Don't sweat the quant stuff

We generally think that workers in India are good at the quant stuff. But is this just stereotype, or is it real? On one hand, 12th standard CBSE mathematics - which the ordinary Indian worker has generally mastered - exceeds what high school students in the US know. India has a significant edge here against the US, though not against Europe. On the other hand, college education in India is pretty awful, and this has generated skepticism about the potential upside for BPO in India. Very bright MBAs in India tend to be underskilled in probability, statistics, optimisation, financial economics; they tend to use spreadsheets too much. Their counterparts - the best MBAs from top schools in the US - seem to be better trained in these four critical blocks of knowledge. (I am comparing like to like: MBAs from the 3 best IIMs and ISB against MBAs from the top 10 schools in the US).

Thanks to Tirthankar Patnaik, I saw mention of an intruiging study by Ravi Aron of Wharton (link):

Questions abound about job functions that are likely to gravitate to places like India sooner than others. Some insights into this can be had from the concept of a "mechanism for complexity arbitrage" that Aron and colleagues worked on in a recent research project funded by the Mack Center at Wharton. The project involved collecting data covering three years from several companies about various processes and the places where they were performed across the globe. Managers at these companies overseeing those processes where then asked to rate each of them on a complexity scale of one to seven, with seven being the most complex.

The researchers found a striking polarization in the way managers assessed the complexity levels in their processes. Those in the U.S. and the U.K. formed one group, while their counterparts in India, China and Singapore made up the other. "Whenever work involved number crunching, quantitative analysis, mathematical formulation, statistical data analysis and numerical calculations, managers in India, Singapore and China would say this is low complexity work," says Aron. "They could find the people to do those jobs and deliver quality on scale, month after month, year after year. But wherever work involves persuasion, communication, context-sensitive responses, interpretation, subjective judgment and cultural sensitivity, managers in the U.K and the U.S. will tell you that is low complexity work."

Are there natural limits to the kind of work that can be offshored? Of course, says Aron, but he adds that Indian service providers will not encounter them "as long as they do not breach the complexity divide." He says certain job functions are a natural fit for the U.S. and the U.K. and not easily outsourced, because they require customer interactions and persuasion. These are activities that are "embedded in the context of the market and they need context-sensitive communication," he says. "The Indian market is nowhere as sophisticated as that in the U.S.; it does not have the range of derivatives like in the U.S. market, and futures and options are just beginning to catch on.

Also see here, another demo of the external perception of Indian quant prowess. How fascinating. Managers in India, Singapore and China think that the quant stuff is "low complexity". :-) I believe similar things are happening in Silicon Valley: many startups are organising themselves as a marketing front-end in the Bay Area, and the engineering team in India. If these effects are real, global capitalism will reshape the geographical allocation of production: activities involving the quant stuff are going to increasingly move to India, Singapore and China. This bodes well for MIFC. If you have the MIFC book handy, see page 172-176 on human capital which offers a gloomy perspective on this, and Chapter 5 on BPO. Both segments of the MIFC book paint a relatively gloomy picture: but maybe (in the light of the above) things are actually a bit better than portrayed there.

Once such a process gets going, it will be self-reinforcing, and it will induce effects that are reminiscent of the specialisation seen in evolutionary biology, where small mutations are accentuated by natural selection, and species separate themselves out in plying different trades. In the decision-making of the global firm, tasks that involve quant skills would be more likely to get sent to India/Singapore/China, while tasks that involve more cultural context are more likely to get done in an industrial-country setting. In the decision-making of the individual, people with quant predilections are more likely to move to India and people in India face a higher marginal product of investing in quant skills. Both these effects (at the firm and at the individual) would reinforce each other.

How will human capital build up in the context of terrible colleges & universities? I think learning-by-doing is the key. The last paragraph of the above quotation rings true to me. With weak colleges and universities, learning is dominated by on-the-job accumulation of skills. I would advise every victim of the terrible higher education system in India to intern, intern, intern and build up on-the-job skills, accompanied by a higher intellectualisation based on a self-study program of reading the best books and textbooks so as to not become a narrowly-specialised technician [link].

Index futures trading is active in India, so there is now plentiful talent that knows how to do index arbitrage. Interest rate futures trading in India is effectively banned, so naturally nobody knows anything about interest rate futures arbitrage. As the local financial system bulks up to higher levels of complexity, this feeds into the range of skills where there can be a global role for Indian professionals. There is thus a three-way synergy between (a) the BPO, (b) the local financial system and (c) the MIFC agenda: each feeds into the other. Conversely, a strategy of financial repression, where products and activities are banned in the domestic economy, has bigger costs than meets the eye: it hurts not just domestic finance but also the BPO and the prospect of MIFC.