Offshoring: The Next Industrial Revolution?

Alan S. Blinder

From Foreign Affairs, March/April 2006

Summary:  Economists who insist that "offshore outsourcing" is just a routine extension of international trade are overlooking how major a transformation it will likely bring -- and how significant the consequences could be. The governments and societies of the developed world must start preparing, and fast.

Alan S. Blinder is Gordon S. Rentschler Memorial Professor of Economics at Princeton University. He served on the White House Council of Economic Advisers from 1993 to 1994 and as Vice Chairman of the Board of Governors of the Federal Reserve from 1994 to 1996.

The range of professional- and business-service jobs includes everything from CEOs and architects to typists and janitors -- a heterogeneous lot. That said, in scanning the list of detailed subcategories, it appears that many of these jobs are at least potentially offshorable. For example, future technological developments may dictate how much accounting stays onshore and how much comes to be delivered electronically from countries with much lower wages.

The leisure and hospitality industries seem much safer. If you vacation in Florida, you do not want the beachboy or the maid to be in China. Reservation clerks can be (and are) located anywhere. But on balance, only a few of these jobs can be moved offshore.

Financial services, a sector that includes many highly paid jobs, is another area where the future may look very different from the present. Today, the United States "onshores" more financial jobs (by selling financial services to foreigners) than it offshores. Perhaps that will remain true for years. But improvements in telecommunications and rising educational levels in countries such as China and, especially, India (where many people speak English) may change the status quo dramatically.

Wholesale trade is much like retail trade, but with a bit less personal contact and thus somewhat greater potential for offshoring. The same holds true for transportation and utilities. Information-service jobs, however, are the quintessential types of jobs that can be delivered electronically with ease. The majority of these jobs are at risk. Finally, the phrase "other services" is not very informative, but detailed scrutiny of the list (repair and laundry workers appear, for example) reveals that most of these services require personal delivery.

The overall picture defies generalization, but a rough estimate, based on the preceding numbers, is that the total number of current U.S. service-sector jobs that will be susceptible to offshoring in the electronic future is two to three times the total number of current manufacturing jobs (which is about 14 million). That said, large swaths of the U.S. labor market look to be immune. But, of course, no one knows exactly what technological changes the future will bring.

A DISEASE WITHOUT A CURE

One additional piece of economic analysis will complete the story, and in a somewhat worrisome way. Economists refer to the "cost disease" of the personal services as Baumol's disease, after the economist who discovered it, William Baumol. The problem stems from the fact that in many personal services, productivity improvements are either impossible or highly undesirable. In the "impossible" category, think of how many musician hours it took to play one of Mozart's string quartets in 1790 versus in 1990, or how many bus drivers it takes to get children to school today versus a generation ago. In the "undesirable" category, think of school teachers. Their productivity can be increased rather easily: by raising class size, which squeezes more student output from the same teacher input. But most people view such "productivity improvements" as deteriorations in educational quality, a view that is well supported by research findings. With little room for genuine productivity improvements, and with the general level of real wages rising all the time, personal services are condemned to grow ever more expensive (relative to other items) over time. That is the essence of Baumol's disease.

No such problem besets manufacturing. Over the years, automakers, to take one example, have drastically reduced the number of labor hours it takes to build a car -- a gain in productivity that has not come at the expense of quality. Here once again, impersonal services are more like manufactured goods than personal services. Thanks to stunning advances in telecommunications technology, for example, your telephone company now handles vastly more calls with many fewer human operators than it needed a generation ago. And the quality of telephony has improved, not declined, as its relative price has plummeted.

The prediction of Baumol's disease -- that the prices of personal services (such as education and entertainment) will rise relative to the prices of manufactured goods and impersonal services (such as cars and telephone calls) -- is borne out by history. For example, the theory goes a long way toward explaining why the prices of health care and college tuition have risen faster than the consumer price index for decades.