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.

The data affirm this benefit. Catherine Mann of the Institute for International Economics conservatively estimates that the globalization of IT production has boosted U.S. GDP by $230 billion over the past seven years; the globalization of IT services should lead to a similar increase. As the price of IT services declines, sectors that have yet to exploit them to their fullest -- such as construction and health care -- will begin to do so, thus lowering their cost of production and improving the quality of their output. (For example, cheaper IT could one day save lives by reducing the number of "adverse drug events." Mann estimates that adding bar codes to prescription drugs and instituting an electronic medical record system could reduce the annual number of such events by more than 80,000 in the United States alone.)

McKinsey Global Institute has estimated that for every dollar spent on outsourcing to India, the United States reaps between $1.12 and $1.14 in benefits. Thanks to outsourcing, U.S. firms save money and become more profitable, benefiting shareholders and increasing returns on investment. Foreign facilities boost demand for U.S. products, such as computers and telecommunications equipment, necessary for their outsourced function. And U.S. labor can be reallocated to more competitive, better-paying jobs; for example, although 70,000 computer programmers lost their jobs between 1999 and 2003, more than 115,000 computer software engineers found higher-paying jobs during that same period. Outsourcing thus enhances the competitiveness of the U.S. service sector (which accounts for 30 percent of the total value of U.S. exports). Contrary to the belief that the United States is importing massive amounts of services from low-wage countries, in 2002 it ran a $64.8 billion surplus in services.

Outsourcing also has considerable noneconomic benefits. It is clearly in the interest of the United States to reward other countries for reducing their barriers to trade and investment. Some of the countries where U.S. firms have set up outsourcing operations -- including India, Poland, and the Philippines -- are vital allies in the war on terrorism. Just as the North American Free Trade Agreement (NAFTA) helped Mexico deepen its democratic transition and strengthen its rule of law, the United States gains considerably from the political reorientation spurred by economic growth and interdependence.

Finally, the benefits of "insourcing" should not be overlooked. Just as U.S. firms outsource positions to developing countries, firms in other countries outsource positions to the United States. According to the Bureau of Labor Statistics, the number of outsourced jobs increased from 6.5 million in 1983 to 10 million in 2000. The number of insourced jobs increased even more in the same period, from 2.5 million to 6.5 million.

POLITICAL ECONOMY

When it comes to trade policy, there are two iron laws of politics. The first is that the benefits of trade diffuse across the economy, but the costs of trade are concentrated. Thus, those made worse off by open borders will form the more motivated interest group. The second is that public hostility toward trade increases during economic downturns. When forced to choose between statistical evidence showing that trade is good for the economy and anecdotal evidence of job losses due to import competition, Americans go with the anecdotes.

Offshore outsourcing adds two additional political pressures. The first stems from the fact that technological innovation has converted what were thought to be nontradeable sectors into tradeable ones. Manufacturing workers have long been subject to the rigors of global competition. White-collar service-sector workers are being introduced to these pressures for the first time -- and they are not happy about it. As Raghuram Rajan and Luigi Zingales point out in "Saving Capitalism From the Capitalists," globalization and technological innovation affect professions such as law and medicine that have not changed all that much for centuries. Their political reaction to the threat of foreign competition will be fierce.

The second pressure is that the Internet has greatly facilitated political organization, making it much easier for those who blame outsourcing for their troubles to rally together. In recent years, countless organizations -- with names such as Rescue American Jobs, Save U.S. Jobs, and the Coalition for National Sovereignty and Economic Patriotism -- have sprouted up. Such groups have disproportionately focused on white-collar tech workers, even though the manufacturing sector has been much harder hit by the recent economic slowdown.

It should come as no surprise, then, that politicians are scrambling to get ahead of the curve. During the Democratic primary in South Carolina -- a state hit hard by the loss of textile jobs -- billboards asked voters, "Lost your job to free trade or offshore outsourcing yet?" Last Labor Day, President Bush pledged to appoint a manufacturing czar to get to the bottom of the outflow of manufacturing positions. In his stump speech, John Kerry bashes "Benedict Arnold CEOs [who] send American jobs overseas."

Where presidential candidates lead, legislators are sure to follow. Senator Charles Schumer (D-N.Y.) claimed in a January "New York Times" op-ed authored with Paul Craig Roberts that because of increased capital mobility, the law of comparative advantage is now null and void. Senator Tom Daschle (D-S.D.) has observed, "George Bush says the economy is creating jobs. But let me tell you, China is one long commute. And let me tell you, I'm tired of watching jobs shift overseas." Senator Christopher Dodd (D-Conn.) and Representative Nancy Johnson (R-Conn.) are sponsoring the USA Jobs Protection Act to prevent U.S. companies from hiring foreign workers for positions when American workers are available. In February, Senate Democrats announced their intentions to introduce the Jobs for America Act, requiring companies to give public notice three months in advance of any plan to outsource 15 or more jobs. In March, the Senate overwhelmingly approved a measure banning firms from federal contracts if they outsource any of the work overseas. In the past two years, more than 20 state legislatures have introduced bills designed to make various forms of offshore outsourcing illegal.