(Bloomberg View) -- Walk into a coffee shop in the southern Indian city of Bengaluru (formerly and more commonly known as Bangalore) and you’re likely to find it full of young people drawing up business plans or meeting with funders. You’d be forgiven for thinking the city -- once a leafy and cool retirees' paradise, now a gridlocked concrete jungle -- and the information technology industry that propelled it to worldwide fame are thriving.
The picture isn't quite so cloudless, however. For one thing, the pipeline of venture capital that's recently super-charged the city's app economy is drying up. More worryingly, the pillars of its IT industry are looking increasingly shaky.
Companies such as Infosys, Wipro and Tata Consultancy Services (TCS) grew into global behemoths precisely because they sprung up in Bengaluru -- far from the watchful eye of Delhi-based bureaucrats. The tech industry fell into a regulatory blind-spot, unhampered by red tape and the labor laws that strangled other sectors. As one Indian minister noted over a decade ago, Indians do well “in IT and beauty contests, the two areas that the government has stayed out of." States like the one Bengaluru is in continue to exempt IT companies from especially suffocating regulations.
These firms offered businesses around the world an efficient, low-cost way to outsource their in-house IT work. Building and maintaining enterprise-specific IT infrastructure for overseas clients provided a steady stream of income. India could beat the competition for this work because of its large pool of trained, low-cost engineers.
Once wildly successful, this model has now begun to run into a whole host of problems.
First, slowing growth in the West means that many companies have cut down on the discretionary spending that once went into outsourcing contracts. Second, more restrictive visa laws in the West are making it tougher for Indian companies to get qualified engineers into their clients’ offices.
Third, that pool of Indian engineers isn’t inexhaustible. Salaries have begun to rise, threatening a business model based on generating relatively little revenue per employee. As far back as 2013, the Economist quoted one IT executive as saying that, for IBM, “the total cost of its employees in India used to be about 80% less than in America; now the gap is 30-40% and narrowing fast."
Fourth and most importantly, the technological landscape is shifting dramatically. Companies could once draw clear distinctions between the core of their business and extraneous IT work that could be outsourced. Now, with the shift to digital services and cloud computing, more and more companies view IT as integral to the transformation of their overall business. They're looking for higher-value services and more innovation than Indian IT companies have traditionally provided. Infosys's struggles with its core consulting revenue led to it declaring disappointing results last Friday.
Bengaluru's flagship companies are hardly unaware of this. Infosys has begun training its employees and board in “design thinking" -- a buzzword for prototype-driven innovation -- hoping this will help prepare them for a future in which they have to serve as all-around advisers for clients seeking to make their businesses fully digital. TCS says its revenue from such work is growing at 10 percent annually.
The problem is that these kind of projects don't require masses of low-priced engineers. TCS is hiring fewer people and laying off some.
A wave of job cutbacks could attract the baleful glare of the state. In a hangover from India's socialist past, the government has traditionally been overprotective of workers in the formal sector. While the roughly 3 million people who work in the IT industry are a tiny drop in India's billion-plus population, they account for a huge chunk of the organized labor market -- almost a quarter of the formal work force.
How will politicians and bureaucrats react to IT champions radically changing their operations, perhaps shrinking or even trying to move offshore? When some Indian airlines, as part of a necessary restructuring, tried to trim bloated bits of their work force a few years ago, the government pressured them into retreating. It's reasonable to fear that similar meddling might be in store for Indian IT.
That would be a deeply unwise move. India needs to create millions of new jobs, not just protect existing ones. And as Prime Minister Narendra Modi has recognized with his "Make in India" push, the only way to do that is to create a vibrant manufacturing sector. That's only going to become more difficult as automation displaces workers in factories around the world.
Competent and globally recognized, Indian IT companies give India a rare edge in this manufacturing revolution. Companies like TCS and TechMahindra are, in fact, part of groups that see themselves as manufacturers first. Allowing Indian IT companies to innovate their way to a new business model is essential not just to ensure that the industry survives, but that India's manufacturing sector develops a forward-looking, digital component. Trying to save a few jobs now could cost the country many more down the road.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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