American executives and managers who practice outsourcing every day must be puzzled by how controversial the practice has become among politicians. Lawmakers in Congress and in more than 30 states have targeted foreign outsourcing as a threat to US employment and prosperity. Along with certain critics in the news media, such as CNN’s Lou Dobbs, they charge that US companies are firing American workers in significant numbers and replacing them with foreign workers in low-wage countries such as India. Legislative proposals have focused on barring federal or state contracts with companies that would “offshore” the work to call centers or IT providers abroad.
1. Economic Benefits of Foreign Outsourcing
Of course, outsourcing itself is nothing new. US companies and governments have been outsourcing domestically for decades such services as payroll, data base management, and janitorial services. The new twist has been the recent increase in foreign outsourcing, or offshoring, in which companies buy services from foreign-based providers. Foreign outsourcing has been made increasingly cost-effective because of the personal computer, which has digitized much of our work, and high-speed and deregulated transmission of that information through broadband and the Internet.
Foreign outsourcing almost certainly benefits the US economy in the short as well as the long run. Like more conventional forms of trade, foreign outsourcing allows US companies to dramatically cut the cost of certain information technology services. As a result, US companies become more competitive in what they do best, their “core competencies.” Better and more affordable services become available for consumers and taxpayers. Outsourcing allows companies to operate on an around-the-clock 24/7 production cycle, further adding to productivity. It is even making possible work that simply wouldn’t exist otherwise, such as chasing down delinquent accounts receivable that were thought to be beyond collection. It could help control spiraling costs in such sectors as healthcare and education.
Foreign outsourcing of services invigorates the US economy, raising productivity and creating new opportunities. According to a 2003 study by Diana Farrell at the McKinsey Global Institute, outsourcing delivers large and measurable benefits to the US economy. It reduces costs for information technology (IT) and other services by as much as 60 percent, keeping US companies competitive in global markets, benefiting workers and shareholders alike. It stokes demand abroad for the export of US-supplied computers, telecommunications hardware, software, and legal, financial, and marketing services. It returns profits from US-owned affiliates abroad, and it allows US companies to re-deploy workers in more productive jobs here at home. In fact, McKinsey calculates that every $1 spent on foreign outsourcing creates $1.12 to $1.14 of additional economic activity in the U.S. economy. Another study by the consulting group Global Insights estimates the US economy will be $124 billion larger in 2008 because of outsourcing compared to an economy where the practice was restricted.
Foreign outsourcing could deliver the same scale of productivity gains to the IT services industry as it has to the hardware industry. Many of the components in a typical computer sold in the United States today are sourced from around the world, especially East Asia. According to a study by Catherine Mann at the Institute for International Economics in Washington, global sourcing for IT hardware cut the final costs to businesses and consumers by 10-30 percent, accelerating the diffusion of IT technology through the US economy. That diffusion added three-tenths of a point to GDP growth and a cumulative $230 billion to US gross domestic product. Foreign outsourcing, by spreading lower IT services costs to service sectors that make up 80 percent of the US economy, could have an even bigger impact on growth than the outsourcing of IT hardware.
2. Outsourcing Job Losses in Perspective
Unfortunately, those impressive economy-wide benefits are overshadowed in the political arena by concerns about job losses. A recent update of the much-cited 2002 study by Forrester Research Inc. projects that the number of US jobs outsourced abroad will increase from an estimated cumulative total of 315,000 in 2003 to 3.4 million by 2015. That would mean an average of 257,000 additional jobs outsourced each year.
Even if accurate, those numbers are just a few drops in the big bucket of an $11 trillion economy that employs 138 million people and creates and destroys millions of jobs every year. Even in times of healthy employment growth, 350,000 people file for unemployment insurance every week. The US Department of Labor estimates that only about two percent of job layoffs can be blamed on foreign outsourcing. New technologies, domestic competition, and changing consumer tastes cause the vast majority.
Think of all the former typists, telephone operators, and bank tellers whose work has been replaced by computers and other machines. For example, Kodak announced in January 2004 that it would lay off as many as 15,000 workers, or one-fifth of its global workforce, not because of foreign competition but because digital cameras have depressed the sale of film. Montgomery Ward, Winn-Dixie and other retailers have laid off tens of thousands of workers in recent years, not because of foreign competition but because of domestic competition from rivals such as Wal-Mart. Between 1988 and 2000, a net half a million jobs for typists and word processors were eliminated, not because they were outsourced but because they were made redundant by computers. Where were the congressional hearings, the angry sound-bites, and the Lou Dobbs’ tirades over all those job losses?
3. The Fall and Recovery of the IT Sector
Outsourcing cannot be blamed for recent troubles in the US information technology sector. Despite the turbulence of the past four years, the IT services sector remains a major force in the US economy. The domestic software, computer, and communications industries accounted for a combined $621 billion of GDP in 2003, up from $510 billion in 1999. IT services that are moving offshore are more than offset by increased output here at home. Any sluggishness in employment growth has been because of rising productivity, not because of falling production.
The jobs that have been lost in the IT sector tend to be the lower skilled and lower paid jobs in the industry–just as trade theorists would predict. Jobs in the sector did fall during the IT recession, but declining employment was concentrated in those occupations requiring relatively low or moderate levels of training and education. In contrast, the number of IT jobs that require a relatively high level of training and education declined more slowly, and they have recovered to their levels in the late 1990s, according to an analysis by the Cato Institute. Contrary to the popular angst that “our best jobs” are going overseas, the best jobs are staying here.
The recovery and expansion of job creation that has already begun in the IT sector should continue into the future. According to the US Department of Labor’s biannual projections, the number of jobs in computer and mathematical science occupations is expected to increase from three million to four million in the next decade, a rate of growth that will be twice as fast as employment in the rest of the private economy. Seven of the thirty fastest-growing occupations will be in the computer field, according to a recent Cato Institute study on job losses and trade.
4. Foreign Outsourcing Is a Two-Way Street
Another reality lost in the outsourcing debate is the amount of outsourcing the rest of the world sends to the United States. We are far and away the world’s top provider of outsourcing in the form of information technology, financial, communications, and other business services. In 2003, Americans sold $131 billion in private business services to the rest of the world. Those services include such outsourcing tasks as legal work, computer programming, management consulting, telecommunications, banking, and engineering. At the same time, Americans were buying or importing $77 billion worth of business services from the rest of the world, including call center and data-entry services from developing countries such as India and the Philippines. In other words, when it comes to outsourcing of business services, the United States ran a $54 billion surplus with the rest of the world last year.
As a Wall Street Journal report concluded, “The numbers suggest that Congressional efforts to restrict outsourcing by US companies may backfire, if they provoke retaliation by US trading partners. Economists also say that US service exporters–insurers for instance–might lose some competitive edge if they can’t use foreign suppliers for call centers or other back-office operations.”
In the more specialized area of IT services, America’s edge is even more pronounced. In 2002, according to the most recent figures, US companies exported $14.8 billion worth of computer, data processing, research, development, construction, architectural, engineering, and other IT services. During that same year, Americans imported $3.9 billion of those same kinds of services. So for every dollar Americans sent abroad for IT outsourcing in 2002, the world sent more than three dollars to the United States for “insourcing.” If Congress and state legislatures declare war against foreign outsourcing, American companies and workers will be among the first casualties.
Daniel Griswold has been the associate director of the Center for Trade Policy Studies at the Cato Institute in Washington since 1998. He has authored numerous studies on trade and immigration policy, which can be found at www.freetrade.org. His email address is dgriswold@cato.org.