Outsourcing & International Trade
ECONOMICS: INTERNATIONAL TRADE & the EFFECT of OUTSOURCING
In the past few years the United States economy has emerged as a growing economy, dramatically and irreversibly impacting the global market. One of the most significant impacts of this growing economy lies in the area of outsourcing to foreign countries. The United States government and large corporations view outsourcing as a method of enabling international trade to prosper and allowing industries to grow. This economy has an international impact in regard to the recent trend in outsourcing and off-shoring; many domestic headquartered companies are now turning to outsourcing manufacturing and production to drive down costs.
As a result, these manufacturing positions are lost in the United States, but are creating more jobs in India, China and the Philippines. Although a majority of the literature regarding outsourcing is critical, concluding that it results in domestic job loss, there is a high amount of evidence to the contrary. According to the Business Council of New York State (2004), foreign outsourcing creates more jobs and higher real wages for American workers, and assists domestic companies in becoming more productive and competitive. This paper will discuss international trade, outsourcing, and the effects of outsourcing on domestic jobs. It will address the evidence proving that outsourcing actually helps to create domestic jobs, and will provide case study analysis regarding outsourcing in India.
A review of the literature regarding outsourcing indicates that it emerged in the early 2000s, but was not publicized until the mid-2000’s by the media reports. The media has been criticized as being responsible for the majority of the negativity associated with outsourcing as a result of their publications and broadcasts highlighting job losses attributable to outsourcing. This is because outsourcing first emerged as a trend in the manufacturing sector, where formerly high-paying jobs moved offshore to countries where vast amounts of labor were available at much lower costs. Outsourcing has been described as holding down the prices consumers pay for goods. According to Manci (2005), price drives demand as opposed to quality or brand recognition — the group of producers or region capable of producing a product for the least cost will dominate the marketplace. This is a benefit since companies will always have to compete with each other, the company selling the same goods at the cheaper price will sell more. As a result, other companies will also have to sell their competing goods at similar low prices. When this occurs, the customer saves money because companies competing with each other will have to maintain low prices for their goods.
Reasons for Outsourcing
Outsourcing is commonly defined as the practice of subcontracting manufacturing work to outside and especially foreign or nonunion companies. Belenkiy (2004) discusses the origins of outsourcing as beginning with the troubled manufacturing sector. He states that manufacturing has seen a decline in workforce as more and more labor intensive intermediate goods of production are being imported from countries that can produce those goods more cheaply. According to Belenkiy (2004), outsourcing activity is a kind of vertical foreign direct investment for the U.S. firm that splits the manufacturing of the final good across different countries. The use of foreign suppliers allows for a reduction in the complexity and in the average cost of producing a final good, without sacrificing proximity to the initial market and overall productivity (Belenkiy, 2004). He discusses that manufacturing jobs in the U.S. declined on their own at first, and were not a direct result of outsourcing. Belenkiy (2004) illustrates this point with statistics from Michigan. Michigan formerly was the nation’s capital of manufacturing; however, between 1970 and 2003 manufacturing employment declined from a 33% share to a 16% share of the job market. In the Michigan area, from 1994 to 2003, approximately 7000 manufacturing jobs disappeared. However, only 21% of those job losses were tied to international trade (Belenkiy, 2004).
As a result of this decline in the manufacturing sector, outsourcing brought some mixed trends in employment patterns in manufacturing industries. For example, advances in technology increased production costs and in order to remain competitive, manufacturers had to emphasize education and training. International trade forces firms to seek to increase the skill levels of their employees, hence increasing productivity over time (Belenkiy, 2004). Domestic manufacturing investment grew in the 1990s and the U.S. was the largest recipient of foreign investment. From 2002 to 2004, manufacturing investment by U.S. manufactures in China and Mexico was only 3% of $140 billion in investment by U.S. manufactures. While many opponents of outsourcing argue that it destroys domestic jobs and decreases wages through manufacturers’ access to cheaper goods overall, Belenkiy’s (2004) research finds that outsourcing actually increases domestic wages. Belenkiy (2004) states that opponents of outsourcing misjudge the real cause of the decline in jobs and the decrease in wages in the manufacturing sector. According to Belenkiy (2004), there is evidence to suggest that this decline is mostly attributable to an increase in the productivity of workers and to the widespread replacement of workers by highly productive machinery. Finally, he states that while it is true that manufacturing jobs are being lost, the loss is not primarily due to outsourcing activity.
Actual Rate of Job Loss Attributable to Outsourcing
Other research indicates that job loses due to outsourcing are actually very small in comparison to the usual rate of job loss. According to research conducted by Baily & Farrell (2004), losses of 30,000 jobs per month are very small compared to the two million or more job changes that occur routinely in a single month in the United States. In another study of related research, the Bureau of Labor Statistics (BLS) examined their unemployment insurance applications to identify firms that had layoffs involving more than 50 workers out of work for more than 30 days. The firms were then asked whether the layoff involved moving workers to a different geographical location within the company, whether the layoff involved moving work that was previously performed in-house to a different company, and the destination for any relocation (the state if domestic or the country if overseas). For the out-of-country relocations, the BLS research concluded that layoffs within a company or to a different company actually accounted for only 1.6% of job separations in mass layoffs over the first six quarters. Even more interesting, the BLS research concluded that outsourcing jobs only accounted for 3.3% of separations in mass layoffs. Thus, it appears that when compared to the normal rate of job loss, outsourcing does not account for more than 5% of the total numbers of domestic job loss. In other words, the majority of the research concludes that the vast majority of job losses do not involve the foreign relocation of work at all.
Positive Domestic Effects of Outsourcing review of the literature indicates that there are several positive effects of outsourcing, including the creation of additional domestic jobs. New York State can expect more than 18,000 new jobs by 2008 as a result of information- technology job growth outside the United States, according to a new study commissioned by the Information Technology Association of America (ITAA) (the Business Council of New York State, 2004). In addition, it is estimated that 18,239 new it jobs will be created over the next four years as a result of it outsourcing. The Business Council of New York State (2004), reports that the U.S. can expect 317,000 new net jobs by 2008, it found. The study also found that only 2.8% of U.S. It jobs losses over the past four years could be attributed to overseas outsourcing (the Business Council of New York State, 2004). Even though foreign outsourcing does cause some to lose their jobs, new economic activity spurred by offshore outsourcing created nearly 100,000 jobs nationwide in 2005. Further studies conclude that outsourcing will also boost the average real wage of U.S. workers by making businesses more productive. Since companies are able to provide outsourced labor at lower prices, more goods are sold at cheaper process, and the company grows, allowing it to pay its domestic workers higher salaries.
McKinsey (2003) concludes that outsourcing creates additional net value for the U.S. economy that did not exist before. For example, when $1 of labor cost is outsourced from the U.S., the total value created globally is $1.45 to $1.47; out of this, the receiving country such as India, captures just 33 cents (McKinsey, 2003). Thus, the remaining $1.12 to $1.14 is captured by the U.S. In terms of new revenues (the receiving country buys goods and services from the U.S.), repatriated earnings, and redeployed labor (Flatworld Solutions, Pvt. Ltd., 2007). In analyzing the McKinsey research, Flatworld Solutions Pvt. Ltd. (2007) states that outsourcing delivers tangible and significant benefits in the following ways: 1) reduced capital costs, 2) increased efficiency, 3) reduced labor costs, 4) quicker project starts, 5) focus on your core business, 6) level playing field, and 7) reduced risk. The benefits of offshore it outsourcing added $33.6 billion to real gross domestic product in the United States in 2003 (Flatworld Solutions Pvt. Ltd., 2007). Furthermore, by 2008, real GDP is expected to be $124.2 billion higher than it would be in an environment without it software and services offshore outsourcing (Flatworld Solutions Pvt. Ltd., 2007). Finally, over the last 10 years, the economy has created an average of 3.5 million new jobs a year, and the vast majority of displaced workers are re-employed within six months.
According to Flatworld Solutions Pvt. Ltd. (2007), between 1983 and 2003, two million manufacturing jobs were lost in the U.S., with the creation of 36 million new jobs in services. Forrester estimates that despite the headlines on offshore outsourcing, it jobs in the U.S. grew in 2003 and will continue to grow at three per cent from 2004 to 2008. Critics of outsourcing argue that it is dangerous to assume that the U.S. has better trained, harder working or more innovative workers capable of higher value added work than its foreign competitors (Flatworld Solutions Pvt. Ltd., 2007). However, proponents of outsourcing counter-argue that the U.S. has more opportunities than its competitors, and that there are not only a fixed number of jobs in the U.S. economy. Unlike its competitors, the U.S. competes in many industries, and new jobs in various sectors are always added. This is because unlike foreign countries that may only compete in a certain type of agriculture or textile industries, the U.S. competes in virtually every industry. Flatworld Solutions Pvt. Ltd. (2007) reports that in the U.S., technology and medicine are expected to be major drivers for domestic job creation.
As companies grow, new jobs are needed to keep up with the level of growth, and the majority of the higher positions are filled in the United States. The lower paid jobs are the ones that are outsourced, such as manufacturing and production, and upper level management positions are filled by domestically located employees. In addition, some countries are moving their plants from foreign countries back to the United States for various reasons. Research conducted by Forrester Research reports that between now and 2013, the U.S. will outsource 3.5 million jobs, or about 300,000 a year (Forbes, 2004). However, while the U.S. economy appears to be at a disadvantage as a result of all outsourcing, the economy is actually benefiting from in-sourcing at the same time. Although less publicized, the U.S. is in-sourcing more jobs than it is out-sourcing. For example, Samsung is placing a half-a-billion dollar plant in Texas, and Novartis is moving its research facility from Switzerland to Massachusetts (Forbes, 2004). According to Forbes (2004), the U.S. economy is creating 2 million jobs plus each year. Thus, outsourcing has greatly assisted in the creation of domestic jobs as well as jobs overseas.
A review of the literature also indicates that in-sourced jobs additionally benefit the U.S. domestic job market. in-sourced jobs pay 16.5% more than the average domestic job, and one-third of them are in the manufacturing sector. These include plants that assemble German and Japanese automobiles and produce pharmaceuticals. In the past 15 years, companies have moved jobs to the U.S. At a faster rate than jobs have been outsourced. For example, in-sourced jobs account for an 82% increase, as compared to a 23% increase in outsourced jobs. Manufacturing jobs have been in-sourced at a faster rate than service jobs, and finally, jobs in-sourced to the U.S. have increased from 4.9 million in 1991 to 6.4 million in 2001.
Benefits to International Trade
Outsourcing additionally carries benefits to international trade, however, these benefits are not widely publicized. For example, even though the U.S. would lose some manufacturing jobs to developing nations where labor costs are lower, the U.S. would gain higher-paying, higher-skilled jobs that poor nations were unable to fill with adequate individuals. The more recent trend of outsourcing service jobs makes that argument less compelling. The Wall Street Journal (2006), reports that a recent study concluded that at least two-thirds of the economic impact from sending jobs offshore flows back to the U.S. economy in the form of lower prices, expanded overseas markets, and fatter profits that U.S. companies can plow back into even more innovative businesses. Companies will sell more of their products if they are able to manufacture at a cheaper cost of labor. Since labor is cheaper, companies are able to hire additional people, and the market becomes more lucrative for U.S. exports. As workers are in desperate need in foreign countries, the low wages paid would eventually disappear, and the gap between low cost and low price will disappear.
Research by Hanson, Mataloni, and Slaughter (2003) examined the substitutability between domestic and foreign workers of U.S. multinational firms. Their research examined data on sales, employment, wages and tax rates, finding that higher sales in foreign affiliates led to an increased labor demand in the U.S. This is because the lower paid wages to lower skilled workers led to higher wages for higher skilled workers location in the United States. Desai, Foley, and Hines (2005) provide further evidence that foreign activity by U.S. multinationals compliments rather than substitutes for domestic activity by the same firms. Desai, Foley & Hines (2002) additionally concluded that an additional $10 of foreign capital investment is associated with $15 in additional domestic investment, and that $10 in additional foreign employee compensation is associated with $18 in additional domestic employee compensation. In research similar to the BLS research, Landefeld and Mataloni (2004) revealed that offshore outsourcing had only a very small impact in the U.S. labor market from 1989 to 1999. Landefeld and Mataloni (2004) found that outsourcing increased substantially over an overall ten-year period. They found that purchases of intermediate goods and services by U.S. multinationals rose as a share of sales from 1977 to 2001 but purchases of imports as a share of parents’ sales did not rise by much and actually decreased since 1998 (Landefeld and Mataloni, 2004). Finally, the majority of the research in this area states that job losses cannot be directly related to outsourcing as the media has portrayed in recent years.
Other research on outsourcing concludes that although the short-term affect of outsourcing may appear to be negative, the long-term effect is positive. The positive benefits of outsourcing have been proven good for international trade. For example, in the New York State Study, the evidence concludes that demand for U.S. exports will grow by more than $6 billion by 2008 due to the lower prices of U.S. produced goods and higher incomes in outsourcing destinations. In addition, while outsourcing does result in some short-term U.S. unemployment, its long-term benefits outweigh its costs. This is due to the fact that the cost savings and use of offshore resources lowers inflation, increases productivity and lowers interest rates. According to this study, these benefits “ripple” through the economy, and led to about 90,000 net new jobs through the end of 2003 (Mankiw and Swagel, 2006). According to Makiw and Swagel (2006), approximately 317,000 net new domestic jobs would be created through 2008.
Outsourcing Case Study in India
Outsourcing has focused on many countries overseas, including China, India and the Philippines; however, India has taken the lead the country most often outsourced to now. Although outsourcing to India has been prevalent for a long time, it has never been as large as it is now. According to Flatworld Solutions Pvt. Ltd. (2007), India has been able to attract jobs from the U.S. And other European countries. One of the reasons for this is that communication can be made between two countries without any difficulty, as the development in communication and technology has broken down barriers. Advancements in calling, emailing and chatting have made communication throughout the course of a project easy (Flatworld Solutions Pvt. Ltd., 2007). Organizations in India can send the completed work to organizations in the U.S. For reviewing many times and work can go back and forth with ease. According to Flatworld Solutions Pvt. Ltd. (2007), this is yet another reason why job outsourcing to India has become an ideal choice for outsourcers.
A review of the literature also indicates that another reason for the utilization of India for outsourcing is that India has a different time zone when compared to the U.S. And Europe. For India, this is a major advantage as jobs sent during the evening in the U.S. can be completed in India during the day and sent back to the U.S. (Flatworld Solutions Pvt. Ltd., 2007). Thus, the time zone advantage between India and U.S. has increased job outsourcing to India. In recent years, India has emerged as a new nation with democracy, support from the government, more freedom for businesses, fewer restrictions and regulations, lesser interest rates and fewer restrictions concerning outsourcing. India has benefited from all of the outsourcing; in prior years the population growth overcame the number of available jobs. In India people are satisfied to work for lesser salaries and what people earn from the outsourcing industry is much higher than what they would have earned elsewhere.
One of the most cited research in the area of outsourcing was conducted by McKinsey (2003), whose research outlines the benefits of foreign outsourcing. In 2003 McKinsey conducted interviews with offshore providers in India and numerical analysis on data from India and U.S. statistical agencies. McKinsey analysts interviewed several dozen offshore providers in India, divided them into categories based on the type of service provided, and estimated models of cost saving based on the company interviews and data from government sources and trade associations in India (McKinsey, 2003). McKinsey then combined this information with data on U.S. users of outsourced services and BLS employment data to arrive at estimates of benefits and cost savings.
McKinsey (2003) also estimated the income earned from re-employing displaced labor (calculated using wages from studies of displaced workers), along with some other smaller changes in income. This research summarized their cost-benefit calculation for one dollar of outsourcing as follows: 1) savings accrued to U.S. investors and/or customers from lower costs resulting from the use of outsourcing came to $0.58, 2) imports of U.S. goods and services by providers in India equal $0.05, 3) profits transferred by U.S. overseas affiliates to parents equal $0.04, and 4) the value from U.S. labor reemployed is conservatively estimated to be $0.45 to $0.47 (McKinsey, 2003). The cost-benefit summary of the McKinsey (2003) research gives a total gross gain to the United States of $1.12 to $1.14 for every dollar of work offshored to India, for a net increase in U.S. income of 12 to 14 cents per dollar of offshore outsourcing. Finally, the McKinsey (2003) research found India gains a total of $0.33 for every dollar of U.S. outsourcing.
An example of work other than manufacturing that has been outsourced to countries such as India is software programming and other technology related jobs. Software programming has been outsourced for years to India. According to the Wall Street Journal (2004), low-paying jobs in call centers also have been shifted to English-speaking countries around the globe. Now high-end computer-systems integration is leaving the U.S., too, as is architectural and design work (Wall Street Journal, 2004). An estimated 200,000 service jobs, a large percentage in information technology, have been shipped abroad to foreign affiliates of U.S. companies during the past three years (Wall Street Journal, 2004). If Indian programmers, for instance, produce software at lower prices than Americans can, that would reduce costs for the many users of information technology (wall Street Journal, 2004). This is a concrete example of how outsourcing to India, even skilled computer programming jobs, does not negatively affect domestic jobs. It illustrates how consumers prices in the U.S. are actually kept low. Also according to the Wall Street Journal (2004), as that lower-price software spreads through U.S. And European companies, those companies become more efficient, more productive and more able to hire new workers. Finally, at the same time, as India and China develop economically, they would become more-lucrative markets for U.S. exports. Thus, an examination of the research in this area concludes that outsourcing to India has many benefits.
As indicated above, the evidence in the area of outsourcing indicates that it favors domestic jobs in the U.S. In several ways. Even though the media presents it in a very negative manner, the reality of the research suggests that it assists in the creation of domestic jobs, and results in higher wages paid to domestic workers. In addition, it maintains the economy by keeping the competition level so that all companies must maintain low prices for the consumer. As Mankiw and Swagel (2006) state, there is a lot that remains unknown about outsourcing, largely because the available data do not provide the information needed to fully understand the magnitude of outsourcing, the reasons behind it, and the effects it has on the economy. However, the available research reaches the following conclusions: 1) the extent of outsourcing to date and in the foreseeable future is modest relative to any meaningful labor market indicator, and 2) as technology develops and global economic integration deepens, more jobs and people will be affected by actual or potential offshore outsourcing (Mankiw and Swagel, 2006).
A majority of the research indicates that outsourcing appears to be connected to an increase in U.S. employment and investment rather than a decrease in U.S. employment and job loss. Even though some domestic jobs are lost to foreign countries, firms involved with offshore outsourcing are not shifting net jobs overseas but instead are creating jobs both in the United States and in other countries. In examining the long-term results and the bigger picture, outsourcing appears to be more beneficial for the United States as a whole. According to Mankiw and Swagel (2006), this presents a challenge of how to best assist people affected by offshore outsourcing without retreating from international engagement and thereby giving up the economic gains that trade in services makes possible. While there will always be Americans affected by losing their jobs to someone overseas, these domestic job losses will be made up somewhere else in the U.S. economy. Finally, a review of the literature and research indicates that outsourcing is likely to be a good thing for the U.S. economy and for international trade.
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