Outsourcing

Outsourcing: it’s a topic where everybody has an opinion, but few have the facts. Yet it’s a most important subject — one that has the potential to alter the fabric of the global economy. It’s particularly important for us to consider in southestern Pennsylvania, at a time when our regional economy is at a crossroads.

We can debate the pluses and minuses of outsourcing, but the fact remains that it’s happening, and it’s growing. How might this affect us locally? Is there any way for us to leverage this trend? Let’s take a closer look.

What is outsourcing?

Any time a company gives out work to be done by someone else, that’s outsourcing. When Sears uses an outside law firm, when Ford asks Goodyear to make the tires for its cars, when iGate directs ADP to process its payroll, that’s outsourcing. Many major U.S. companies such as IBM, EDS and Accenture built their business on outsourcing.

Much outsourced work is done in the United States. Although different companies may be doing the work, the national economy retains all of the jobs. What creates concern is work outsourced to other countries (“offshore”), because it generates jobs somewhere other than domestically.

Offshore outsourcing has been happening for centuries. It became a subject of national concern in America in the 1970s and 1980s, when U.S. manufacturers — to stay competitive — started shutting down plants in the U.S. and either setting up their own plants in lower-cost countries, or subcontracting (outsourcing) the work to other manufacturers in these countries.

More recently, there have been a lot of stories in the media about services jobs moving offshore, particularly in the software and call center industries. This has ignited a new wave of concern. Given that the services sector accounts for the majority of jobs of the U.S. economy, as well as in southwestern Pennsylvania, is any job safe?

Why do companies do it?

Very simply, for the same reason so many of us shop at Wal-Mart: better value. Our purchases are driven by value — getting the quality we desire at the best possible price.

Companies as buyers of goods and services have the same motivation. Global competition for winning the hearts, minds and dollars of consumers has become brutal. The only way to win is by offering the best value, as industry leaders Dell, Toyota, Southwest and Wal-Mart have proven beyond any doubt. Conversely, companies not using every tool at their disposal to provide the best value lessen their ability to compete, putting their future — and that of their employees — at risk. Offshore outsourcing provides a way to potentially lower operating costs, access the best talent globally, run 24-7 global operations and even increase quality — all of which help create greater value.

What’s striking is that industry-leading companies such as Citibank, American Express, GE, Dell, Apple and Microsoft are also, by and large, the ones that use offshore outsourcing aggressively. And as it happens, these companies are also hiring more employees in the U.S. GE, for example, added over 7,000 U.S. employees between 2001 and 2004; its employment in other countries declined by 10,000 in the same period (most recent numbers available). Citibank added 10,000 U.S. employees between 2002 and 2005. Microsoft grew its U.S. employee base from 27,000 in 2000 to over 40,000 in 2005. Dell grew from 21,000 U.S. employees in 2003 to 26,000 in 2006.

But hold on, you say — the companies that use offshore outsourcing are also the ones hiring more employees in the U.S.? The answer is yes, because these are the companies that are using every tool in their arsenal — offshore outsourcing is just one — to provide the best customer value. And the companies that provide the best customer value are the ones that grow.

What is the impact?

At this stage, very small. Less than 1 percent of the services outsourced by U.S. companies is done offshore, with estimates of the number of U.S. jobs affected varying from several thousand (U.S. Bureau of Labor Statistics) to half a million (Forrester Research). Even the high end represents less than one-half of 1 percent of the U.S. workforce.

Many more jobs are affected in the U.S. by other domestic factors such as productivity gains, technology change, the business cycle, or consumer demand shifts. For example, every percentage point increase in U.S. productivity means 1.4 million jobs lost. A 3 percent annual productivity increase means 4 million fewer jobs — and that’s every year.

Here’s another interesting fact: Foreign companies outsource more services work to U.S. companies than we send to them. Foreign businesses recognize that U.S. financial institutions, advertising agencies, legal and accounting firms lead the world, and therefore send a lot of work their way. As a result, the U.S. generates a trade surplus in services.

Should we put up protectionist walls? Countries that tried protecting workers this way — like Germany and France — now have systemic unemployment rates almost double that of the U.S. Other benefits include the impact on families in the world’s poorer countries, where standards of living, health care and education continue to improve.

And, of course, what are people in these countries buying with their growing income? Nike sneakers, Gap jeans, Pepsi-Cola, Hollywood movies, Citibank lines of credit — the majority of the most recognized brands in these countries are, in fact, American. As a result, U.S. exports to these countries are growing rapidly.

How will services outsourcing affect southwest Pennsylvania?

Many of the largest economic sectors in this region — health care, government, education, retail, hospitality, construction — offer services that are difficult to provide remotely.

In addition, a large proportion of this region’s employment in other sectors is concentrated in small businesses, which would not see significant economic benefit by sending work offshore — it takes a certain minimum scale for offshore outsourcing to be effective. As a result, the overall effect of offshore services outsourcing on local employment is likely to be very small.

That said, the more interesting question for local companies is whether they could leverage offshore outsourcing to strengthen their value proposition and competitive position — the way the industry leaders previously mentioned have done.

What can the U.S. do?

In the near term, there’s more that we can and should do to assist workers displaced by offshore services outsourcing, such as providing portable health care coverage and government displacement benefits (this is currently provided to manufacturing workers only). In addition to government-provided skills training, tax credits would spur the private sector to play a more active role.

The McKinsey Global Institute recently developed a plan where earmarking 5 percent of the savings that companies realize from offshore outsourcing could insure all full-time workers who lost jobs as a result. The program would compensate those workers for 70 percent of missed wages, as well as offer two years of health care subsidies.

For the long term, the best way to ensure continued U.S. competitiveness in the global economy is to invest in education and research. Over the last century, such investments have enabled the U.S. to become the world leader in innovation, with millions of new jobs created as a result.

Unfortunately, recent trends are worrisome. U.S. government spending on basic research has been declining as a percentage of GDP, even as other countries are growing this key measure of future innovation and competitiveness. Our primary and secondary schools are falling behind the rest of the world. As other countries increase their number of science and engineering graduates, ours decline. We have done better in the past. We can — and must — do better once again.

Any wild cards?

Several. For one, wages are escalating rapidly in countries where the demand for specialized service workers is growing. In India, salaries for software engineers are now increasing at close to 15 percent annually, vs. a 3 percent rise in the U.S. At this rate, the wage gap soon will be a misnomer.

A major terrorist incident or conflict in a country like India or China could change the sentiment about sending work offshore. So could a major breach of data security or privacy regulations.

Perhaps the biggest wild card is the impending labor shortage in the U.S. Over the next five to 10 years, 77 million baby boomers will reach retirement age, with only 35 million Americans available in the workforce to take their place. The U.S. Bureau of Labor Statistics estimates that there could be as many as 29 million unfilled jobs by 2010.

So, despite the current fears about job losses as a result of offshore outsourcing, the U.S. economy could soon be short of workers, not jobs. Offshoring is one way to meet that need.

Final takeaway?

In every decade since World War II, pessimists have predicted that global trade would leave American workers consigned to dead-end, entry-level jobs. Yet every decade has seen the creation of millions of new jobs, along with higher per capita income. We’ve created about 40 million new jobs in the last 20 years, and 17 million in the last 10 years.

These new jobs sprang from American-born industries, including railroads, automobiles, telephones and aircraft manufacturing — and, more recently, computers, telecommunications and the Internet. Each time we created more high-quality jobs by driving waves of innovation. We can continue this pattern by focusing on the key issues — expanding education and spurring innovation.

As Robert Reich, Labor Secretary under former President Clinton, said: “Our economic future is wedded to technological change, and most future jobs are ours to invent.”