There have been many hues and cry over the phenomenon of outsourcing and the benefits and downsides of the same. The debate is primarily on the kind of effect that outsourcing has on the US economy. While the concept of outsourcing is not new to the world with manufacturers relying on outside suppliers to provide them with the parts for their products, the concept of moving jobs abroad as part of services outsourcing and moving plants and equipment overseas as part of the outsourcing of manufactured goods is a relatively recent phenomenon.
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It is now clear that outsourcing is here to stay. Despite talk of protecting American jobs in the recent presidential campaign, it is my view that as long as we are dependant on capital from China and elsewhere and as long as productivity gains are to be made because of outsourcing, there would not be a rollback of this aspect of the economic system.
I examine the writings of Bhagwati, Chanda, and others to find out the pros and cons of outsourcing as well as to get a perspective on the debate. There has been much rancor over outsourcing with prominent television talk show hosts like Lou Dobbs taking on the issue head-on and giving it a negative flavor. The other side on which the corporations are ranged protests that the coverage does not reflect the ground realities.
This paper starts by defining what outsourcing is and the types of outsourcing along with the benefits and criticisms of the same. It then argues that outsourcing as a phenomenon is a win-win situation for American companies and the economy in general. I look at this aspect closely along with empirical and statistical evidence supporting this point.
The definition of outsourcing varies from “Outsourcing is the act of obtaining services from an external firm” (Blog Source, 2004) to “sub-contracting the parts or the whole process to a third-party firm”. The concept of outsourcing started with the EDS (Electronic Data Systems) company way back in 1962 when they started to hive off processes to vendors. The outsourcing in the manufacturing space took shape in the 1990s when auto majors and retailers started to procure their components and slowly the entire product from overseas plants in China and elsewhere.
In the services space, Blog Source states that outsourcing in “BPO occurs when an organization turns over the management of a particular business process (such as accounting or payroll) to a third party that specializes in that process. The underlying theory is that the BPO firm can complete the process more efficiently, leaving the original firm free to concentrate on its core competency” (Blog Source,2004). This is a relatively recent phenomenon that has grown exponentially over the last ten years. The outsourcing of business functions happens to countries like India and the Philippines where there is a substantial pool of highly skilled and English proficient workforce available to do the work.
The other category of outsourcing is the software services aspect that is related to making offshore developers collaborate with the onshore experts in producing software. This can happen with in-house subsidiaries or sub-contracting the work to third-party providers. American companies are at the forefront of all types of outsourcing and the US is the primary outsourcer in the world. In all the types of outsourcing, the benefits accrued to the companies arise mainly from cost savings and efficiencies as we shall see in the next section.
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Outsourcing is supposed to benefit corporations in improving their business processes and making them concentrate on their core processes. This makes the company that is outsourcing competitive by raising the efficiency level and the resultant productivity jumps contribute to the bottom line of the company. This is the argument for outsourcing on the process efficiency front. According to the Dir Journal website, “One example is that of the early 90s, when the price of personal computers dipped because the U.S. chip manufacturers outsourced this offshore and thus reduced chip prices anywhere between 10 to 30 percent” (Dir Journal, 2008).
The main argument that outsourcing benefits the companies is that they save substantially in terms of profiting from lower labor costs overseas due to the wage differential and due to the dollar’s pre-eminence against the currencies of the developing countries. The lower labor costs make the companies save on payroll costs and this is significant in service industries that are labor dependant. The availability of skilled resources in the target countries makes the process of outsourcing that much cheaper and easy. The perceived benefits of outsourcing to the American economy, in general, have been described as mixed given the fact that outsourcing is a phenomenon that results in profits to the corporations but job losses to the workers.
Outsourcing in the manufacturing space is alluring as well. As the McKinsey Quarterly points out, “By shedding assets, companies can be born again as product designers, solutions providers, industry innovators, or supply chain integrators—and, it is said, quickly boost their return on invested capital” (Doig et al, 2001). Thus the high rate of returns enjoyed by the manufacturing industry in recent times is due to the incidence of outsourcing among manufacturing components.
For instance, Bhagwati and others argue that the benefits of outsourcing to the American economy are evident when one considers the categories of export and import. According to them, “This may happen, for example, because the U.S. exports goods that are more intensive in information technology services and imports goods that are less intensive in information technology. Taking outsourcing as given, foreign (say, Indian and Chinese) growth then makes the outsourced information technology services cheaper to the United States, which is beneficial” (Bhagwati et al, 2004).
The main criticism against Outsourcing is that it leads to job losses and a drain on the economy in terms of business loss. One of the reasons the debate is “muddled” is the lack of reliable data in the way the debate is framed. Thus, while Lou Dobbs claims that millions of jobs are being lost because of outsourcing. And as Srinivasan and others point out, “But even accepting these estimates at face value, Forrester is suggesting an average annual outflow of jobs of at most 300,000 (without any offset for the inflow of jobs due to outsourcing by other nations from the United States)” (Srinivasan et al, 2004).
Thus, the estimates that outsourcing is resulting in a net outflow of jobs remain contested. The criticism here is that the “U.S. investors, shareholders and American consumers derive the benefits of outsourcing, although sometimes at the expense of American wage earners” (Dir Journal, 2008). This becomes a contentious issue particularly at the time of the US presidential elections. This has been the plank of democratic presidential candidates from John Kerry to Barack Obama and the latter had promised in his campaign speeches that “he would do everything to protect the jobs in the US” and this would imply that he would take a more protectionist stance towards outsourcing.
At the macroeconomic level, the potential fallout of Outsourcing has been the steady indebtedness of the American economy to the Chinese. This is an area that still has not been openly discussed except in the last few days when Obama declared that he does not want “America to be a debtor nation to China”. How this works is that by exporting goods and providing services to the American consumers and corporations, the Chinese gain dollars to the extent that they are sitting on over 2 Trillion dollars of reserves. Because of the recent economic crisis in the US, this makes it easy for the Chinese to participate in the American economy by buying bonds and securities issued by the Federal government.
Thus, we have a situation where the transfer of dollars to China has resulted in the US being a net debtor instead of a creditor. And this is one bone that the opponents of outsourcing would gleefully pick with the proponents of the same. And there is the issue of the loss of competitiveness of the American companies to the point where regaining the edge in Manufacturing and Services may prove difficult.
Zero-sum game or win-win situation
We have seen in the preceding sections how there are benefits as well as downsides to the issue of Outsourcing. Now I want to examine the question of whether outsourcing is just a zero-sum game where one side gains at the expense of the other or whether it can be a win-win situation for both.
The most famous proponent of the win-win situation scenario is Thomas Friedman. In his book, The World is Flat, he talks about “how American companies stand to gain because of the theory of comparative advantage applied to contemporary economic conditions”. The theory of comparative advantage was originally proposed by the famous economist, Ricardo when he stated that two economies stand to gain when one economy that is good at producing a particular product trades with another economy that is good at a different product but not in the first one. Thus, both economies stand to gain in this comparative trade with each other.
Thomas Friedman argues that with the “flattening” of the world, there exist opportunities for people and companies all over the world to jump on to the global economy and reap the benefits of trade. Thus, what one company can produce and collaborate with others becomes a sort of synergistic fusion of people, processes, and products giving rise to a global economy charged with gains for everybody. While this scenario looks rosy, it overlooks the fact that there exist barriers to trade and the movement of people that pull the economy down. This is particularly relevant in the context of the current economic crisis where there might be protectionist trends in the US with the economy in deep recession.
As we have seen, outsourcing as a phenomenon has positive effects on the US economy as well as undesirable effects in terms of job losses. The mitigating factors for the undesirable effects would be to outsource non-key functions and ensure that the core competencies are retained. And there can be training programs and skill upgrades for workers who have lost their jobs on account of outsourcing and alternate employment found for them.
The outcry over outsourcing is bound to grow with the economy going into a deep recession. As we have seen in the preceding sections, this might lead to protectionist tendencies prevailing in the US. This would happen as the country may not be able to tolerate further losses on account of outsourcing. The other reason would be the increasing indebtedness of the US towards China that makes the cries for lesser outsourcing that much shriller.
However, if the US has to ensure that it does not do away with outsourcing completely. As we have seen it can be a win-win situation provided the right conditions are in place. These include prudent trade policies and sound fiscal and monetary policies as well. The US economy cannot fall into the trap of high costs on account of processes that can be outsourced but are retained. On the other hand, it cannot cope with severe job losses as well.
Thus, the need of the hour for the incoming administration would be for a well-thought-out strategy that takes into account all these factors and then considers policy responses. The bottom line should be that there cannot be a blind aversion to outsourcing and only when the informed debate takes place and all options are considered, there would be meaningful progress on the economics of outsourcing.
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- Bhagwati, Jagdish and Srinivasan, T. N. “The Muddles over Outsourcing”. Journal of Economic Perspectives.
- Doig, Stephen. “Has Outsourcing gone too far?” The McKinsey Quarterly. 2001.
- Friedman, Thomas. The World is Flat: A Brief History of the 21st Century. New York: Penguin, 2005.
- “How Outsourcing affects the US economy”. Dir Journal Website. 2008. Web.
- “Outsourcing 101”. Blog Source Website. 2004. Web.