) (OLS) (3) (2SLS) (4)
Lagged Eng. College 0.62 0.74 1.31 2.02
Capacity (0.36) (0.50) (0.27) (1.95)
Lagged Electronics 0.21 1.60 1.35
Production (0.23) (0.80) (0.56)
Lagged Industrial -0.03 -0.11 -0.16
Output (0.05) (0.08) (0.20)
Lagged Per Capita -0.67 0.98 0.83
Income (0.67) (1.68) (1.54)
Population -0.15 -0.73 -0.56
(0.14) (0.56) (0.35)
Constant -4773 9397 43376 25642
(4489) (11527) (37591) (34762)
State-fixed effects Yes Yes Yes Yes
Year-fixed effects Yes Yes Yes Yes
R2 0.45 0.44 0.75 0.73

Note: Cluster corrected std. errors in parenthesis. No. of obs. 182

Table 8b presents the corresponding instrumented estimates. Columns 1 and 2 present
results where the dependent variable is change in software exports over the previous year.
Note that the estimated coefficient increases three fold as compared to the OLS estimate,
suggesting that upward bias was unlikely and that measurement error is more likely. However,
the coefficient is imprecisely estimated, possibly because the instrument is weak. We also
present analogous results where we use the log of software exports, rather than the annual
change in software exports, in columns 3 (OLS results) and 4 (2SLS). The estimated coefficient
of capacity in this case also increases upon instrumenting for it, although the increase is not as
large. Once again, the estimated coefficient has a large standard error. The other noteworthy
point is that lagged electronics production also has a positive and significant impact on the level
software exports, but not on the annual change in software exports. Other time varying controls
are statistically insignificant. Specifically, per capita income and industrial output do not play any
role in explaining software exports growth. Consistent with this, some of the richer states like
Punjab and Gujarat lag in software exports compared with Karnataka and Andhra Pradesh.

VIII. Discussion and conclusions:

The importance of human capital -- skilled and creative workers -- to a “high-tech”
industry is routinely acknowledged but often public policy discussions tend to focus on more
trendy prescriptions such technology parks, venture capital, incubators and university industry
centers. Software, perhaps more than any other high-tech industry, relies more intensively
upon human capital. Software services, the engine of the Indian software sector, is arguably
even more human capital intensive than software products. Thus, few would question the role
of human capital stocks in the rise of the Indian software industry. What is less clearly
appreciated is that there are significant variations across Indian states in stocks of human
capital, specifically engineers, and that these have played an important part in conditioning
where the software industry has flourished. Even less well understood are the reasons for this
regional disparity in human capital stocks. We find that these variations exist even after
controlling for factors such as how rich or large the state is, and measures of industrial
production, electronics production or telecommunication investment. Since engineering
education has been controlled, and in the main, provided by state funded colleges, differences
in the willingness of states to invest in engineering colleges could, but do not, explain the bulk of
the inter-state variation. Instead, it is the role of private engineering colleges which is the key
the puzzle. Simply put, states which allowed private engineering colleges to enter early were
able to get a head start and, this early advantage has persisted for nearly a decade and a half.
This persistence is noteworthy, and may be the result of a number of factors. Klepper’s
studies of automobiles, tyres and televisions indicates that early entrants are likely to be the
source of eventual market leaders, accounting for large shares of output and revenue (see
Arora, Gambardella and Klepper, 2005). In the Indian software industry, there is evidence that
larger firms are able to attract larger (and more lucrative) contracts (Athreye, 2005). Thus, our
results are consistent with the notion that states relatively abundant in engineering talent, by
attracting software production, were able to ride the coat-tails of these firms, as (some) grew
into the industry leaders. These effects could be amplified if employees of existing software
firms are also a significant source of new firm formation and tend to locate in the same region.
The persistence also points to the potential importance of positive feedback forces.
Gain in reputation is an obvious one, as exemplified by the tremendous positive publicity
Bangalore has received. It is possible that software firms located in Bangalore had an easier
time attracting foreign contracts as a result. Similarly, a firm entering the software industry in
Bangalore may have found it easier to attract talented and experienced software developers
and project managers. Finally, as noted earlier, the enhanced visibility of the industry in the
leading states may have attracted eager students and equally eager educational entrepreneurs
wanting to educate them, to those leading states. Indeed, a topic for further research is indeed
to model the process by which educational entrepreneurs decide to start an engineering college.
 Our results assume limits on geographical mobility of software workers. Potential
software workers can change location at two stages, once when they decide upon where to go
to college, and then after graduating from college. Local levels of human capital matter to the
extent workers are imperfectly mobile after graduating. Alternatively, it must be assumed that
software firms incur lower search costs (or matching costs) with local graduates. The empirical
and theoretical foundations for these assumption remains for future research.
Our unit of analysis is state even though the industry we are analyzing is mostly located
in urban centers in India. The possible extension of this work would also include developing
theoretical model for modeling interregional migration for engineering education and for work
and its effect on regional labor supply and consequently on growth of the industry.
Our results corroborate the findings in the literature about the increasingly important role
of institutional and policy differences across states. But they also illuminate how successful
policies are rapidly imitated. Every state in our sample had adopted policies allowing the entry
of private engineering colleges by 1998!. This underscores the importance of economic
decentralization in a large country such as India, and of allowing states to act as laboratories for
policy experiments.

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Appendix A
Private Self-financed Institutions:
These institutions are privately founded and operated, with no financial support from the
government. The government exercises no control on its day-to-day functioning though there are various
regulations by regulatory body AICTE. The creation of new institution, increase in capacity of a discipline
or addition of new discipline in existing institution is with the approval of the AICTE (and prior to AICTE,
state government’s approval). Most of their resources are derived from tuition fees and a small share from
donations. Their principal activity is undergraduate education, and the opportunities for additional
resource generation are very limited.
Tuition fees were prescribed by State government on the recommendations of expert committee.
The fee is same throughout state though there are inter-state variations. Recently there have been some
changes in the mechanism of admission into such institutions. Now each institution can have its separate
fee structure, to be approved by a committee headed by a retired High Court judge and experts and
technical education secretary of the concerned state government.
These institutions are affiliated to universities (universities are set up by an act of state legislature
or by an act of parliament), which prescribes syllabi for various disciplines and conducts examinations.
The degrees are awarded by the universities. The faculties educational qualification, wage structure, etc
are mandated by AICTE.

Appendix B: Data Source:

The main source of data is the “Annual Technical Manpower Review (ATMR)” reports published
by National Technical Manpower Information System NTMIS. These reports are prepared by a state-level
nodal center of NTMIS and give details of sanctioned engineering college capacity and outturn for all
undergraduate technical institutions in the state. Each institution has discipline-wise approved intake (this
is approved by AICTE). The sanctioned intake for an institution puts upper limit on the number of students
that it can admit in a given discipline in an academic year. The outturn is the number of students
graduating in a given year. The ATMR has information on sanctioned intake and outturn. The NTMIS
publication “Directory of Technical Institutions” has institution level details of intake and outturn. The
Handbook of Engineering Education, a publication of the Association of Indian Universities has also been
used as a supplementary source. We have also used printed publications and web-published data of
AICTE whenever needed. In certain cases the website of the institution has been useful in providing
relevant information. Sometimes the data from these reports are inconsistent. That is the trend in the
intake or outturn do not reflect trend in growth. In such cases the other sources have been used to arrive
at the acceptable figures of sanctioned intake.
The data on software exports are obtained from various reports published by NASSCOM and
ESC24. NASSCOM publishes “Indian Software Directory” and these directories have details of software
exports, location of company, etc. ESC compiles state-wise exports data. The Dataquest25 magazine
carries a detailed survey of software companies and provides useful information about various software
companies. The annual reports of STPI are also very important source of information. Our dataset also
includes variables like population, per capita power consumption, industrial output26, teledensity, per
capita income and number of students passing 12th grade for each state and for each year. The
information on these variables is obtained from various publications and websites of concerned
departments of Government of India.

24
ESC (Electronics and Computer Software Export Promotion Council) is India’s apex trade promotion
organization. ESC is actively engaged in the promotion of India’s export of computer software and services,
computer hardware, consumer electronics, telecom equipments and cables.
25
Dataquest covers information technology industry in detail since 1982. They provide details on exports, turnover
and employees of software companies.
26
Industrial output is the net value additions by all manufacturing units in a given state in a given financial year. The
data is taken from Annual Survey of Industries conducted by Government of India.
 Table A1 : Software Export ( in millions of Rupees at constant prices of 1993-94)

Year KA TN MH AP DL HA UP WB OA KL MP GJ PN RJ
1990 626 374 1,571 127 301 0 129 80 0 2 0 0 0 0
1991 1,189 489 1,774 158 430 0 188 94 0 6 0 0 0 0
1992 1,595 654 2,521 242 387 119 248 143 0 13 0 0 0 0
1993 2,235 1,124 3,836 277 986 170 385 251 3 17 0 2 0 0
1994 3,079 1,800 4,771 511 2,849 248 541 319 4 19 0 10 0 0
1995 4,386 2,725 6,321 857 3,459 458 770 410 9 29 0 12 0 0
1996 7,609 4,563 9,764 1,813 5,493 745 1,288 465 15 62 0 30 0 0
1997 12,630 7,502 12,751 2,127 9,458 1,442 1,644 743 28 196 0 40 0 0
1998 24,347 9,174 14,114 4,587 17,643 7,763 7,057 1,411 565 374 106 93 56 26
1999 29,158 13,171 18,703 7,037 26,027 6,448 8,255 2,434 726 442 239 183 99 99
2000 48,681 24,435 26,853 12,103 23,869 9,108 21,935 2,946 1,256 706 314 641 314 188
2001 71,786 36,465 37,866 18,052 14,215 17,923 15,451 4,363 1,545 909 544 754 433 278
2002 81,834 43,529 40,754 22,001 17,121 20,377 17,992 7,545 1,741 958 604 609 406 269
2003 107,598 44,925 54,921 28,152 19,412 27,732 19,689 8,874 1,803 1,212 693 782 1,009 277

Table A2: Outturn from Undergraduate Technical Institutions

(in numbers)
Year AP Delhi GJ HA KA KL MP MH OA PN RJ TN UP WB
1990 3927 630 2137 235 9015 2325 1940 9575 723 331 1054 5861 2412 1857
1991 4368 846 2164 465 8663 2319 1798 10900 824 307 1109 6147 2412 1959
1992 4385 900 2372 547 9169 2161 2268 12339 805 337 1131 6349 2412 1587
1993 4367 994 2742 533 7665 2246 1823 14323 845 429 1111 6595 2502 2106
1994 4405 847 2852 625 11494 2157 1651 14742 870 522 1265 6669 2502 2304
1995 5610 940 3132 621 11611 2547 2123 15283 851 554 1338 6660 2610 2301
1996 6298 910 3087 683 12182 2441 1849 13772 901 679 1429 7835 2886 2241
1997 5900 1160 3158 662 11977 2795 1647 16812 913 813 1217 9111 2749 2439
1998 5390 1097 3168 657 12036 3001 1763 19516 994 816 1443 11941 3294 2432
1999 7817 1085 3851 1004 12259 3571 2287 20534 1181 679 1469 13452 3323 2518
2000 8102 1103 4723 1120 12526 3877 2158 19706 1498 1365 1445 15524 3552 2644
2001 12171 974 4762 1788 14173 4126 2727 26341 2950 1991 1693 16670 4822 2754
2002 14680 1160 4902 2225 14195 3764 2050 26791 3259 2081 1901 20550 6703 3459
2003 20099 1089 6944 1950 14550 3944 3439 27157 4316 2944 1976 28107 8083 3834
KA: Karnataka, TN: Tamil Nadu, MH: Maharashtra, AP: Andhra Pradesh, DL: Delhi, HA: Haryana, UP:
Uttar Pradesh, WB: West Bengal, OA: Orissa, KL: Kerala, MP: Madhya Pradesh, GJ: Gujarat, PN:
Punjab, RJ: Rajasthan