by Arpit Kaushik

Politics and Economics of Offshore Outsourcing

Feb 10, 20096 mins

Offshore outsourcing is forcing major changes in terms of job content, location, wages and job security--it's an economic nreality and many are completely unprepared. Instead of debating its impact on the economy, experts suggest that the U.S. nntransform its social safety net (unemployment insurance, tax credit, health insurance, pensions etc.), prepare the workforce nnfor the future, and climb up the comparative advantage ladder through innovation.

There are two hot topics in the offshore outsourcing industry today—first, what the likely impact of the recession will be and second, what will be the likely impact of Barack Obama’s presidency. While the former has attracted some good intellectual debate, with sound arguments and evidence to support both sides of the story, the latter has received pretty naive coverage, mostly from senior executives of offshore outsourcing or advisory firms desperate to allay their customer’s concerns. One fundamental question that they fail to address is why Obama should care about offshore outsourcing. If it was so simple and so straightforward that offshore outsourcing is good for corporations, good for countries, good for economies, then why would Obama even consider doing anything about it?

The debate began when Obama campaigned, “I will stop giving tax breaks to companies that ship job overseas and I will start giving them to companies that create good jobs right here in America.” This was subsequently detailed in October 2008 as a $3,000 tax credit for the next two years to businesses, for each new full-time employee they hire onshore. The general response to this scheme has been that it hardly matters and will not make any difference to companies engaged in offshoring. The credit amount will be made up by just one month due to the wage differentials. Some concerns also arose about whether Obama will cut the current H1B visa cap of 65,000. But this fear is largely unfounded—Obama in fact favors a temporary increase in limit and a permanent reform of the system, as stated in a pre-election interview.

Recently, as if to allay all concerns about potential adverse impact of his stance on outsourcing, Obama filled some of his top White House posts with people who not only support expanding the H-1B visa program, but see offshore outsourcing as a plus for the U.S. economy.

But is offshore outsourcing a plus for the U.S. economy? This is a question being asked increasingly not just by economists, but also by ordinary U.S. citizens impacted by the surge in unemployment .

When offshore outsourcing started, it was at a micro level. Companies were happy with this new supply of high quality, low cost labor, and no one was complaining. Then companies started offshoring in droves and it became a macro level phenomenon. McKinsey recognized this trend, built up a consulting practice around it and won many projects in advising governments on how to tap the global labor market using outsourcing, and advising companies on how to get their global sourcing strategies right. Offshore outsourcing works for all was the general perception.

But then came a problem—someone asked “hey what happens to all the jobs that we let go here onshore. Isn’t that kind of bad for the local economy?” So the backlash started. To respond, the McKinsey Global Institute (headed by Diana Farrell, who’s just been appointed as deputy economic advisor to the president) released a study that created a new thumb rule for offshore outsourcing: For every dollar spent on a business process outsourced to India, the U.S. economy gains at least $1.12. It relied on estimates by Forrester (yes, yes, the same Forrester that, on seeing the magnitude of the global crisis, rendered all its previous studies obsolete) to conclude that offshoring is already benefiting the U.S. economy. In addition, it also argues that offshore outsourcing frees up U.S. workers to do other tasks (I wonder if collecting unemployment benefits was included in that list of tasks!). In 2005, another of their studies predicted that multinational companies in the entire developed world would have outsourced to low wage countries only 1 percent of total number of service jobs in developed countries.

MGI’s 2003 report “should be viewed as a self-interested lobbying document that presents an unrealistically optimistic estimate of the impact of offshore outsourcing,” say public policy professors Ron Hira and Anil Hira. In sharp contrast to MGI’s 1 percent figure, noted economists have cited a figure of 11 percent to 29 percent, as the percentage of U.S. jobs that could be potentially offshored. For those who say “so what—losing a job makes one go and acquire higher skills that result in a higher pay”, read this—about 70 percent of laid off workers in the United States earn less three years later than they did at the time of the layoff; on average, those reemployed earn 10 percent less than they did before. Additionally, a study by Harvard labor economists found that every 1 percent drop in employment due to imports or factories gone abroad shaves 0.5 percent off the wages of the remaining workers in that occupation. Another article by Business Week reported that government statistics have underestimated the damage to the U.S. economy from offshore outsourcing.

So there is no simple or straightforward answer to whether and how offshore outsourcing benefits the economy. Yes, it delivers value to corporations who operate in that economy, but as Dr. Ron Hira says, “what’s good for America is no longer good for IBM (or take your pick of major U.S. corporations) and vice versa”. What we need now is a much more rational and realistic approach that creates the context to allow offshore outsourcing to work for all. That of course may require certain disruptive changes in economic programs, policies and business models.

Professor Alan Blinder of Princeton University says offshoring will force major changes in the industrial economy, in terms of job content, job location, wages, job security, turnover, standard of living and so on. That’s an economic reality and many will not like it. Moreover, the societies of the rich countries seem to be completely unprepared for the coming industrial transformation. In such a scenario, it’s tempting to erect barriers against offshoring, But protectionism is not the answer. Blinder suggests that U.S. transform its social safety net (unemployment insurance, tax credit, health insurance, pensions et al), prepare the workforce for the future (the high-end personal services occupations that cannot be offshored) and climb up the comparative advantage ladder through innovation.

Blinder’s work gives a fresh perspective to this ongoing issue of impact of offshore outsourcing. Instead of debating on whether it works or not for the economy and how, instead of fighting against the tide, maybe we are better off just accepting it as reality and then figuring out how we can adjust to it. This is a radical shift in thinking and mindset. The answers—what specific innovation to pursue, what comparative advantage to create, which professions to build for the future, what kind of skills and training to impart—will all follow. First comes the change in our mindset.

Who will make this change? And when? Well as Obama said, “Change will not come if we wait for some other person or some other time.” So it’s us, and it’s now.

Arpit Kaushik runs the London-based outsourcing service design firm, Crystals, that helps forward-looking companies to realise the promised benefits of outsourcing.