October 15, 2004 | Volume 1, Issue 2
Offshore Outsourcing: Sizable Rhetoric and Little Progress
The debate over outsourcing has been underway for more than a year but the policy response design process has lagged because of the refusal of elites, economists and corporate executives to acknowledge the full effects of this transformation. There has been a well-funded effort to portray the issue of moving jobs overseas as a binary choice: you are either in favor of free trade or protectionism. Because of the noxious connotations of protectionism, many potentially useful policy responses have been eliminated before they can even be considered. This artificial categorization ignores the complexity of the effects of outsourcing and impedes the policy dialogue. Like most complex issues there are multiple impacts, some positive and others negative, due to outsourcing. And like most interesting policy issues outsourcing will have wide ranging impacts on the US workforce and economy.
A powerful group of interests that cross ideological boundaries are shaping the outsourcing dialogue in a way that serves their collective purpose—maintaining the status quo. The status quo ensures both the unfettered ability of firms to move whatever they wish offshore and the ability to hide behind the politically convenient banner of “free trade.” Ironically, many of these same firms argued for protections during the 1980s when they were losing market share to foreign competition. Their efforts have been backed by a flurry of studies that purport to show the benefits of outsourcing far outweigh the costs.1 Almost all of the studies use a standard economic efficiency model with the firm as the unit of analysis.
The arguments in these studies follow the logic of mainstream economics and are quite straightforward. By moving work offshore, firms are able to lower their production costs. Some domestic workers will be displaced but the benefits from lowering production costs, captured by the firms and customers, far outweigh any costs to displaced workers. They also argue that many of the displaced workers will actually be net beneficiaries because they will be “freed up” to do more interesting and lucrative work. While these studies have some merit, they are terribly incomplete in a number of respects. First, they assume a very optimistic re-employment scenario for “freed up” workers, predicting short durations of unemployment and higher wages in their new positions. Second, most do not account for the lost wages due to unemployment in their models. Third, and most importantly, the studies do not capture difficult to measure effects such as the impact on future innovation and security. (For instance, evidence is already surfacing that many of our best and brightest college students are avoiding technology majors because of outsourcing.) Lastly, they ignore the downward pressure on domestic wages for jobs that are competed across borders.
The fact that these studies are incomplete is some cause for concern, but the ways in which these studies have been promoted and used in the policy dialogue is downright disturbing. With access to sizable budgets, these studies are marketed as analytic and definitive to the press and public. For example, the McKinsey Global Institute (MGI), funded by McKinsey Consulting, promoted their study as “The Real Economics of Outsourcing.”2 They conclude that the US gains 12 to 14 cents for every dollar that is spent offshore. This remarkably precise result is based on proprietary data and models, and does not include a sensitivity analysis. As part of their marketing process MGI did not disclose that one of McKinsey Consulting’s business lines is selling outsourcing; they clearly stand to gain financially from increases in outsourcing.
Another favorite source of outsourcing advocates is a policy brief written by Dr. Catherine Mann of the Institute for International Economics. Called “Globalization of IT Services and White Collar Jobs: The Next Wave of Productivity Growth,” Dr. Mann argues that information technology (IT) outsourcing will actually generate more US IT jobs.3 This scenario, while possible, seems highly implausible. Even the Bureau of Labor Statistics, which she liberally cites for part of her optimism, rejects her hypothesis.
Finally, Foreign Affairs Magazine recently published an essay by Professor Daniel Drezner, “The Outsourcing Bogeyman,” which is intended to ridicule anyone who might question the net impacts of outsourcing.4 Drezner’s article synthesizes a selected number of outsourcing advocacy pieces to paint a distorted picture. The following quote from the essay provides a sense of the tenor of the article: “But believing that offshore outsourcing causes unemployment is the economic equivalent of believing that the sun revolves around the earth: intuitively compelling but clearly wrong.” Contrary to his statement, there is a near consensus that trade does indeed cause unemployment in the short term—the hope is that those displaced workers will be re-employed rapidly. It is also obvious that Drezner has little understanding of the current US IT labor market, where American workers are being forced to train their foreign replacements or risk losing unemployment insurance. Those IT workers are indeed unemployed because of outsourcing; their job has in fact gone to Bangalore, and with record levels of US IT unemployment it is doubtful that they will be re-employed soon.
Another reason to question the balance of such pieces is that they argue that higher skill and higher wage positions will be created in the US, but none acknowledge the increasing use of H-1B and L-1 guest worker visa programs by corporations. These programs allow corporations to fill jobs that must be performed in the US with foreign workers rather than American workers.5
The political demagoguery has been equally vacuous, with Democratic Presidential candidate John Kerry calling CEOs that move work offshore “Benedict Arnolds.” Republican congressmen espouse the benefits of “insourcing” without explaining that it often occurs because foreign corporations want access to US consumers. Even with conspicuously heated exchanges on outsourcing, politicians have done very little to address it. So far, the government has spent $335,000 to study the issue, a puny sum by any measure.
So how do we make progress? There are many things about outsourcing that we do not yet know, such as its scale and scope and what its net impact will be on the economy. However, there are a number of things that we do know. First and foremost, outsourcing causes both positive and negative impacts and those impacts are not evenly distributed. Second, we know that corporations that sell in the US market are accelerating their efforts to move work offshore, and that many US workers will be adversely affected. Unfortunately, we have few mechanisms to help those who are hurt by outsourcing. In order to make progress, we need to move to a more complete discussion of outsourcing, its benefits and costs, the mal-distribution of those benefits and costs, and how to correct that imbalance.
1 For a sample, see recent studies sponsored by the Information Technology Association of America, American Electronics Association and US Chamber of Commerce.
2 McKinsey Global Institute, “Offshoring: Is it a Win-Win Game?” August 2003, can be downloaded from www.mckinsey.com
3 Catherine L. Mann, “Globalization of IT Services and White Collar Jobs: The Next Wave of Productivity Growth,” Policy Brief 03–11, December 2003, Institute for International Economics. It can be downloaded from www.iie.com
4 Daniel W. Drezner, “The Outsourcing Bogeyman,” Foreign Affairs, May/June 2004, v.83 no.3, Council on Foreign Relations, New York.
5 For more information on these programs see, Ron Hira, “U.S. immigration regulations and India’s information technology industry,” Technological Forecasting and Social Change, forthcoming.