Thursday, September 15, 2005

Understanding the Offshoring Challenge

Almost overnight, concern over the issue of offshoring has swept the country. In February, White House economist Gregory Mankiw was forced to recant after saying offshoring is good for our economy. A few weeks later, an embarrassed Bush administration retracted its appointment of a new manufacturing tsar, an industrialist who, it turned out, had moved some of his factory operations to China. Federal and state lawmakers, meanwhile, have introduced a slew of bills purporting to slow the movement of U.S. jobs overseas.
The number of service sector jobs that have gone overseas is actually relatively small. But the fears engendered by offshoring have a valid basis. Since January 2001, the U.S. economy has lost almost 2 million jobs. Even now, with the economy (GDP) growing at over 3 percent a year, job creation has been surprisingly weak this far past the recession.1
The trade liberalizations of the 1990s, coupled with the explosive growth of Internet capacity worldwide, have made it possible to move many information processing and business service jobs offshore to low-wage but increasingly higher-skill countries, like China and India. This has exposed a whole new swath of our labor market to global competition, including high-wage, high-value-added jobs in fields such as software programming and accounting.
During the optimistic 1990s, U.S. workers were told that it did not matter if the United States lost lower-skill manufacturing jobs, as long as we replaced them with better paying jobs in new sectors like information technology (IT), and as long as workers upgraded their skills so they could qualify for the new jobs. But with slow job growth and offshoring, the impact of international trade and investment no longer seems so benign. Improving one's skills is a necessary but no longer sufficient condition for economic success. Working Americans wonder whether any job will be safe in the fiercely competitive global marketplace.
The debate over outsourcing and offshoring has been characterized by a confusion of terms. We define "outsourcing" as the process by which a company contracts with another to conduct specific business tasks (e.g., payroll, customer relations). Companies can outsource work to companies located in the United States or in other nations. When people complain about outsourcing, what they really mean is offshoring, which occurs when U.S. companies move a branch of their company overseas. For purposes of this paper, "offshoring" will refer to any process whereby work is moved outside this nation. While this can include both goods and services, this paper focuses on IT-enabled services.
It is unclear how many jobs have been lost due to offshoring. The Progressive Policy Institute has estimated that around 840,000 manufacturing jobs have been lost since the beginning of 2001 due to increased imports and decreased exports.2 Because the data are less robust, it is more difficult to estimate the number of jobs lost to services offshoring; however, some place the number at around 300,000 jobs during this period.
How many and what kinds of jobs are at risk? PPI estimates that the new digital economy is enabling as many as 12 million information-based jobs -- once considered relatively immobile -- to potentially be located virtually anywhere across the globe.3 While forecasting the number of jobs actually to be moved offshore in the next decade is difficult, a reasonable estimate comes from Forrester Research, which estimates that American companies will move 3.4 million jobs offshore by 2015.4 We calculate that 54 percent of these jobs pay more than the median wage of $28,580, and almost 33 percent pay in the top wage quintile ($46,000 and up).
There are three factors driving this trend. First, when an increasing share of work can be digitized or conducted by telephone, a place like Bangalore, India, is now functionally as close as the neighborhood bank or insurance office. Second, many low-wage developing nations have developed the infrastructure, skilled workforces, and business climates to become attractive locations for this work. Finally, wages in low-cost developing nations that on average are 20 percent of U.S. rates mean that companies can reduce their costs, often significantly, by moving work offshore.5
Is offshoring good or bad for America? The answer depends in part on where one sits. Those who see economic welfare as synonymous with consumer welfare view offshoring in a more positive light because it lowers prices and boosts competition. Likewise, those who see investor interests as paramount, as many in the Bush administration do, view offshoring as an unalloyed plus.6 In contrast, those who equate economic welfare with the welfare of workers see offshoring as lowering wages and boosting economic churning and job loss.
Offshoring has the potential to help the U.S. economy by allowing producers to lower prices and, in turn, raise living standards. But that textbook result only works if the country is close to full employment, if most of the offshored jobs are not higher-wage, higher-skill jobs, and if the United States continues to move up the ladder to higher valued-added work.
And while there is no doubt that offshoring, like trade in general, benefits everyone by lowering prices on a wide array of services, it is also true that it threatens particular workers, and in some cases entire communities. If most of the jobs lost due to offshoring are low-skill, low-wage jobs, the United States will benefit, as laid-off workers move up to higher wage, higher-skilled jobs -- especially if they receive necessary supports and retraining. Only the most hard core market fundamentalist, however, will argue that offshoring high-wage industries like aerospace, software, biotech, investment banking, and the movie and music industries to low wage nations would be in the national interest.
But the real threat posed by offshoring is that it could worsen an already alarming erosion of middle-class jobs. Jobs that pay middle-class wages are growing more slowly than higher-paid "knowledge" jobs at the top and lower-paid "service" jobs at the bottom. From 1999 to 2002, the lowest wage quintile gained 660,000 jobs and the first and second highest quintiles gained 820,000 jobs (see Figure 2). In contrast, job growth in the middle quintile was virtually flat, and the fourth wage quintile saw a jobs loss of 157,600. Moreover, wages for occupations in the top quintile grew three to four times faster than wages for jobs in the bottom two wage quintiles. Bureau of Labor Statistics (BLS) projections suggest that this bifurcation of the U.S. labor market is likely to continue (see Figure 3, PDF version). While not the only source of a middle-class job squeeze, offshoring could exacerbate this trend because the very jobs that are most amenable to offshoring -- manufacturing jobs and information-based services -- support middle-class families.
Offshoring is opening up a significant share of our services sector to trade and in some ways is making the U.S. economy more like a big state. When a state loses a job in manufacturing or any other sector to out-of-state residents, the multiplier effect in terms of additional lost income and jobs can be significant. As a greater share of the U.S. economy is traded, this means that changes in exports or imports will have a larger short-term effect on income and jobs than before. While it is true that the United States loses many more jobs to automation and other kinds of domestic churning than to trade, the multiplier from these jobs is much less since the activity is taking place within the U.S. economy. This does not mean that offshoring does not provide benefits, but it does suggest that the adjustments, for workers and regions, are not automatic or necessarily quick, especially if national economic policy ignores the problem.
Today, Americans are more anxious about trade because it is harder for them to envision where the next wave of goods jobs will come from to replace the ones lost to offshoring. It is always much easier to anticipate the employment losses from trade and technology than to predict where the new jobs will develop. An economist would say that the new jobs will come from where they always come from: the demand from 8 million businesses and 290 million Americans. As prices fall from productivity and trade, Americans do not put the savings under their mattresses. Lower prices mean consumers have more money to spend on vacations, cars, entertainment, and the like, and businesses have more to invest in research and new machinery. If the United States keeps innovating, we can be fairly confident that the country will continue to develop new and interesting work.
We can, however, make educated guesses about which sectors are likely to generate new jobs. As cited above, the BLS projects that, in terms of percentage growth, nine of the top 10 fastest growing occupations over the next decade will likely be either in the IT field (network systems and data communications analysts, up 57 percent) or health care (medical assistants up 58 percent). Sixteen of the 20 fastest growing occupational categories are health-related, five are IT related, and three are in education.7
Finally, what is to be done about offshoring? Opinions vary wildly, but four basic camps are emerging:
Ignore and Do Nothing: Laissez-faire conservatives, including some in the Bush administration, see offshoring not as a challenge for our economy, but as an opportunity. They take the Panglossian attitude that the market will ensure that all works out for the best. PPI is less confident that, absent public policy, offshoring will be a net benefit for the U.S. economy, particularly in the short run. Likewise, while trade normally boosts global prosperity, it does not always boost a nation's prosperity, particularly if it is subject to significant distortions as currently exist in both services and goods trade. By minimizing the problem, the Bush administration is eroding Americans' confidence in our ability to succeed in the global economy and thus unwittingly fueling protectionist sentiments.
Reject and Protect: Some on the left demand an end to "sending American jobs overseas." Anti-globalization activists call for laws that would prevent or heavily penalize offshoring. Such steps are probably doomed to failure for no other reason than because the new information and communications technologies make global production inevitable. Moreover, since America is the beneficiary of considerable "insourcing" -- foreign investment that creates good jobs here -- we should be wary of the risk that protectionism could trigger a destructive trade war.
Subsidize and Hand-Out: Some in the corporate community clamor for tax cuts and regulatory relief in the belief that such subsidies will enable U.S. industry to compete with companies in low-wage countries. Such a rear-guard strategy designed to reduce labor cost differentials through subsidies is simply the flip-side of protectionism.8 It might make companies marginally more competitive, but it would also lower our standard of living as taxpayers would have to pay higher taxes (or receive reduced government services) and/or face a more polluted and less safe environment. The goal of economic policy should not simply be to compete -- that is a means, rather than an end. The goal instead should be to foster a high standard of living for Americans, and transferring money from one group to another with the intention of reducing corporate costs does not achieve it.
Adapt and Innovate: If, as PPI believes, America cannot secede from the global economy, then we have no choice but to craft new public policies that help our firms become more productive and our workers become more skilled and agile. The proper response to outsourcing is to enhance our nation's ability to specialize in innovative, high-valued-added work, and fight more vigorously to end distortions in trade, while boosting aid to workers and communities hurt by global competition. On top of this, policy needs to facilitate a return to the kind of robust job creation the nation enjoyed during the Clinton administration.
This report does not purport to "solve" the complex problem of offshoring. It intends rather to describe the phenomenon, put it in proper perspective, and define the economic stakes for Americans and for policymakers. In a subsequent report, we will propose a comprehensive, "adopt and innovate" strategy. It has three key elements: A national competitiveness policy that feeds innovation, a commitment to tougher enforcement of global trade rules, and a plan to equip working Americans with new tools for economic success.


Post a Comment

<< Home