Outsourcing production and jobs: costs and benefits.

The current economic expansion has generated an atypically anemic quantity of new employment opportunities. Compounding the loss of over two million actual jobs since 2000 is the loss of six to seven million potential jobs that would have been created in a typical economic recovery. In the absence

of strong job creation, the weak labor market and the prolonged economic recovery have generated an enormous amount of concern about the outsourcing of production and jobs to other countries. If the economy had expanded rapidly and started creating job opportunities after the recession ended in the fall of 2001, the intensity of concerns about outsourcing would have been swept away by the euphoria of the economic expansion. Since job creation has been non-existent since 2000 for most areas of America, it is understandable that American workers, businesses, and government officials are increasingly concerned about the welfare of the U.S. economy.

What actually is outsourcing? Simply defined, outsourcing occurs when an organization transfers some of its tasks to an outside supplier. (1) Offshore outsourcing occurs when these tasks are transferred to other countries. This outsourcing may take the form of constructing facilities and hiring labor offshore to produce services or products for sale and consumption offshore. Alternatively, offshore outsourcing may involve the utilization of offshore facilities and labor for the importation of goods and services into the U.S. In both scenarios, the purpose of offshore outsourcing is to take advantage of lower production costs, increase profits, and remain competitive in an increasingly global economy.

Economists and managers easily focus on the gains that may be generated from meeting global competition in an unencumbered world economy where all competitors face the same set of constraints. Cheaper and frequently better products are generated for consumers both domestically and in the world economy. New employment and income generating opportunities in foreign markets generate new market opportunities for domestic and international producers of goods and services. Finally, international outsourcing of production and employment causes the domestic economy to undergo a new wave of evolution that sets the stage for the next surge of economic growth. An example might be that the outsourcing of parts of the manufacturing supply chain have shifted U.S. jobs from manufacturing to services and simultaneously prepared the U.S. economy to shift its attention to activities that have a higher market value.

Financial institutions and service providers subsequently found outsourcing to be a source of competitive advantage for their businesses. The Boston Consulting Group cites the following companies (and the locations where they outsourced) as among the most prominent early movers:

* GE Capital (India, China, and Ireland);

* American Express (India and the Philippines);

* Bank of America (India and the Philippines);

* Citigroup (India, the Philippines, Malaysia, Taiwan, and Singapore);

* HSBC (India and China); and

* Standard Chartered Bank (Malaysia, India, and China). (2)

Based upon this history, outsourcing will likely increase, continuing in the manufacturing sectors and expanding significantly into the service sectors including healthcare. (3)

What factors are driving these sectors to outsource their production and employment? According to Bill Sweeny, Vice President of EDS--Global Government Affairs, the decision to outsource is based upon the following factors:

* The demand of the customer;

* The type of local talent available;

* Cost;

* Productivity;

* Political risk; and

* Infrastructure delivery. (4)

Ashok D. Bardhan and Cynthia Kroll with the Fisher Center for Real Estate and Urban Economics at the University of California, Berkeley, further develop this thought by explaining that the "push" factors for outsourcing services are cost driven much like they are for manufacturing, but the "pull" factors provided by the countries where services are being outsourced are somewhat different. (5) As Bardhan and Kroll clarify, the "pull" factors include the following:

*Widespread acceptance of English as a medium of education, business, and communication;

* A common accounting and legal system, with the latter based on either the U.K. or U.S. common law structure;

* General institutional compatibility and adaptability;

* Time differential determined by geographical location leading to a 24/7 capability and overnight turnaround time;

* Simpler logistics than in manufacturing; and

* A steady and copious supply of technical-savvy graduates. (6)

All of these factors result in the potential for significant cost savings by taking advantage of skilled, quality labor at a fraction of the cost associated with producing domestically.

Understandably, from producers and consumers points of view, moving jobs to minimize production costs means some combination of higher profits, lower prices, and improved economic conditions around the world. From the perspective of the workers displaced and the families forced to downsize their expectations, the losses are much more personal and difficult to justify on the basis of the gains in other countries. In previous periods of economic disruption, critics voiced concern over jobs being moved overseas but understood that domestic economic growth would soon accommodate the workers who were displaced. In addition, the majority of the jobs shipped elsewhere were either high-wage, (frequently unionized) blue-collar jobs in manufacturing that generated abundant envy and little public understanding or sympathy, and low-wage and low-skill jobs that could not be protected in a world market overrun by a glut of low-wage workers. Outsourcing was a necessary evil for the betterment of consumerism and capitalism. As long as white-collar, high-wage professional, managerial, and service jobs were immune, there was no real alarm.

Now, however, white-collar jobs are very much at stake and are a newfound cause for concern. As John C. McCarthy noted, these once sacred jobs are now moving to other locations (see Chart 1). (7) In Tables 1 and 2, Bardhan and Kroll provide more detail regarding specific industries and jobs at risk to outsourcing, primarily to India and East Asia. Globalization, faster communications, lower costs, and the Internet have all been contributing factors in this evolution. Daniel W. Drezner adds, "The reduction of communication costs and the standardization of software packages have now made it possible to outsource business functions such as customer service, telemarketing, and document management". (8) As Thomas F. Siems and Adam S. Rather note:

   Specialized tasks--such as software
   development, financial research and call
   centers--can often be accomplished
   elsewhere in the world at a fraction of U.S.
   costs.... It is often in a firm's best interest to
   outsource certain tasks and use the abilities
   of its remaining workers in other, more
   productive activities. (9)

Service-sector jobs that are subject or most vunerable to the risk of outsourcing share some common attributes. Among these are:

* No face-to-face customer servicing requirement;

* High information content;

* Work progress is telecommutable and Internet enabled;

* High wage differential with similar occupation in destination country;

* Low setup barriers; and

* Low social networking requirements. (10)

Unquestionably, workers who have lost and will lose jobs to offshore outsourcing have suffered and will suffer economically, especially in the short run. Consumers ultimately benefit from the lower market prices as a result of businesses seeking the lowest-cost methods for producing goods and services. But, all of this depends on the assumption that U.S. workers can retain the means to earn a living in an increasingly competitive global economy.

How many U.S. service jobs will be outsourced? The most frequently cited figures have been those from Forrester Research that estimates almost 600,000 U.S. service jobs will be outsourced by 2005 and up to 3.3 million jobs will be outsourced by 2015 (see Chart 2). (11) Although this news seems dismal at best, Drezner tempers the Forrester number with the following observation:

   The Forrester prediction of 3.3 million lost
   jobs, for example, is spread across 15 years.
   That would mean 220,000 jobs displaced
   per year by offshore outsourcing--a
   number that sounds impressive until one
   considers that total employment in the
   United States is roughly 130 million, and
   that about 22 million new jobs are expected
   to be added between now and 2010.
   Annually, outsourcing would affect less
   than .2 percent of employed Americans. (12)

While it is clear that Drezner's observations about job creation seem wildly optimistic, it is true that the disruptions caused by the flight of jobs overseas is probably equally overstated.

   Gartner [Consultants] assumed that more
   than 60 percent of financial-sector
   employees directly affected by outsourcing
   would he let go by their employers. But
   Boston University Professor Nitin Joglekar
   has examined the effect of outsourcing on
   large financial firms and found that less
   than 20 percent of workers affected by
   outsourcing lose their jobs; the rest are
   repositioned within the firm. Even if the
   most negative projections prove to be
   correct, then, gross job loss would be
   relatively small. (13)

Although the U.S. has overcome more challenging obstacles, the nation (especially policymakers and businesses) cannot ignore the responsibilities and needs of the labor force. The key to the success of the U.S. will be how the nation deals with the challenge. Bardhan and Kroll offer some possible scenarios:

1. Services job outsourcing proves more costly to the economy than the earlier round of manufacturing outsourcing. The U.S. will no longer dominate the next wave of innovations since centers of skilled, high-tech professionals build up in other parts of the world. As a result of outsourcing, workers displaced through outsourcing face prolonged periods of unemployment. Such workers would finally be absorbed in lesser-paying service jobs. Alternatively, there could be a downward adjustment of salaries and wages, making the outsourced occupations internationally competitive again.

2. A backlash against globalization could occur within the U.S. and worldwide, slowing down the process of business services outsourcing. Protectionism, although inefficient from an economic point of view, may result in the retention of some outsourceable jobs.

3. Industry shrinkage may come in part from a redistribution of jobs within the U.S. rather than a net loss. This scenario could result from the shifting of jobs from large employers to smaller firms in support sectors, as well as domestic outsourcing from high-cost regions within the U.S. to relatively low-cost regions elsewhere in the U.S. (14)

Some critics of outsourcing suggest that while the gains from free trade are clearly true, the issue of fair trade must be considered. As strong and patriotic as it sounds, protectionism results in increased prices and ultimately long-term jobs losses. But, the long-term benefits of participating in the international exploitation of either people or resources are equally dubious.

Largely ignored in this article, but keenly understood, is India's relation to the U.S. in regard to offshore outsourcing. Indeed, most articles written and comments cited use India as the main comparison. With support from the U.S. and by nurturing a large, educated technical workforce, India became the market it is by being the second-largest English-speaking nation in the world. (15) However, somewhat neglected in discussions and consideration are other Asian nations, particularly China, that are also emerging as serious contenders in the global economy. Simply put, a nation hungry to grow economically will compete at many levels. For the U.S., complacency is not an option, and time is definitely not a luxury.

Globalization means that the U.S. is no longer the only significant economic power and must be innovative in its actions to remain competitive. The first solution must be the creation of new jobs. The next administration, either Bush or Kerry, must not only promise new jobs, but actually deliver them. U.S. Secretary of State Colin Powell recognizes this as a priority:

Outsourcing invariably does result in the loss of jobs and we have to do a better job in the United States, a good job in the United States, of creating opportunity in the United States to provide more jobs, so that those who have lost jobs will have opportunities in the future. (16)

Retraining of displaced workers must occur. In the past, retraining sometimes meant transferring a displaced worker from one low-skilled job to another. This type of retraining is no longer an option. Retraining must be for high-tech and high-skilled positions and will require increased funding for post-secondary education.

Foresight in dealing with ongoing globalization means the challenge must also be met at the primary and secondary levels of education. The global market has a focus on Math and Sciences; U.S. education must also focus on Math and Sciences. U.S. education has fallen short of its goals. Lael Brainard, Senior Fellow with the Brookings Institution, makes a dire observation:

In five years, we're going to be having a debate about one of the worst skill shortages we've ever seen because the demographics are actually going to start moving in the other direction and demographers are forecasting that starting in five years, and certainly 10 and 20 years out we are going to be seeing skill shortages of the sort that we didn't even really begin to see in the late '90s. So this issue about trying to integrate our labor force with international labor forces is going to become absolutely critical to our competitiveness into the longer-term future. (17)

In order for the U.S. to remain competitive, it must meet this new challenge. Proactive, sound, successful measures must be implemented immediately. Realistically, businesses will continue to minimize costs to maximize profits. As Siems and Rather note:

   Businesses in India and elsewhere are
   developing an important competitive
   advantage in outsourcing by providing
   quality services at low costs. In the Internet
   Age--where a company's physical location
   is of little relevance and information travels
   quickly and cheaply--firms will continue
   to boost productivity and keep costs low
   by doing what they do best and outsourcing
   the rest.

   And consumers reap the benefits. (18)

Table 1. Employment Change in Industries at Risk to
Outsourcing *

                                               U.S. Employment (000)

Industry Name                                   Q1-2001     Q2-2003

Nonmanufacturing Sectors

Software Publishers (Except Internet)              276.1       247.9
Internet Publishing and Broadcasting                50.6        33.7
Telecommunications                               1,323.4     1,138.9
ISPS, Search Portals, and Data Processing          516.0       433.2
  Data Processing and Related Services             320.9       292.2
Accounting, Bookkepping, and Payroll               976.3       875.7
  Payroll services                                 158.9       124.6
Computer System Design and Related Services      1,341.2     1,148.1
Business Support Services                          784.4       746.2
  Telephone Call Centers                           406.2       363.2
  Telephone Answering Services                      54.8        50.9
  Telemarketing Bureaus                            351.4       312.3

Manufacturing Sectors

Computer and Electronic Products                 1,862.1     1,415.9
  Semiconductors and Electronic Components         308.7       237.9

Subtotal: At-Risk Industries                     6,853.9     5,791.8

All Nonfarm                                    131,073.0   130,513.3
  Manufacturing                                 16,932.3    14,757.7
  Nonmanufacturing                             114,141.3   115,757.7

                                              U.S. Employment (000)

                                                    % Change
Industry Name                                       2001-2003

Nonmanufacturing Sectors

Software Publishers (Except Internet)                -10.2%
Internet Publishing and Broadcasting                 -33.4%
Telecommunications                                   -13.9%
ISPS, Search Portals, and Data Processing            -16.0%
  Data Processing and Related Services                -8.9%
Accounting, Bookkepping, and Payroll                 -10.3%
  Payroll services                                   -21.6%
Computer System Design and Related Services          -14.4%
Business Support Services                             -4.9%
  Telephone Call Centers                             -10.6%
  Telephone Answering Services                        -7.1%
  Telemarketing Bureaus                              -11.1%

Manufacturing Sectors

Computer and Electronic Products                     -24.0%
  Semiconductors and Electronic Components           -22.9%

Subtotal: At-Risk Industries                         -15.5%

All Nonfarm                                           -0.4%
  Manufacturing                                      -12.8%
  Nonmanufacturing                                    +1.4%

* These industries have been most often noted as outsourcing to India
and East Asia.

Source: U.S. Bureau of Labor Statistics.

Table 2. U.S. Employment in Occupations at Risk to Outsourcing

Sectors                                Employment 2001  Average Annual
                                                         Salary 2001

All Occupations (Total U.S. Employment)

Occupations at Risk of Outsourcing         127,980,410     $34,020
Office Support *                             8,637,900     $29,791
  Computer Operators                           177,990     $30,780
  Data Entry Keyers                            405,000     $22,740
Business and Financial Support **            2,153,480     $52,559
Computer and Math Professionals              2,825,870     $60,350
Paralegals and legal Assistants                183,550     $39,920
Diagnostic Support Services                    168,240     $38,860
Medical Transcriptionists                       94,090     $27,020

Total in Outsourcing Risk Occupations       14,063,130     $39,631
Percent of All Occupations                       11.0%

* Office support aggregates data from 22 detailed Office and
Administrative Support categories.

** Business and financial support aggregates data from 10 detailed
Business and Financial Occupations.

Source: U.S. Bureau of Labor Statistics.

Chart 1. A Variety of Jobs Being Outsourced

Office         53.0%
Computer       26.0%
Business       11.0%
Sales           4.0%
Architecture    3.0%
Legal           2.0%
Art Design      1.0%

Note: Percentages computed on estimates for 2000.

Source: John C. McCarthy, "3.3 Million U.S. Services Jobs
to Go Offshore," TechStrategy Research Brief, Forrester
Research Inc., November 11, 2002.

Note: Table made from pie chart.

(1) Thomas F. Siems and Adam S. Ratner, "Do What You Do Best, Outsource the Rest?" Southwest Economy, November/December 2003, <http://www.dallasfed.org/research/swe/2003/ swe0306c.pdf>.

(2) Antonio Riera, Janmejaya Sinha, and Alpesh Shah, "Passage to India: The Rewards of Remote Business Processing," The Boston Consulting Group, 2002.

(3) Daniel W. Drezner, "The Outsourcing Bogeyman," Foreign Affairs, May/June 2004, <http://www.foreignaffaris.org.>.

(4) "Understanding Outsourcing," March 10, 2004, <http:// www.csis.org/040310_OutSourcing.pdf>.

(5) Ashok Deo Bardhan and Cynthia Kroll, "The New Wave of Outsourcing," Fisher Center Research Reports: Report #1103, Fisher Center for Real Estate & Urban Economics, November 2, 2003, <http://repositories.cdlib.org/iber/fcreue/reports/1103>.

(6) Ibid.

(7) John C. McCarthy, "3.3 Million U.S. Services Jobs to Go Offshore," TechStrategy Research Brief, Forrester Research Inc., November 11, 2002, <http://www.forrester.com/FirstLook/ 0,5767,117,00.html>.

(8) Drezner, <http://www.foreignaffaris.org.>.

(9) Siems and Ratner, <http://www.dallasfed.org/research/swe/2003/ swe0306c.pdf>.

(10) Bardhan and Kroll, <http://repositories.cdlib.org/iber/fcreue/ reports/1103>.

(11) McCarthy, <http://www.forrester.com/FirstLook/ 0,5767,117,00.html>.

(12) Drezner, <http://www.foreignaffaris.org.>.

(13) Drezner, <http://www.foreignaffaris.org.>.

(14) Bardhan and Kroll, <http://repositories.cdlib.org/iber/fcreue/ reports/1103>.

(15) Siems and Ratner, <http://www.dallasfed.org/research/swe/ 2003/swe0306c.pdf>.

(16) John Ribeiro, "Outsourcing Means U.S. Job Creation Is a Must, Powell Says," Computerworld, March 17, 2004.

(17) Understanding Outsourcing," March 10, 2004, <http:// www.csis.org/040310_OutSourcing.pdf>.

(18) Siems and Ratner, <http://www.dallasfed.org/research/swe/ 2003/swe0306c.pdf>.