The Economic Implications of Outsourcing

Prepared by

Shalley Dash

Fellow, Economics area

Institute of Integrated Learning and Management

3, Lodhi Institutional Area

Lodhi Road

New Delhi – 1100 03

Mobile : 9350837459

shalley.dash@ iilm.edu
 Abstract

For a developing economy such as India with a large pool of trained manpower outsourcing

represents a huge economic opportunity. In the West there has been considerable media led agitation

against outsourcing due to the unemployment it causes. The key point is that jobs created by

outsourcing are not really in Indian hands. It becomes imperative to understand what the political and

economic imperatives are governing outsourcing in the West. If political conditions in the West turn

adverse towards outsourcing it is likely to lead to protectionist tendencies and restrictions on

companies outsourcing to India.

This paper examines the economic implications of outsourcing within the context of the standard

Ricardian Comparative Advantage framework. An attempt is made to identify what are the benefits

and costs of outsourcing to both the US and India both theoretically and empirically. Key predictions

from trade theories are identified and the analysis distinguishes between losers and gainers both in

the short and medium run. This is further explored by looking at the evidence regarding employment

and outsourcing trends in the US and identifying future trends in outsourcing. The implications of

increased protectionist tendencies in the West for growth, and outsourcing are also explored.
Introduction

For a developing economy such as India with a large pool of trained manpower outsourcing

represents a huge economic opportunity. A study by the McKinsey Global Institute predicts that the IT

sector is expected to employ 4 million Indians and generate US$57 billion, or 7% of the GDP, by

2006.1 Outsourcing offers employment possibilities to trained labour without requiring labour mobility.

This has macroeconomic benefits too as increased employment adds to India’s national income and

purchasing power which adds to demand leading to a cycle of further growth.

From the perspective of the West outsourcing is in line with what neo classical economics suggests.

Firms outsource because they find that certain processes can be performed more cheaply elsewhere,

possibly developing economies. Outsourcing therefore represents a form of labour mobility without

actual movement of labour. Outsourcing reduces costs for firms and increases productivity. In the long

run both the individual firms and the economy can only benefit from such reduced costs and

increased profitability. But in the short run outsourcing causes unemployment .It is the short run where

we have to consider what is the euphemistically termed by international trade theories as ‘adjustment

costs’ or ‘redistributive’ effects of such policies and their implications for the future of outsourcing.

From the Indian perspective, outsourcing clearly represents a win win situation. Outsourcing brings in

jobs, provides employment for India’s large population of the educated unemployed graduates. In fact

as the Economist points out India has become one of the most important global offshoring

destinations primarily because of the more than 300,000 English-speaking college graduates a year
2
being churned out by the Indian educational system. If we factor in the macro effects of this

increased employment, it implies more expenditure, savings, demand for goods and services.

The theory of comparative advantage predicts that countries will specialize in production of goods

and services that they have a relative comparative advantage in and would import goods in which

other countries are more efficient. In this case the issue is that of the relative edge that the two

countries enjoy in the area of service exports. A key prediction from the International trade theory is

that for the outsourcing country there will be an increase in productivity, growth and employment in
sectors that benefit from outsourcing, whereas sectors facing outsourcing will shrink both in terms of

output and employment. A major problem that has surfaced with outsourcing has been the high

pitched emotional reaction of the American public, press and even politicians to the issue of jobs lost

due to outsourcing.

The key point is that jobs created by outsourcing are not really in Indian hands. We do the work but it

is created elsewhere. Therefore it becomes imperative to understand what are the political and

economic imperatives governing o utsourcing in the West. If political conditions in the West turn

adverse towards outsourcing it is likely to lead to protectionist tendencies and restrictions on

companies outsourcing to India. The moment this happens the flow of jobs to India or any other

outsourcing destination may start to dry up.

This paper seeks to provide an analysis of the costs and benefits associated with outsourcing within

the framework of international trade theories. An attempt is made to identify what are the benefits and

costs of outsourcing to both the US and India. The analysis distinguishes between losers and gainers

both in the short and medium run. The conclusions and predictions based on trade theories are

examined for relevance in the real world.

The structure of the paper is as follows: Section 1 examines the basic dimensions of the outsourcing

issue. Section 2 analyzes the outsourcing problem in a more formal way within the framework of the

theory of Comparative Advantage. Section 3 examines the empirical evidence regarding size and

benefits of outsourcing. One of the main problems associated with outsourcing is the perception that

outsourcing is moving up the skill ladder and upper end White Collar jobs are also being exported to

cheaper destinations. Section 4 anal yzes evidence of recent trends in outsourcing. Section 5 looks at

the effect of outsourcing on the American economy in terms of industrial growth, productivity and

employment. A major fall out of the recent media debate on is that there have been increasing calls

for protectionism by many sections of American society. Section 6 analyzes the likely fall out of

possible protectionist measures on the American economy. Section 7 summarizes the main

conclusions and offers some policy implications both for India and the US.
Section 1

Traditionally, outsourcing has been described as the sub-contracting of services from one company to

another - an activity as old as the first firms. Today, the term has come to encompass the specific

trend of importing services from low-cost providers located offshore – “offshoring.”

The outsourcing market for Information Technology (IT) services has been transformed over the past

decade. Rapid changes in communications and IT technology have reduced both the cost and time

required in transferring large amounts of data. For example advances in telecommunications have

resulted in an 80% rate reduction for a one -minute telephone call between India and US/Britain since

2001 and have made India one of the world's most attractive destinations for the offshoring of
3
services. Further outsourcing has started to diversify from its traditional strongholds of IT services to

many other types of business services for example the “Call Centre” is an example of outsourcing to

handle service-rel ated problems. Outsourcing has rapidly expanded to encompass a wide range of

services and back room operations of companies.

Companies in several sectors including healthcare, industrial, and information and communication

technologies have been establishing R&D bases in Asia - especially China and India. For instance,

Microsoft has set up its R&D arm in China, while GlaxoSmithKline plans to conduct four clinical trials

in India in 2004. Industrial companies including Visteon are launching R&D centers in China while

automotive companies such as General Motors have chosen India to outsource its complicated,

technical white-collar work to. The spread of this trend has been so pervasive that it has spread to all

kinds of services for example newspapers report that churches in the US and Europe are
4
“outsourcing” Holy Mass to parishes in Kerala in India where it is now known as the “Dollar Mass.”

Empirical evidence on the size of outsourcing presents a confused picture. Statistics are few and far

between, though there are a lot of emotional claims regarding the size of outsourcing to India and

other developing economies. Yet, in the absence of ‘hard numbers’, the public debate that has been

generated in the US is in danger of obscuring the powerful technolo gical and organizational changes
driving this phenomenon. Few large companies are now even prepared to discuss their outsourcing

strategies in public.

The Political and social dimensions of the outsourcing debate

Why is the export of service sector jobs causing so much of public anxiety? Outsourcing of

manufacturing jobs, for example, has been going on for a much longer time and probably affected far

more workers in the early 70’s? Outsourcing was one of the dominant issues in the recent 2004

elections with some political and organizational bodies demanding regulations on offshoring.

The outsourcing debate got a serious fillip when George Manikiw: Chairman of Economic Advisers to

the white house came out strongly in favour of outsourcing. His now much quoted comment goes as

follows:

“Outsourcing is a growing phenomenon, but it’s something that we should realize is probably a plus

for the economy in the long run. We’re very used to goods being produced abroad and being shipped

here on ships or planes. What we are not used to is services being produced abroad and being sent

here over the Internet or telephone wires. But does it matter from an economic standpoint whether

values planes and ships or over fiber-optic cables?” 5

Manikiw’s comment provoked a virtual storm of protest from all quarters of the American public.

Shorn of political rhetoric and media hype the main fear of the American public at large is that in a

world, where technology is evolving rapidly, the information revolution (especially the Internet) has

accelerated the decimation of U.S. manufacturing. Even service-sector jobs once considered safe,

can now be easily outsourced to cheaper destinations in the developing world.

The next section examines at the economics behind Manikiw’s com ment and its validity in the context

of the theory of Comparative Advantage.

Section 2

An Analysis of Outsourcing Within the Framework of Ricardian Comparative Advantage

As Manikiw’s comment shows there is nothing intrinsically different between imports of services and

imports of manufactured goods. The outsourcing problem lends itself to being analyzed most simply

using the simple Ricardian Comparative Advantage Model. In this section we overview the main

elements of this approach and it applicability to the outsourcing problem. An attempt is made to derive

predictions and hypotheses regarding the course of outsourcing and the impact of outsourcing on

other domestic sectors. The analysis is as yet in the preliminary stages and no attempt is made to

fo rmalize it into a mathematical model. Although the Ricardian model represents a gross

simplification of reality, it can still offer important guidance on the current outsourcing controversy,

expected benefits for the American economy and predictions for future trends.

Current day trade theory has its beginning in the late eighteenth century by David Ricardo who first

articulated the key concept of Comparative Advantage. Ricardo demonstrated that for two nations

without input factor mobility, specialization and trade could result in increased total output and lower

costs than if each nation tried to produce in isolation. Key to Ricardo’s analysis is the distinction

between absolute and comparative advantage for a country.

Comparative Advantage Explained

A country has a comparative advantage in producing a particular good if the opportunity cost of

producing that good in terms of other goods is less than in another country. The key point about

Ricardian Comparative Advantage is that it allows a country to specialize in producing the good in

which it has a comparative advantage. Even if one country can make everything more cheaply than

the other, it still gains from focusing on the goods in which its relative advantage is greatest—i.e., in

which it has a comparative advantage —and importing the rest.

We now introduce the great outsourcing debate. If we assume that America has a comparative

advantage in high technology items such as defense equipment, NASA rockets, supercomputers, etc.

India, on the other hand, has a comparative advantage in the production of or generation of low end

services, i.e., Call centers, computer code writing, etc.

The comparative advantage argument would go as follows: America should specialize all its

resources in the productio n of high tech products – both, service and manufactured, and import cheap

services from India. This essentially enables America to focus its resources on high tech and avoids

wastage of resources on low-end services. This situation would result in the greatest possible

increase in national output and hence growth and social welfare for both nations. Why? America

benefits because it specializes in production of high tech products, which it can then export to other

countries. India, which has a ready supply of educated manpower and hence low wages and where

the level of technological development is still behind America, can specialize in producing and

exporting low end services as cheaply as possible.

America benefits because it gets services at a much lower cost than they would cost in America. This

means the bottom line of American companies improves and they can invest more resources in areas

more in line with American comparative advantage. India benefits because of the increased

employment and income generated by the booming service exports. It appears to be a win win

situation for both countries.

However not all economists regard the benefits as being so clear-cut. In America the outsourcing

debate has polarized economists sharply. Two recent papers in the Journal of Economic

Perspectives , both by greatly respected economists, confront this question. The first paper is by Paul
6
Samuelson, a Nobel laureate and grand old man of current day economics. Samuelson raises a word

of caution against free trade always being beneficial. He takes the example He takes the case of a

poor country, where technical progress, improves productivity dramatically in the rich country's export

goods: again we can think of China's advances in semiconductors or India's in fi nancial services. In

this case its possible trade can turn to the poor country's advantage. The improvement in productivity

in the poor country can reduce the price of the rich country's exports by enough to make it worse off,
despite the increased availability of cheaper goods. It may be that not just some Americans lose, but

that the country as a whole is worse off.

7
The reply to this paper has come from Jagdish Bhagwati, Arvind Panagariya, and T.N. Srinivasan.

They show, using the classical trade model, that outsourcing is no different in economic terms from

the trade that has been going on since Ricardo's time. The standard results still hold including the

possibility that a country's export prices could fall so much that it becomes worse off.

Howeve r they also review empirical evidence available regarding such negative effects of free trade.

They find that historically, as productivity levels rise in developing economies, wages in these

economies also tend to rise. This phenomenon has been seen in the case of South Korea for

example. Secondly they are of the view that the skilled labour potential of economies such as India

and China has been over claimed. The supply of high quality skilled labour capable of taking away

American white collar jobs is no where near as large as the figure of 300 million which is often

claimed. Thirdly they are of the view that the current size of outsourcing is too small compared to the

total turnover of jobs in the American economy in an year to be a significant source of unemployment.

For example the figure of 3.4 million jobs by Forrester Research to be outsourced by 2015 represents

only .5% of the jobs in the industries affected. In an average year, the American economy destroys

some 30million jobs and creates slightl y more, dwarfing the effect of offshoring. 8 The view of the

authors is that even if many jobs that can be done cheaply do get outsourced this will after a period of

temporary unemployment result in reemployment in other high growth sectors. Thus they give the

example of American radiologists who lose out to their Indian counterparts. But if Radiology as whole

shrinks in America , other sectors such as advanced surgeries, etc may show higher growth.

Problems with Outsourcing

What are the problems as predi cted by theory? One view shared by Bhagwati and Manikiw among

others is that outsourcing can only benefit the American economy. Samuelson has raised a word of

caution when interpreting the impact of outsourcing on the American economy. The Ricardian model

predicts that one of the effects of outsourcing on the American economy will be to cause the service
sector in America to contract as jobs are outsourced. This leads to some unemployment. Trade

theories predict that this unemployment is basically frictional and the unemployed labour will be soon

absorbed by other sectors that are booming. The gap between what theory predicts and what the

American worker perceives as a net fall out of outsourcing represent the areas of controversy.

Analysis of some of the media and political commentary that has appeared on this issue over the last

few months suggests the following list of key questions which need to be answered:

1. The first problem appears to be the fears of unemployed American labour not getting jobs or no t

getting jobs quickly enough.

2. The second problem is that Americans are worried about the types of jobs being outsourced.

They were quite happy to outsource manufacturing activities to developing economies where they

can be done more cheaply. But they are less comfortable about exporting out white -collar jobs.

3. Thirdly and most fundamentally is the perception of the American public regarding the changing

nature of the comparative advantage of America. For quite some time America has led the world

in the ar ea of IT services. Now it seems developing countries are not just catching up in this area

but could also possibly actually take over other services that were earlier considered

nontradables. The much quoted example is that of outsourcing of work to Radiologists in India for

example.

These represent the core issues around which much of the American public angst against outsourcing

is centered. The only way to answer these questions is to look at the actual track record of

outsourcing and its impact on the American economy in terms of growth, employment, etc. Key

issues that need to be investigated are as follows:

• Is the current size of outsourcing of sufficient size to merit the kind of hue and cry that has

been made over it?

• What is the evidence regarding the impact of outsourcing on unemployment?

• Granted that theory predicts the benefits of outsourcing what is the evidence regarding size of

benefits from outsourcing ?

• What evidence is there of the changing nature of comparative advantage in America?

There are few serious studies available which can concretize any of the claims and counterclaims

being associated with outsourcing and its impact on the economy. The next few sections overviews

such evidence as there is available on this issue.

Section 3

Current size of outsourcing and it impact on unemployment

Loss of American jobs is an emotive issue; yet is the current size and scale of current levels of

outsourcing significant enough to have a significant impact on employment in America? The main

problem can arises due to limitations of short run labour mobility across sectors. To put it crudely: can

a displaced call center employee join NASA? Obviously not. Nevertheless we need to explore

whether the generalized benefits of outsourcing actually resul t n generating more employment

opportunities even for them? There is no one answer to this issue. Ultimately we need to analyze

facts to determine how valid are the fears of the American public.

Evidence regarding size of outsourcing

The key question is whether in the current scenario the scale of outsourcing is such as to justify the

current reactions to outsourcing? Empirical evidence on the size of outsourcing presents a confused

picture. Statistics are few and far between, however there are a lot of emotional claims regarding the

size of outsourcing to India and other developing economies. For example Forrester Research

updated a 2002 report in which it predicted an offshore migration of 588,000 US service-sector jobs

by year's end 2005 and 3.3 million by 2015. While the updated estimates reflect only a marginal

increase to 3.4 million jobs departing in the 2015 tally, the predicted jobs lost in the short term was
9
raised by 40%, to 830,000 through 2005. A study by Gartner suggests that 1 in 10 IT jobs will be

offshored, and that revenues from offshoring will grow from US$1.3 billion in 2003 to US$3.0 billion in
10
2004.

However these figures need to be interpreted with caution keeping in mind the total volume of service

exports in the US. For example Amiti and Wei(2004) find that U.S. business service imports as a
share of GDP have roughly doubled in each of the past several decades, from 0.1 percent in 1983 to

0.2 percent in1993 and 0.4 percent in 2003.

The share of India in total service imports to the US is still very small. In 1992, imports of private

services from India were only 1/2 of 1 percent of total U.S. imports of private services. In 2002,

imports of private services from India to the United States increased to nearly 1 percent of total

imports of these services. There was a larger increase in U.S.

imports from India in business services—a subcategory of private services—which has been the focus

of most of the media attention. They increased from 0.45 percent in 1992 to nearly 2 percent o f total

imports of business services in 2002. In fact the largest supplier of private services to the United
11
States is, in fact, Canada.

Again in terms of trading partners: contrary to popular perceptions the data shows the bulk of US

trade in services is with other industrialized countries. Imports of private services from developing

economies are low: In 1992, only 28 percent of U.S. imports of private services came from developing

countries. Although this share increased between 1992 and 2002, it still remains quite low at 32
12
percent; 68 percent of service imports originate in other industrial countries.

Empirical evidence therefore suggests that at least some of the hype is misplaced. Services account

for a very small proportion of total trade for the American , though it is a growing segment. Secondly

the US is itself a large exporter of services and most of US trade in services is with other developed

countries rather than developing countries.

Section 4

Impact of outsourcing on employment in the US

There is little hard evidence and much media hue and cry regarding the effects of outsourcing on

unemployment in America.

Amiti and Wei (2004) analyze data for the effects of foreign outsourcing of services on employment

and labor
productivity in U.S. industries between 1992 and 2001. The sample included all manufacturing

services and five service industries for a total of 100. Their results show that increases in service

outsourcing in

U.S. manufacturing and services sectors go hand in hand with g reater labor productivity. Why might

this be? This is likely due to firms relocating their least efficient parts of production to cheaper

destinations.

For manufacturing firms, the largest category of outsourced services is, indeed, business ser-vices.

Their results indicate that, when looking at finely disaggregated sectors, you find that only a small

number of jobs are lost as a result of service outsourcing. For example, when disaggregating the U.S.

economy to

450 industries, there is a small negative effect on employment. But aggregating up to 100 sectors,

there were no joblosses associated with service outsourcing. This implies that a worker could lose her

job due to outsourcing but then she, or an unemployed worker, may find a job in another firm within

the broader industry classification. Hence, aggregated data would indicate that there are no net job

losses when there is sufficient job creation in another sector. Similar results for found for the U.K. and
13
other European countries.

They conclude that although service outsourcing is growing rapidly, it still remains a small fraction of

industrial countries’ GDP. And it is not dominated by lopsided, one-way outsourcing from developed to

developing countries. In fact, most industrial countries do not outsource more (when adjusted for

economic size) than many developing countries. The United States, for example, which is a large

importer of business services, is also a large exporter of these services and, as has been noted, has a

growing net surplus i n business service trade. As for fears about job loss, our studies show that jobs

are not being exported, on net, from industrial countries to developing countries as a result of

outsourcing. In fact, the evidence suggests that job losses in one industry o ften are offset by jobs
14
created in other growing industries.

Trends in outsourcing
The outsourcing trend started with software development, and back office work. But the trend has

spread to often more technologically sophisticated, service sectors too . For example, estimates of

cost savings from outsourcing select engineering, information technology and other support functions

in the automobile component industry range up to nearly 50 per cent, compared with performing the

same functions in the U.S. S imilarly, the cost of developing a new drug, currently estimated at

between $600 million and $900million, can be cut by as much as $200 million if development work is

outsourced to India.15

This has led to fears that jobs in fields ranging from architectu re to radiology are at risk. Although

firms were able to relocate abroad in the past, they had to give something up—their closeness to

important markets, for example. With the new technologies, they can retain these links while also

obtaining access to che ap but well -trained labor. As a result, there does appear to be a backslide in

support for free trade policies, particularly among white-collar workers. This reinforces the perception

that outsourcing is moving up skill ladder threatening many White Collar jobs.

The evidence in this area is largely anecdotal. However according to figures by Forrester Research, it

is estimated that 3.3m American service-industry jobs will have gone overseas by 2015— this is a

very small proportion of the 7million -8million jobs lost every quarter in America through job-churning.

Further the bulk of these exports will not be the high-flying jobs of IT consultants, but the mind-

numbing functions of code-writing. 16

An online study by Freetrade.org reports that the biggest drop in employment was among jobs that

are relatively low on the skill ladder such as data entry keyers and electrical and electronic equipment

assemblers. Such jobs may require vocational training but not typically a bachelor's degree. 17 Job

losses were also heavy among IT occupations requiring even less education and training, such as

billing and posting clerks, machine operators, communications equipment operators, and computer

and office machine operators. From 1999 through 2002, total jobs in the first category requiring

moderate education and training declined 14. 6 percent, and those in the second category requiring
18
the least education and training declined by 10.5 percent.

In contrast, the number of jobs in the IT industry that required a relatively high level of training and

education was actually slightly higher in 2002 than it was in 1999. In the year before the dot.com and
telecom bubbles burst, the industry employed 3.43 million workers whose jobs required an associate's

degree, bachelor's degree, or work experience plus a bachelor's degree or more. After a surge of

hiring in 2000, followed by a painful shakeout, the number of such highly skilled workers stood at 3.51
19
million in 2002, up 2.3 percent from 1999.

The recovery and expansion of job creation that has already begun in the IT sector should continue

into the future. According to the U.S. Department of Labor's biannual projections, the number of jobs

in computer and mathematical science occupations is expected to increase from three million to four

million in the next decade, a rate of growth twice as fast as employment in the rest of the private

economy.

U.S. companies are also discovering the limits to outsourcing. There are perfectly good, market-driven

reasons why U.S. companies will continue to do most of their IT work onshore if not in-house. Foreign

outsourcing can generate costs of its own, such as the need for more travel, training, and

management oversight. Depending on the type of project, those costs can eat into if not entirely erase

the costs savings from lower wages abroad. Sending work abroad can also risk the loss of control of

sensitive personal and financial data and copyrighted material. It can mean the loss of control over

time-sensitive aspects of a project or becoming too reliant on outside firms. As some U.S. companies

have discovered, it can result in reduced quality of service if the providers are not sensitive to cultural

differences or lack specialized information expected by customers.

Section 5

Benefits of outsourcing

The benefits to the US economy are textbook. Outsourcing essentially implies that companies can

outsource some part of their activities to other countries where the work can be carried out more

cheaply as skilled labour salaries in developing economies are a fraction of what they are in the US.

It is obviously in the interests of profit maximizing firms to outsource activities. This will have the effect

of reducing costs and hence increasing profitability. This is the neoclassical side of the argument. The
benefits of outsourcing should therefore translate into higher productivity levels and output for the

firms benefiting from outsourcing. For the economy as a whole also outsourcing should be beneficial,

as it should result in higher growth and output levels for the economy as well.

Yes, some Americans in low value service jobs do lose their jobs due to outsourcing. But this should

be more than compensated by the increase in employment and output in industries higher up the

technological ladder that are more in line with America’s comparative advantage. The lost jobs and

lower wages in the U.S., should be more than offset when countries specialize like this, leading to

more robust exports and lower prices on imported goods. We have alrea dy seen that there is some

evidence this is already occurring.

A recent widely-cited report by the McKinsey Global Institute estimates a net cost reduction of 58

cents on every $1 “offshored” by firms, “even as they gain a better (or identical) level of service”.

Further the 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. 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. U.S. labor can be reallocated to more competitive, better-

paying jobs; for exam ple, 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.20 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
21
in services.

This is further corrobor ated by an Institute for International Economics study by Catherine Mann that

finds that globalization of computer hardware manufacturing led to a 10 to 30 percent decline in

prices, making such equipment more affordable and leading to a far greater increase in jobs in the

long run. Mann believes globalization of Information Technology (IT) services “will yield even stronger

job demand in the United States for workers with IT proficiency and skills.” Indeed, she notes that
overall employment in job classifications most affected by IT service outsourcing is rising, not falling.
22

Apart from the cost factor outsourcing also has some other benefits to outsourcing. Some of these are

Increase in Product Availability. An Institute for International Economics study by Catherine Mann

notes that globalization of computer hardware manufacturing led to a 10 to 30 percent decline in

prices, making such equipment more affordable and leading to a far greater increase in jobs in the

long run.

Stronger U.S. Job Demand. Mann believes globalization of Information Technology (IT) services “will

yield even stronger job demand in the United States for workers with IT proficiency and skills.” Indeed,

she notes that overall employment in job classifications most affected by IT service outsourcing is

rising, not falling.

Competitive Gains for Small Businesses. Researchers have also found that small firms and new

startups gain more from outsourcing than large corporations. The latter have managerial structures

that hinder their ability to take full advantage of outsourcing’s benefits. Smaller and younger

companies can easily organize themselves to utilize outsourcing, thereby gaining sales and

competing better in today’s global marketplace.

Rising Standards of Living. Indians now doing jobs outsourced from America are seeing a rapid rise in

their wages and standard of living. In the process, they are becoming more like Americans, which is

translating into demand for American goods and lifestyles. Thus, according to the McKinsey Global

Institute, for every $1 outsourced, the economic gain to the United States as a whole is $1.12 to

$1.14; whereas the country to which a job is outsourced gains just 33 cents.

Researchers have also found that small firms and new startups gain more from outsourcing than large

corporations. The latter have managerial structures that hinder their ability to take full advantage of

outsourcing’s benefits. Smaller and younger companies can easily organize themselves to utilize
outsourcing, thereby gaining sales and competing better in today’s global marketplace.

Indians now doing jobs outsourced from America are seeing a rapid rise in their wages and standard

of living. In the process, they are becoming more like Americans, which is translating into demand for

American goods and lifestyles. Thus, according to the McKinsey Global Institute, for every $1

outsourced, the economic gain to the United States as a whole is $1.12 to $1.14; whereas the country

to which a job is outsourced gains just 33 cents.

Sect ion 6

Adverse Effects of Protectionist Measures

So far the American government has stood squarely by outsourcing as being in the best interests of

the nation. Imposing tariffs makes Americans in general poorer. The workers in a "protected" industry

may have higher wages than they otherwise would under free trade, but US consumers would be

worse off because of higher prices. Most economists favor free trade because (at least under classical

assumptions) when the government imposes a tariff, the monetary gains to the winners are

outweighed by the monetary losses to the losers.

Since productive jobs are created by private companies, not the government, it is argued that

hamstringing U.S. firms with protectionist measures won't help them compete with their counterparts

in China or India or Singapore. Further such protectionist regulations may lead to retaliatory measures

by foreign countries. To prosper in the years ahead, U.S. firms need to have market access to the

large Indian and Chinese markets.

Outsourcing has led to calls for increased protection by workers and the media in the West. For

example in the UK British Telecom’s employee union initiated a series of one day strikes in 2003 to

resist the company decision to set up a call center in India and to force the High Court to intervene to

stop it. In the U.S., at the federal level, a flurry of bills like the “Job Protection Act” were introduced in

2003, designed to eliminate the tax incentives for offshore production and instead to provide tax

incentives to produce in the US. Another example is that in January 2004, the US Senate passed an
amendment that would prevent private companies from using offshore workers in order to compete

successfully against government workers on some contracts opened up to competition. Similarly

Drezner (2004) notes that coupled with statistics from various research organizations predicting an

exodus of service-sector jobs to offshore service providers, elected officials have begun calling for

tariff barriers, tax penalties for jobs -exporting companies, and other protectionist measures in an effort

to stem the offshoring

tide.

Proposed protectionist measures that have been suggested include a requirement for a company to

notify workers 90 days in advance of its intenti on to outsource their jobs overseas. Such measures

would be difficult to enforce, since it would be complicated to determine which jobs were transferred

overseas, rather than eliminated. In Europe, eliminating obsolete jobs is an expensive, lengthy

process for businesses. Burdensome job protection measures create a climate in which European

businesses are very reluctant to create jobs in the first place. Rather than outsource jobs, their

corporations make job-creating investments in other countries to begin with — including the United

States. Thus unemployment rates are far higher in Europe than in the United States.

Section 7

The Future of Outsourcing and Conclusions

Outsourcing is not a new concept. Blue-collar manufacturing jobs have been outsourced for 100

years. Textile jobs in South Carolina today were originally outsourced from Massachusetts. While the

transition was painful for Massachusetts textile workers in the short run, they soon found better jobs in

new industries. The same will be true for the current wave of outsourcing to developing economies.

The benefits of outsourcing to American workers and the U.S. economy greatly outweigh the costs.

Restrictions on outsourcing may save a few jobs in the short run, but they will come at the expense of

better jobs in the future — jobs that will not be created. Putting quotas and tariffs to stop people from

importing software and data from other countries over the Internet when it therefore makes little

economic sense.
For America the answer to outsourcing lies not in acceding to calls for protectionist measures.

Protectionism always hampers the growth of organizations by raising costs. In a fast changing world

where technological and comparative advantage equations change rapidly between nations,

measures that put legislative brakes on a firm’s ability to reduce costs and increase productivity will

ultimately damage growth prospects in the US. The evidence reviewed in the foregoing sections has

shown that by and large the unemployment created by outsourcing is more than made up the new

jobs created. In the short run there is however a case for providing a cushion to dislocated workers in

terms of soft educational loans, etc.

For India the future of outsourcing if allowed to continue is rosy. According to NASSCOM, the Indian

industry's lobby, the country's exports from the software, other IT services and business-process-

outsourcing industries grew by more than 25% to $12 billion last year, of which infrastructure services

accounted for just over $300m. But the potential is huge. A report by Deutsche Bank puts the entire

size of the global infrastructure-management market at $86 billion.

However the supply of cheap , skilled man power will definitely become a severe crunch According to

a Forbes report it is estimated that India would need to have 1 million qualified software engineers to

support exports of $50 billion. Currently it graduates around 110,000 computer science students a

year. With a dearth of experienced project leaders already on the horizon, that problem will reach a

crisis point as outsourcing continues to expand at a rate of more than 50% a year.23 India therefore

needs to invest aggressively in its educational system to ensure that it is able to produce the required

number of skilled labour .

 Footnotes

1
“Relocating the back office,” The Economist, December 13 2003.

2
Ibid.

3
Ibid.

4
See Rai, Saritha (2004). “Short on Priests, U.S. Catholics Outsource Prayers to Indian

Clergy,” New York Times , June 13, 2004 : A15.

5
See the report in the New York Times, Feb 11, 2004, page A26. For a statement in the same

vein, see the Council of Economic Advisors’ “Testimony before the Joint Economic Committee, US

Congress,” available at:

http://www.whitehouse.gov/cea/economic\_report\_20040210.html)

6
Samuelson, P.A.,(2004). “Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream

Economists Supporting Globalization” Journal of Economic Perspectives , Summer 2004, Vol. 18, No.

7
Bhagwati, Jagdish, Panagariya,.A. & Srinivasan, T. N., (2004). “The Muddles over Outsourcing.”

Journal of Economic Perspectives, Vol. 18, No. 4 September 2004.

8
For details on the estimates cited in this paragraph, see McKinsey Global Institute (2003). McKinsey

Global Institute (2003). “Offshoring: Is It a Win-Win Game?” San Francisco, CA,August 2003.

Available at: http://www.mckinsey.com/knowledge/mgi/rp/offshoring/perspective/

9
See http://www.forrester.com/Research/Document/Excerpt/0,7211,34539,00.html

10
Gartner Research, http://www4.gartner.com/Init
11
See “Demystifying Outsourcing:The numbers do not support the hype over job losses,”Mary Amiti

and Shang-Jin Wei in Finance and Development IMF Dec 2004)

12
Ibid.

13
See “Demystifying Outsourcing:The numbers do not support the hype over job losses,” Mary Amiti

and Shang-Jin Wei in Finance and Development IMF Dec 2004)

14
Ibid.

15
For details on the estimates cited in this paragraph, see McKinsey Global Institute (2003). McKinsey

Global Institute (2003). “Offshoring: Is It a Win-Win Game?” San Francisco, CA,August 2003.

Available at: http://www.mckinsey.com/knowledge/mgi/rp/offshoring/perspective/

16
“The great hollowing-out myth” The Economist print edition, Feb 19th 2004

17
HYPERLINK "http://www.freetrade.org/pubs/FTBs/FTB -010.html" \l "_edn5" \o ""

18
Ibid.

19
For details on the estimates cited in this paragraph, see McKinsey Global Institute (2003). McKinsey

Global Institute (2003). “Offshoring: Is It a Win-Win Game?” San Francisco, CA,August 2003.

Available at: http://www.mckinsey.com/knowledge/mgi/rp/offshoring/perspective/

20
Ibid.

21
See “Demystifying Outsourcing:The numbers do not support the hype over job losses,”Mary Amiti

and Shang-Jin Wei in Finance and Development IMF Dec 2004)

22 Available
Cathernine Mann “ Study on Outsourcing”, Institute for International Economics at

http://www.iie.com/

23
Todd Jatras “Can India Retain Its Reign As Outsourcing King?” Forbes.com,
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Staff, SMH.com.au, May 19

Shalley Dash

Shalley Dash is Associate Professor Economics in the School of Arts & Management Sciences

(SAMS) and Rai Business School. Shalley has completed her Masters in Economics from the Delhi

School of Economics and an M. Phil in Economics from J.N.U. She has also worked for several years
in marketing research agency ORG-Marg Pvt. Ltd. Her current areas of interest include Managerial

Economics, Macroeconomics, International Economics and Marketing Research.

Email: shalley.dash@raifoundation.org