The Outsourcing Bogeyman

Daniel W. Drezner

From Foreign Affairs, May/June 2004

Summary:  According to the election-year bluster of politicians and pundits, the outsourcing of American jobs to other countries has become a problem of epic proportion. Fortunately, this alarmism is misguided. Outsourcing actually brings far more benefits than costs, both now and in the long run. If its critics succeed in provoking a new wave of American protectionism, the consequences will be disastrous -- for the U.S. economy and for the American workers they claim to defend.

Daniel W. Drezner is Assistant Professor of Political Science at the University of Chicago and the author of "The Sanctions Paradox." He keeps a weblog at www.danieldrezner.com/blog; full references and data sources for this article can be found here.

At first glance, current macroeconomic indicators seem to support the suspicion that outsourcing is destroying jobs in the United States. The past two years have witnessed moderate growth and astonishing productivity gains, but overall job growth has been anemic. The total number of manufacturing jobs has declined for 43 consecutive months. Surely, many observers insist, this must be because the jobs created by the U.S. recovery are going to other countries. Morgan Stanley analyst Stephen Roach, for example, has pointed out that "this is the first business cycle since the advent of the Internet -- the enabler of a new real-time connectivity to low-cost offshore labor pools." He adds, "I don't think it's a coincidence that this jobless recovery has occurred in such an environment." Those who agree draw on anecdotal evidence to support this assertion. CNN's Lou Dobbs routinely harangues U.S. companies engaged in offshore outsourcing in his "Exporting America" series.

Many IT executives have themselves contributed to this perception. When IBM announced plans to outsource 3,000 jobs overseas this year, one of its executives said, "[Globalization] means shifting a lot of jobs, opening a lot of locations in places we had never dreamt of before, going where there's low-cost labor, low-cost competition, shifting jobs offshore." Nandan Nilekani, the chief executive of the India-based Infosys Technologies, said at this year's World Economic Forum, "Everything you can send down a wire is up for grabs." In January testimony before Congress, Hewlett-Packard chief Carly Fiorina warned that "there is no job that is America's God-given right anymore."

That last statement chills the blood of most Americans. Few support the cause of free trade for its own sake, out of pure principle. The logic underlying an open economy is that if the economy sheds jobs in uncompetitive sectors, employment in competitive sectors will grow. If hi-tech industries are no longer competitive, where will new jobs be created?

INSIDE THE NUMBERS

Before answering that question, Americans need to separate fact from fiction. The predictions of job losses in the millions are driving the current outsourcing hysteria. But it is crucial to note that these predictions are of gross, not net, losses. During the 1990s, offshore outsourcing was not uncommon. (American Express, for one, set up back-office operations in India more than a decade ago.) But no one much cared because the number of jobs leaving U.S. shores was far lower than the number of jobs created in the U.S. economy.

Similarly, most current predictions are not as ominous as they first sound once the numbers are unpacked. Most jobs will remain unaffected altogether: close to 90 percent of jobs in the United States require geographic proximity. Such jobs include everything from retail and restaurants to marketing and personal care -- services that have to be produced and consumed locally, so outsourcing them overseas is not an option. There is also no evidence that jobs in the high-value-added sector are migrating overseas. One thing that has made offshore outsourcing possible is the standardization of such business tasks as data entry, accounting, and IT support. The parts of production that are more complex, interactive, or innovative -- including, but not limited to, marketing, research, and development -- are much more difficult to shift abroad. As an International Data Corporation analysis on trends in IT services concluded, "the activities that will migrate offshore are predominantly those that can be viewed as requiring low skill since process and repeatability are key underpinnings of the work. Innovation and deep business expertise will continue to be delivered predominantly onshore." Not coincidentally, these are also the tasks that generate high wages and large profits and drive the U.S. economy.

As for the jobs that can be sent offshore, even if the most dire-sounding forecasts come true, the impact on the economy will be negligible. 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.

There is also reason to believe that the unemployment caused by outsourcing will be lower than expected. Gartner assumed that more than 60 percent of financial-sector employees directly affected by outsourcing would be 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.

Moreover, it is debatable whether actual levels of outsourcing will ever match current predictions. Despite claims that the pace of onshore and offshore outsourcing would quicken over time, there was no increase in 2003. In fact, TPI Inc., an outsourcing advisory firm, even reports that the total value of business process outsourcing deals in the United States fell by 32 percent in 2003.

There is no denying that the number of manufacturing jobs has fallen dramatically in recent years, but this has very little do with outsourcing and almost everything to do with technological innovation. As with agriculture a century ago, productivity gains have outstripped demand, so fewer and fewer workers are needed for manufacturing. If outsourcing were in fact the chief cause of manufacturing losses, one would expect corresponding increases in manufacturing employment in developing countries. An Alliance Capital Management study of global manufacturing trends from 1995 to 2002, however, shows that this was not the case: the United States saw an 11 percent decrease in manufacturing employment over the course of those seven years; meanwhile, China saw a 15 percent decrease and Brazil a 20 percent decrease. Globally, the figure for manufacturing jobs lost was identical to the U.S. figure -- 11 percent. The fact that global manufacturing output increased by 30 percent in that same period confirms that technology, not trade, is the primary cause for the decrease in factory jobs. A recent analysis of employment data from U.S. multinational corporations by the U.S. Department of Commerce reached the same conclusion.