The Argument for Outsourcing

Outsourcing is not a new idea. Everyone’s heard it before. Most often than not the term tends to have a negative connotation associated with it.  In this day and age where companies are continually striving for efficiency in operations and cost, it is not uncommon to look into overseas alternatives.  In this essay we will explore the history of outsourcing and refer to many economists to finally decide if it’s good for our society or not.

Why do companies expand operations to other foreign countries? There can be many reasons; the labor is not as costly, companies can investigate new markets, they can operate 24 hours a day, and they can pick from a different talent pool.  They can also do so for tax benefits, if the country’s corporate tax rate is lesser than what it is in the states.  However, we must not confuse this with inversion.  Inversion is when a firm will simply change its mailing address of its headquarters to another country in order to escape certain tax regulations.  This is different from outsourcing because it doesn't involve any core business operations in the country and it has no impact on jobs.

The image above shows the average hourly wage of entry-level accountants in different countries.  As you can see, firms can save a large amount if they went offshore to China or India with their accounting needs. 

Accounting is not the only area in which companies go abroad in.  Call center and recruitment facilities are now huge in India.  Because these are business functions that require a large amount of employees at once, they are perfect to outsource.  Gurgaon, Bangalore, and Hyderabad are all cities that have been swept up by large corporations and transformed into customer service and delivery mass hubs.  When you are on the phone with customer support, you almost always will hear an Indian accent on the other end of the line.  This can be frustrating to many Americans, not only because it’s hard to understand the accent, but also because some think that these workers “stole” jobs that belong to Americans.

Let me give some background on that last point.  In order to do this we will have to understand how the term “outsourcing” came into our world and became popular.  It dates back to the 2004 presidential campaign, when John Kerry and President George W. Bush both contributed to fueling the fierce debate about outsourcing.  On January 7, 2004, Senator Charles Schumer and Paul Craig Roberts published an Op-Ed in the New York Times and led a panel discussion on the modern instances of free trade.  They argued that free trade has become a thing of the past because of changes in our now global economy. 

Now, what does this have to do with outsourcing? Well, economists unanimously view business abroad as a form on international trade.  Trade almost always creates winners and losers, but that's the nature of it.  It produces winners and losers but also “involves gains to overall productivity and incomes” according to Gregory Mankiw, former CEA chairman.   This panel discussion sparked a new wave of interest to the activity known as outsourcing. 

In February of 2004, the White House released its Economic Report of the President and held a press conference for it.  Of course, the topic of the hour seemed to be outsourcing.  When asked for a comment on the subject, the chairman responded with the following:

I think outsourcing is a growing phenomenon, but it's something that we should realize is probably a plus for the economy in the long run. Economists have talked for years about trade, free international trade, being a positive for economies around the world, both at home and abroad. This is something that is universally believed by economists. The President believes this. He talks about opening up markets abroad for American products being one of his most important economic priorities. And we saw discussions this weekend of the Australia agreement. So it's a very important priority.

When we talk about outsourcing, outsourcing is just a new way of doing international trade. We're very used to goods being produced abroad and being shipped here on ships or planes. What we're 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 of items produced abroad come on planes and ships or over fiber optic cables? Well, no, the economics is basically the same. More things are tradable than were tradable in the past, and that's a good thing. That doesn't mean there's not dislocations; trade always means there's dislocations. And we need to help workers find jobs and make sure to create jobs here. But we shouldn't retreat from the basic principles of free trade. Outsourcing is the latest manifestation of the gains from trade that economists have talked about at least since Adam Smith.

After the report and the panel discussion, the Los Angeles Times was first of many to publish a twisted version of events with the headline “Bush Supports Shift of Jobs Overseas”, while the Washington Post published the article “Bush Offers Positive Outlook on Jobs, with 3% Growth Rate” and chose to highlight other aspects of the ERP report.  But it was the words of the Los Angeles Times article that spread like wildfire in America. The John Kerry campaign jumped on it and slammed President Bush with accusations of supporting cruel multinational corporations who take their jobs to other countries.  Because of the disappointing employment rate, the term “outsourcing” soon became synonymous with “job loss”.  

From the Op-Ed article to the ERP report to the Los Angeles Times article; it all seems like a huge misunderstanding to me.  I mean “offshoring” and “outsourcing” were still pretty new terms back then, and the media could have just amplified the confusion around them.  It could have to do with the wording of the panel discussion answer for the ERP.  The chairman started with the argument for outsourcing, but ended on a somber note- that there will be displacements of jobs.  Perhaps the correct way to go about this would be to get the negative point out of the way first and then to focus on the positives.  This also helps to acknowledge and satisfy the skeptics’ first thoughts but then to try and change those very thoughts using positive arguments.  But of course, the media will always try to stir up a controversial story especially one regarding White House affairs.

Soon after, John Kerry came up with a proposal to handle outsourcing, which would be implemented if he were elected president.  It proposed that US corporations who do work abroad would no longer be able to defer the corporate tax they would have to pay the government.  However, this may hurt the firms in a global environment because they will have to compete with foreign firms who may pay a lesser tax, or they are able to defer payment.  The stricter tax codes seem as though they may actually influence corporations to engage in an inversion!  We don’t want inversions because then we can’t include the earnings in our GDP, in turn, making our country look worse off.

On March 10, 2004 President Bush acknowledged recent concerns about offshoring and proceeded to attack the politicians whose wish was “to build a wall around this country and to isolate America from the rest of the world.” Bush had to continually emphasize this very idea, since the issue of outsourcing remained a major talking point all the way up to the November election. 

Bush was right; international trade needs to be protected and upheld as important to our economy.  Based on empirical evidence, increased employment abroad correlates with increased employment at the US location.  Although some jobs may be lost to outsourcing, the majority of jobs now days are actually lost to automation.  The real problem is with our mid-level jobs.  With vast technology innovations becoming mainstream, there is a lesser need for low to mid level employees.  It’s pretty obvious, why should firms pay workers a salary when they can get the job done by automation for a fraction of the cost?  Harvard economics professor Gregory Mankiw thinks that prohibiting outsourcing will lower our standard of living:

Economists understand that international trade is not, fundamentally, about job creation. An open economy can just as easily be fully employed as an autarkic one, and by realizing the gain from specialization and trade, it will have higher real wages and living standards. Moreover, exports and imports go hand in hand, so when a nation blocks imports, real exchange rates will adjust so it exports less as well. These are subtle lessons, however, and not easily explained in a short sound bite.

The thing is, it’s hard to tell if the jobs overseas are replacing jobs domestically.  If a company is doing some business in a different country, it cannot be assumed that they are outsourcing the work.  They could, in fact, be attempting to meet consumer demand via other avenues.  The only way to tell would be if companies were forced to tell the reason for each layoff.  This is where the mass layoff data comes in, and it very well may be the only systematical way to tell whether workers are being displaced because of outsourcing endeavors or not.

The Bureau of Labor Statistics confirmed in its report of Mass Layoff data that outsourcing work overseas was not a major reason behind mass layoffs. In fact, when analyzing the data, outsourcing appeared to be negligible and insignificant. 

In an academic report prepared by Desai, Foley, and Hines, international operations by American countries is said to “complement rather than substitute for domestic activity by the same firms”.  This makes sense because as companies explore foreign markets, they most likely will want to do business there, which will increase the need for domestic assistance and monitoring.  Mataloni, Hanson, and Slaughter also produced a report which states the same thing : “foreign activity does not crowd out domestic; the reverse is true. “

The idea of outsourcing isn’t at all a bad one, but it seemed to possess such a negative and twisted result.  Like I mentioned above, communication of new ideas need to be clarified and projected in a careful manner.  I don’t know if outsourcing would have gotten the attention it did if the chairman of the ERP did not end on the poor note of Americans losing jobs.  When firms are questioned why they are sending some processes overseas while domestic unemployment is high, they need to respond strategically.  As discussed before, they need to first acknowledge the fact that some jobs may be lost, and then explain why it would be better as a whole for the company.  Some tips would be to use the word “specialized” instead of “cheaper”, and “meeting customer’s needs” instead of “cost cutting”.  

The benefits of outsourcing are countless.  Not only are companies able to streamline and enhance their operations, they can change the lives of workers who live in under-developed towns.  I myself have visited to Gurgaon, India, a major tech hub for US multinationals, and have witnessed the poverty and scarcity there.  The American companies have built office buildings and various centers for cities like Gurgaon.  International trade is simply a win/win situation and I think our government needs to keep that in mind.