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.

Constantly rising relative prices have predictable consequences. Demand curves slope downward -- meaning that the demand for an item declines as its relative price rises. Applied in this context, this should mean decreasing relative demand for many personal services and increasing relative demand for many goods and impersonal services over time. The main exceptions are personal services that are strong "luxury goods" (as people get richer, they want relatively more of them) and those few goods and impersonal services that economists call "inferior" (as people get richer, they want fewer of them).

Baumol's disease connects to the offshoring problem in a rather disconcerting way. Changing trade patterns will keep most personal-service jobs at home while many jobs producing goods and impersonal services migrate to the developing world. When you add to that the likelihood that the demand for many of the increasingly costly personal services is destined to shrink relative to the demand for ever-cheaper impersonal services and manufactured goods, rich countries are likely to have some major readjustments to make. One of the adjustments will involve reallocating labor from one industry to another. But another will show up in real wages. As more and more rich-country workers seek employment in personal services, real wages for those jobs are likely to decline, unless the offset from rising demand is strong enough. Thus, the wage prognosis is brighter for luxury personal-service jobs (such as plastic surgery and chauffeuring) than for ordinary personal-service jobs (such as cutting hair and teaching elementary school).

IS FOREWARNED FOREARMED?

What is to be done about all of this? It is easier to describe the broad contours of a solution than to prescribe specific remedies. Indeed, this essay is intended to get as many smart people as possible thinking creatively about the problem.

Most obvious is what to avoid: protectionist barriers against offshoring. Building walls against conventional trade in physical goods is hard enough. Humankind's natural propensity to truck and barter, plus the power of comparative advantage, tends to undermine such efforts -- which not only end in failure but also cause wide-ranging collateral damage. But it is vastly harder (read "impossible") to stop electronic trade. There are just too many "ports" to monitor. The Coast Guard cannot interdict "shipments" of electronic services delivered via the Internet. Governments could probably do a great deal of harm by trying to block such trade, but in the end they would not succeed in repealing the laws of economics, nor in holding back the forces of history. What, then, are some more constructive -- and promising -- approaches to limiting the disruption?

In the first place, rich countries such as the United States will have to reorganize the nature of work to exploit their big advantage in nontradable services: that they are close to where the money is. That will mean, in part, specializing more in the delivery of services where personal presence is either imperative or highly beneficial. Thus, the U.S. work force of the future will likely have more divorce lawyers and fewer attorneys who write routine contracts, more internists and fewer radiologists, more salespeople and fewer typists. The market system is very good at making adjustments like these, even massive ones. It has done so before and will do so again. But it takes time and can move in unpredictable ways. Furthermore, massive transformations in the nature of work tend to bring wrenching social changes in their wake.

In the second place, the United States and other rich nations will have to transform their educational systems so as to prepare workers for the jobs that will actually exist in their societies. Basically, that requires training more workers for personal services and fewer for many impersonal services and manufacturing. But what does that mean, concretely, for how children should be educated? Simply providing more education is probably a good thing on balance, especially if a more educated labor force is a more flexible labor force, one that can cope more readily with nonroutine tasks and occupational change. However, education is far from a panacea, and the examples given earlier show that the rich countries will retain many jobs that require little education. In the future, how children are educated may prove to be more important than how much. But educational specialists have not even begun to think about this problem. They should start right now.

Contrary to what many have come to believe in recent years, people skills may become more valuable than computer skills. The geeks may not inherit the earth after all -- at least not the highly paid geeks in the rich countries. Creativity will be prized. Thomas Friedman has rightly emphasized that it is necessary to steer youth away from tasks that are routine or prone to routinization into work that requires real imagination. Unfortunately, creativity and imagination are notoriously difficult to teach in schools -- although, in this respect, the United States does seem to have a leg up on countries such as Germany and Japan. Moreover, it is hard to imagine that truly creative positions will ever constitute anything close to the majority of jobs. What will everyone else do?

One other important step for rich countries is to rethink the currently inadequate programs for trade adjustment assistance. Up to now, the performance of trade adjustment assistance has been disappointing. As more and more Americans -- and Britons, and Germans, and Japanese -- are faced with the necessity of adjusting to the dislocations caused by offshoring, these programs must become both bigger and better.

Thinking about adjustment assistance more broadly, the United States may have to repair and thicken the tattered safety net that supports workers who fall off the labor-market trapeze -- improving programs ranging from unemployment insurance to job retraining, health insurance, pensions, and right down to public assistance. At present, the United States has one of the thinnest social safety nets in the industrialized world, and there seems to be little if any political force seeking to improve it. But this may change if a larger fraction of the population starts falling into the safety net more often. The corresponding problem for western Europe is different. By U.S. standards, the social safety nets there are broad and deep. The question is, are they affordable, even now? And if so, will they remain affordable if they come to be utilized more heavily?