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.

What about the service sector? Again, the data contradict the popular belief that U.S. jobs are being lost to foreign countries without anything to replace them. In the case of many low-level technology jobs, the phenomenon has been somewhat exaggerated. For example, a Datamonitor study found that global call-center operations are being outsourced at a slower rate than previously thought -- only five percent are expected to be located offshore by 2007. Dell and Lehman Brothers recently moved some of their call centers back to the United States from India because of customer complaints. And done properly, the offshore outsourcing of call centers creates new jobs at home. Delta Airlines outsourced 1,000 call-center jobs to India in 2003, but the $25 million in savings allowed the firm to add 1,200 reservation and sales positions in the United States.

Offshore outsourcing is similarly counterbalanced by job creation in the high-end service sector. An Institute for International Economics analysis of Bureau of Labor Statistics employment data revealed that the number of jobs in service sectors where outsourcing is likely actually increased, even though total employment decreased by 1.7 percent. According to the Bureau of Labor Statistics "Occupation Outlook Handbook," the number of IT-related jobs is expected to grow 43 percent by 2010. The case of IBM reinforces this lesson: although critics highlight the offshore outsourcing of 3,000 IT jobs, they fail to mention the company's plans to add 4,500 positions to its U.S. payroll. Large software companies such as Microsoft and Oracle have simultaneously increased outsourcing and domestic payrolls.

How can these figures fit with the widespread perception that IT jobs have left the United States? Too often, comparisons are made to 2000, an unusual year for the technology sector because Y2K fears and the height of the dot-com bubble had pushed employment figures to an artificially high level. When 1999 is used as the starting point, it becomes clear that offshore outsourcing has not caused a collapse in IT hiring. Between 1999 and 2003, the number of jobs in business and financial operations increased by 14 percent. Employment in computer and mathematical positions increased by 6 percent.

It is also worth remembering that many predictions come from management consultants who are eager to push the latest business fad. Many of these consulting firms are themselves reaping commissions from outsourcing contracts. Much of the perceived boom in outsourcing stems from companies' eagerness to latch onto the latest management trends; like Dell and Lehman, many will partially reverse course once the hidden costs of offshore outsourcing become apparent.

If offshore outsourcing is not the cause of sluggish job growth, what is? A study by the Federal Reserve Bank of New York suggests that the economy is undergoing a structural transformation: jobs are disappearing from old sectors (such as manufacturing) and being created in new ones (such as mortgage brokering). In all such transformations, the creation of new jobs lags behind the destruction of old ones. In other words, the recent recession and current recovery are a more extreme version of the downturn and "jobless recovery" of the early 1990s -- which eventually produced the longest economic expansion of the post-World War II era. Once the structural adjustments of the current period are complete, job growth is expected to be robust. (And indeed, current indicators are encouraging: there has been a net increase in payroll jobs and in small business employment since 2003 and a spike in IT entrepreneurial activity.)

Offshore outsourcing is undoubtedly taking place, and it will likely increase over the next decade. However, it is not the tsunami that many claim. Its effect on the U.S. economy has been exaggerated, and its effect on the U.S. employment situation has been grossly exaggerated.

THE UPSIDE OF OUTSOURCING

To date, the media's coverage of outsourcing has focused on its perceived costs. This leaves out more than half of the story. The benefits of offshore outsourcing should not be dismissed.

The standard case for free trade holds that countries are best off when they focus on sectors in which they have a comparative advantage -- that is, sectors that have the lowest opportunity costs of production. Allowing countries to specialize accordingly increases productivity across all countries. This specialization translates into cheaper goods, and a greater variety of them, for all consumers.

The current trend of outsourcing business processes overseas is comparative advantage at work. The main driver of productivity gains over the past decade has been the spread of information technology across the economy. The commodification of simple business services allows those benefits to spread further, making growth even greater.