Who wins in offshoring?, McKinsey Quarterly, Vivek Agrawal & Diana Farrell

Edited for class usage, http://news.com.com/2030-7341-5096283.html?tag=cd_hed

The number of US service jobs lost to offshoring will accelerate at a rate of 30-40% annually during the next five years. Wage differentials are prompting companies to move labor-intensive service jobs to countries with low labor costs. Developers, who cost $60 an hour in the US -- the country that does the most offshoring of jobs -- cost $6 an hour in India, the biggest market for offshore services.

Some believe that money spent to buy services abroad is lost to the US economy. Companies move business services offshore because they can make more money, which means that wealth is created for the US as well as for the country receiving the jobs. A McKinsey Global Institute study reveals the extent of the mutual benefits. For every dollar previously spent on business processes in the US and now goes to India, India earns a net benefit of at least 33 cents, in the form of government taxes, wages paid by U.S. companies and revenues earned by Indian vendors of business-process services and their suppliers. What is the impact on the U.S. economy? Some 70% of jobs in the US are in service industries such as retailing, catering and personal care. This work cannot be moved abroad. Any job losses must be seen as part of an ongoing process of economic restructuring. Technological change, economic recessions, shifts in consumer demand, business restructuring, and public policy (including trade liberalization and environmental regulation) can and frequently do result in job losses. Even when the economy is growing, mass layoffs -- usually from restructuring -- are much higher than the job losses predicted from offshoring. In 1999, for instance, 1.15 million workers lost jobs through layoffs, out of a total of 2.5 million lost. Liberalized, competitive economies with flexible labor markets can cope with such restructuring; the U.S. economy should be able to do so. Over the medium to long term, a flexible job market and the mobility of US workers will make it possible for the US to create new jobs faster than offshoring eliminates them.

According to the Organization for Economic Co-operation and Development, the US has the highest rate of reemployment of any member country by a factor of almost two. Over the past 10 years, 3.5 million private-sector jobs a year have been created, on average, for a total of 35 million new jobs, so most workers who lose their positions find another within six months. Jobs lost to low-cost foreign competitors are not so easy to replace, but from 1979 to 1999, 69% of the people who lost jobs as a result of imports in sectors other than manufacturing were reemployed. The mean wage of those reemployed was 96.2% of their previous wage. At current productivity levels, the country will need 5%, or 15.6 million, more workers by 2015 to maintain both its current ratio of workers to the total population and its living standards. By 2015, despite fears about job losses as a result of offshoring, the U.S. economy will need more, not fewer, workers. Offshoring is one way to meet that need. Offshoring creates value for the U.S. economy by creating value for U.S. companies and freeing resources for activities with more value added. It creates value in four ways:

Cost savings: For every dollar spent on business services that moves offshore, U.S. companies save 58 cents, mainly in wages. Offshore services are identical to those they replace. Reduced costs are the greatest source of value creation for the U.S. economy.

New revenue: Firms that provide offshore services need goods and services themselves. For every dollar of offshore corporate spending, suppliers of offshore services buy an additional 5 cents worth of US goods and services. Exports from the US to India stood at $4.1 billion in 2002, compared with $2.5 billion in 1990.

Repatriated earnings: Some offshore service providers are U.S. firms that repatriate earnings. Such companies generate 30% of the revenues of the Indian offshore industry. Four cents of every dollar spent on offshoring creates value for the US.

Redeployed labor: Capital savings can be invested to create new jobs, which is what has happened as manufacturing jobs moved offshore. The Bureau of Labor Statistics reports that manufacturing employment shrank by 2 million jobs in the past 20 years. Workers have found it easy to locate jobs in other areas. Service jobs, on average, pay more than the manufacturing ones they replaced, helping to increase the population's standard of living. As jobs in call centers, back-office operations and repetitive IT functions go offshore, retraining and investing capital will generate opportunities in higher-value-added occupations.

The Bureau of Labor Statistics estimates that from 2000-2010, there will be a net creation of 22 million new jobs in the US, mostly in business services, health care, social services, transportation, and communications. Using the data on reemployment and wage levels already noted – 69% of non-manufacturing workers are reemployed at 96.2% of their previous wages -- and 72 cents of every dollar that goes to offshoring had previously been spent on U.S. wages, the indirect benefit to the U.S. economy is an additional 45-47 cents for every dollar spent on offshoring. That is a conservative estimate because workers in IT and business services tend to find jobs more quickly than do workers in the service sector as a whole, and the demographic shift will increase the demand for workers. Offshoring, far from being bad for the US, creates net value for the economy. It directly recaptures 67 cents of every dollar of spending that goes abroad and indirectly might capture an additional 45 to 47 cents -- producing a net gain of 12-14 cents for every dollar of costs moved offshore.

The total possible wealth creation does not help people who lose their jobs or find lower-wage ones. Although 69% of those who lost non-manufacturing jobs were reemployed, 31% were not fully reemployed. Those who found new jobs secured similar wages (96.2% of their previous wage), 55% took lower-paid jobs, and 25% took pay cuts of 30% or more. Retraining and severance packages, accompanied by innovative insurance programs, could mitigate the effects of the transition without great cost to the economy. If U.S. companies can't move work abroad, they will become less competitive -- weakening the economy and endangering more jobs -- and miss the chance to raise their productivity by focusing on the creation of jobs with higher value added. The openness of the U.S. economy and its inherent flexibility -- particularly that of its labor market -- are two of its great recognized strengths. The current danger is that public policy will make its economy less flexible.

Discussion Questions

1. What is the current impact of offshore outsourcing on the US IT Job market?

2. Is the US IT market facing a temporary restructuring or a dramatic, permanent shift in the level of IT employment?

3. Even if the US is really creating new jobs faster than offshoring takes them away, what do the job losses mean to US IT workers? (Is relocation & retraining really “easy”?)

4. What is the problem with basing the number of workers needed in the US economy on current productivity levels per employee?

5. Are there flaws in the reasoning or data presented in this study?