Global: Offshoring -- Myth and Reality
______________________________________
By Stephen Roach (from Bangalore, India)
Morgan Stanley
Mar 30, 2004
In America, the global labor arbitrage has quickly turned into the major domestic issue of Campaign 2004. In Asia, the political backlash to the globalization of employment is seen as the single greatest threat to the hopes and aspirations of economic development. Nowhere is this more evident in India, where I have just begun the final leg of my two-week swing through Asia.
It's worth reviewing the evidence on offshoring before plunging into the great debate. That doesn't take long -- in large part because the actual data points on the empirical magnitude of offshoring are few and far between. Not surprisingly, the consultants -- most of who are in the IT advisory business -- have tended to downplay the loss of jobs from the high-wage developed world to the low-wage developing world. The most widely cited estimate of the impact of offshoring comes from a study of US trends conducted by Forrester Research; they calculate that only about 400,000 business process jobs have been "offshored" -- a total they expect to rise to about 3.3 million by 2015. That may sound like a lot but it works out to annual job losses of only about 300,000 over the next decade -- not much of a dent in a US economy that currently employs 130 million workers.
As best I can tell, this is a pretty flaky estimate. Forrester does not provide much detail on the methodology or the empirics that lie behind this number (see the April 2003 Forrester study by Christine Ferrusi Ross, "Can Outsourcers Really Transform IT?"). Moreover, it is important to keep in mind that the Forrester estimate pertains only to business process jobs -- a relatively small slice of white-collar jobs that could ultimately be affected by IT-enabled offshoring. Unfortunately, a similar approach is taken by the other IT consultants, even by those who think the macro impacts are a big deal (see Gartner's July 2003 research note by D. Morello, "US Offshore Outsourcing: Structural Changes, Big Impact").
The best work I've seen on the so-called offshoring phenomenon has been produced by Catherine Mann of the Washington-DC-based Institute for International Economics (see her December 2003 IIE Policy Brief, "Globalization of IT Services and White Collar Jobs: The Next Wave of Productivity Growth"). Mann's approach is solid -- relying on both analytics and empirics to develop a framework for assessing the impact of this phenomenon. But even she concedes that "there are no publicly available data on jobs 'lost' to workers in foreign economies." Nevertheless, she concludes by extolling the virtues of offshoring as yet another IT-enabled development that lowers operating costs of US businesses. As a result, she maintains that such efficiency enhancements have the potential to provide US companies with the wherewithal to expand hiring in the future. While it's hard to rule out such a possibility, there are many other conceivable outcomes. The bottom line, as I see it: We're largely flying blind in assessing the current and prospective magnitude of this important transformation in the US labor market. My gut instinct tells me that this trend -- like most IT-enabled developments in the past decade -- is likely to proceed at a much faster pace than the consultants believe.
Meanwhile, the circumstantial evidence that has allowed xenophobic US politicians to make the case against offshoring has been sensationalized, to say the least. It rests mainly, of course, on the pain and distress of America's unprecedented jobless recovery. Fully 27 months into the current cyclical upturn, we estimate that private nonfarm jobs are tracking 8.3 million workers below the profile of the typical hiring cycle. At the same time, America now has a record foreign trade deficit -- the smoking gun that has led politicians of all stripes to conclude that the shortfall in job creation can be tied directly to this loss of market share to overseas providers of goods and services. If it’s not offshoring, what else could it be? That's the lament that plays so well in the heartland, especially in an election year. But the added twist is that job losses are now touching many middle-aged, high-skilled, upper-income white-collar workers for the first time ever. The offshoring debate resonates with the fears and insecurities brought about by such white-collar shock -- afflicting workers who have long harbored the presumption of lifetime employment but who now fear that their jobs are gone forever. Opportunistic politicians have been quick to play off this palpable and rising sense of angst. So has the media.
Where do I come out on this? While I think offshoring is an inevitable by-product of free trade, comparative advantage, and globalization, I don't think it should be minimized as a contributor to America's jobless recovery. Sure, there are other factors at work -- especially the high fixed costs of hiring associated with the benefits inflation that Dick Berner has stressed (see his March 26 dispatch, "Fixed Labor Costs, Operating Leverage and Job Growth"). And there is the post-Enron, post-Sarbannes-Oxley risk aversion that continues to constrain Corporate America.
At the same time, I do believe the impacts of globalization are likely to be an increasingly big deal in driving the great American job machine in the future. This conclusion is best understood within the context of the mix of forces that drive turnover in the US labor market -- namely, the interplay between the constant flux of hiring and firing. The sum of these flows is considerably larger than the net changes that get such great attention when the state of nonfarm payrolls is reported each month by the US Bureau of Labor Statistics (BLS). For example, the BLS Business Employment Dynamics tabulation puts the sum of gross job gains and losses at some 15.2 million workers in 2Q03 (latest data point) -- dwarfing the net change of -180,000 they estimated for the quarter. According to Alan Greenspan, layoffs have not been the dominant force shaping America's jobless recovery. Instead, it's the lack of hiring. He argues that "Gross separations from employment, two-fifths of which have been involuntary, are about what would be expected from past cyclical experience, given the current pace of output growth. New hires and recalls from layoffs, however, are far below what historical experience indicates" (see Testimony of Chairman Alan Greenspan on the Federal Reserve Board's semiannual Monetary Policy Report to the Congress before the Committee on Financial Services, U.S. House of Representatives February 11, 2004 ).
What matters most in shaping macro trends is change at the margin. The global labor arbitrage could well be having a differential effect on the gross flows in the US labor market. It's not that domestic jobs are being eliminated on a large scale in the US and shifted offshore to the developing world. Instead, it's far more likely that the impacts are being felt on the hiring side of the equation. US companies are now letting the "opportunity cost" of the domestic hiring decision be shaped increasingly by the alternative of highly-educated, well-skilled, low-cost workers now readily available in many developing countries. At the same time, by lowering the perceived incremental cost of the "next hire" in many occupational categories, the arbitrage could also be playing an increasingly important role in the wage determination process that effects a much broader cross-section of American workers. In other words, the globalization of labor input need not be large in the absolute sense to make a difference in shaping change at the margin. The increased prevalence of offshoring suggests that such a critical mass may well have been attained in the United States. As a result, US companies have no choice other than to become more global in both their perspective and structure.
Like it or not, this is the way globalization is supposed to work. Which takes us to the toughest aspect of the problem -- the distinct possibility that there may be strong social and political objections to the very concept of globalization itself. The idea that job contracts need to get re-written because of trade liberalization and an increasingly integrated borderless world doesn't sit terribly well with disenfranchised workers on the front line of making the adjustment. Globalization may work well in the long run but it appears to have profoundly disruptive impacts in the short run. That could reflect its inherent asymmetries -- developing countries first come on line as producers long before they emerge as consumers. That leaves a very tenuous interregnum, where the creation of new markets in the developing world lags the penetration of old markets in the developed world.
And that's what takes us to the most dangerous point of all -- the politicization of the offshoring debate. In this election year, the American body politic has been forced to take sides on this highly charged emotional issue. Analytics and empirics ring hollow in this deeply personal context. Free trade and now offshoring lie at one end of the spectrum -- protectionism at the other. For America -- complete with its jobless recovery and gaping trade deficit -- the pendulum is now swinging in an ominous direction. Out here in Asia, that is a huge and puzzling concern.
morganstanley.com |
