The Big Squeeze
A 'second wave' of offshoring could threaten middle-income, white-collar and skilled blue-collar jobs.
Illustration by Joel Elrod for Newsweek
By Richard Ernsberger Jr.
Newsweek International
May 30 issue - The United States and Europe were pleased with China's economic boom—for a few years. That's not the case anymore. Suddenly, the Asian giant seems more of a threat than an opportunity. In response to China's surging exports, growing by 30 percent annually, many U.S. legislators now delight in bashing the country's trade practices; one congressman criticized Beijing last week for flooding America "with trinkets and trousers, shirts and shoes... and yet they don't want to open their market to us." The EU is also glowering. It warned China last week to restrict its booming textile exports, which it said were causing "irreparable harm" to European producers. Washington has already reinstituted textile-import quotas on China—and more generally, the Bush administration last week practically ordered Beijing to revalue the yuan within six months. U.S. officials blame the currency's low value for America's $162 billion trade deficit with China—the largest ever with a single country. Seeking to avert a trade war, China has agreed to concessions. Beijing announced last Friday that it would raise tariffs by upwards of 400 percent on 74 categories of clothing exports, starting June 1.
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That may temporarily allay worries about one long-vulnerable, low-tech industry—but not the many other sectors where China, India and other low-cost countries have gained competitive advantage. In fact, say economists, the trade pressure from globalization is certain to increase. Here's a big reason why: 15 years after U.S. and European multinationals started shipping large numbers of manufacturing jobs overseas, experts are saying that the "second wave" of offshoring is at hand—and it promises to be bigger and more disruptive to the U.S. and European job markets than the first. In the years ahead, sizable numbers of skilled, reasonably well-educated middle-income workers in service-sector jobs long considered safe from foreign trade—accounting, law, financial and risk management, health care and information technology, to name a few—could be facing layoffs or serious wage pressure as developing nations perform increasingly sophisticated offshore work. The shift portends a dramatic realignment of wealth over the next couple of generations—valued by the U.S. consultancy McKinsey Co. at "hundreds of billions of dollars."
For Europe and the United States, that's a troubling scenario at a time when there is already plenty of economic insecurity. The EU unemployment rate is 9 percent. U.S. job growth has been weak the last few years, and real wages are falling at the fastest rate in 14 years. As economist Richard Freeman of Harvard points out, information technology was supposed to be "the magic field" that insulated North America and Europe from the harshest effects of globalization. In essence, some 2 billion new workers in about a dozen developing countries have joined, or will soon join, the global work force. This vast new labor supply, a sizable portion of it well educated, could squeeze the standard of living of both skilled blue-collar workers and higher-income white-collar workers.
According to a recent report by McKinsey, many Western workers in crucial "skill-intensive industries will feel substantial pressure [from low-cost countries] for the first time." And that competition will lead big firms in those sectors to buy products from developing nations, or even move plants abroad. The industries include auto parts, fabricated metals, machinery, pharmaceuticals and telecom equipment, which together account for nearly half of the manufacturing consumption in America. By 2015, notes McKinsey, those key "second-wave" industries will account for fully half of all U.S. imports from low-cost countries. Cambridge, Mass.-based Forrester Research estimates that more than 3 million U.S. jobs, and about half that number in Europe, will be moved overseas in the next 10 years. Two weeks ago, IBM said it was laying off 13,000 of its European workers.
This isn't the first time that the West has glanced fearfully at a foreign juggernaut. In the 1970s and 1980s there was much fear that Japan Inc. would steamroll complacent U.S. and European companies. Things didn't turn out that way. But this time the competitive attack is much broader. In a recent paper, University of California, Berkeley, professors Stephen S. Cohen and J. Bradford DeLong professed "a lot of confidence" that the impact will be large, if only because there are 240 million service-sector jobs in the First World today.
To be sure, China's manufacturing might is still concentrated on the low end of the technology scale. And India's fast-growing outsourcing industry (which employs 1 million people and accounts for about $5 billion in exports) remains dependent on call centers, telemarketing, data entry, billing and low-end software development. But both nations are poised to make great leaps forward over the next decade or two. China is obsessed with acquiring advanced manufacturing technology—including telecom and chip-making equipment—and often makes tech acquisition a part of negotiations with foreign investors. India has a deep pool of scientists, software engineers, chemists, accountants, lawyers and physicians who are steadily moving India's IT-related outsourcing industry up the value-added chain. Radiologists working for Wipro HealthScience, a division of the Indian software giant, now read CT scans and MRIs remotely for Massachusetts General and other U.S. hospitals—a medical specialization requiring seven years of postgraduate work. "From life sciences to financial consultancy, Indian companies can do any of these jobs," brags T. K. Kurien, the president of Wipro HealthScience.
Europe is less vulnerable to offshoring than America. Rigid labor laws insulate its workers from pay cuts and layoffs. Still, Deutsche Bank predicts that 2 percent of all service jobs in Germany could move overseas within four or five years. Ian Marriott, head of global-offshoring research for the Gartner Group, says that Nordic companies have been slow to catch on to offshoring and will soon be "at a financial disadvantage to global competitors who come into their markets."
The OECD recently analyzed how many European jobs could be affected by service-sector offshoring. It examined occupational classifications where people use PCs heavily, use the Internet to transfer work, and where the work involves "codified information" (as opposed to "implicit knowledge") and little face-to-face contact with customers. The study found 15 at-risk job categories—among them clerks and keyboard operators, engineers and architects, mathematicians and statisticians, chemists and physicists—representing 19 percent of total employment in the EU-15, which is the EU minus the 10 new members who joined last year. The OECD's Desiree van Welsum, author of the report, called the result "calming, not alarming," because the 19 percent number is the "outer limit" of occupations at risk, and "the entire sector would never be affected."
Economists don't believe that the next phase of offshoring will cause massive unemployment. Indeed, they emphasize that as a percentage of all job losses, those attributable to low-cost foreign competition are modest—well under 10 percent. And many experts—including those at McKinsey—have long argued that the benefits of offshoring considerably outweigh the costs. Globalization keeps consumer prices low, raises corporate productivity and frees up money for further investment in new technologies and industries.
But intense global competition could erode incomes and, hence, standards of living. Wages are not now tracking productivity gains. Since 2001 U.S. productivity has risen by about 4 percent annually, but wage growth has averaged only 1.5 percent. Jagdish Bhagwati, an economics professor at Columbia University, says that globalization is not a zero-sum game: the hiring of an insurance-claims technician in Manila does not necessarily mean that a technician in Pittsburgh or Berlin is losing his or her job. "But some workers do lose out. In America, this loss comes in the form of wages. If the Federal Reserve does its job, and unemployment stays at around 5 percent, then if you're fired by Boeing, there will be other jobs available. The problem is that the new job may pay less than the previous one; and if this happens to enough people, wage rates will go down. There will be fewer good jobs and thus greater competition for the good ones."
Europe faces an arguably more serious dilemma. If its companies start offshoring more, unemployment could rise—and with it the impulse to enact self-defeating protectionist laws. If it doesn't offshore more aggressively, the Continent will lose global competitiveness and become something of a long-term loser itself. Many economists argue that the EU needs labor-market flexibility and U.S.-style job churn to spark innovation. "Unions have such control over wages there," says Bhagwati, "that unemployment results and people live off the welfare state," stifling productivity and growth. According to McKinsey, just over half of Americans who are laid off and find new jobs take a pay cut of at least 15 percent, and one quarter will see their salaries fall by 30 percent. In Europe, confirming Bhagwati's point, McKinsey says that most who lose their jobs are still unemployed after several months. That illustrates a lack of the dynamism from which comes new businesses, new skill de—velopment, and the creation of new jobs.
No one can say with any authority just how much the West's competitiveness might weaken over time. But there are suggestions that the technological edge that the U.S. and European companies have enjoyed might gradually disappear. According to the Washington-based Economic Policy Institute, the U.S. software industry lost 16 percent of its jobs in the three years from March 2001 to March 2004. That, in turn, may have dampened the enrollment of U.S. students in computer and engineering programs—down 23 percent between 2002 and 2003, according to the Computing Research Institute. As an official at the Washington Alliance of Technology Workers, a union group, asks: why major in computer science when technology jobs are headed offshore?
Meantime, India and China are teeming with tech talent. India turns out about 150,000 engineering grads every year, and China 250,000. Diana Farrell, the director of the McKinsey Global Institute, McKinsey's economic think tank, notes that most of those grads do not have the English-language skills and training that multinationals typically seek. Maybe not, but India is becoming a favored outsourcing destination for high-end telecommunications, software development and R&D work. French telecom giant Alcatel is doing the R&D work on its 4G cell-phone technology in Bangalore. In the past five years, more than 100 multinationals, including General Electric, Boeing and Exxon-Mobil have set up R&D centers in India. Microsoft is steadily moving most of its customer-service functions, except those for its "premier" corporate customers, to India. Sangeeta Gupta, a vice president of the National Association of Software and Service Companies, predicts that India's IT and business-operations outsourcing business will be a $50 billion industry by 2008.
Says Harvard economist Richard Freeman: "We knew the Chinese would make cheap toys, and the Indians would maybe do data input, but they certainly don't do sophisticated engineering. In fact, it turns out the Indians and Chinese are pretty smart. Almost any economic theory would say, 'If there's a whole lot of guys who do the same work as you can, that's not so good for you. If the labor supply is big, you're going to be in trouble.' "
America's strengths—innovation and entrepreneurship—remain formidable and should keep its middle class relatively prosperous, despite the gains being made by other nations. When Japanese and South Korean companies began to dominate the low-end memory-chip market in late 1980s, U.S. competitors like Intel and Motorola shifted gears and began to specialize in the production of more sophisticated, higher-margin semiconductors. That same process of climbing the value-added product ladder will have to continue.
Daniel Trefler, a University of Toronto professor, is sanguine for another reason. He notes that currency appreciation and rising wages will eventually work against China, India and other ascendant developing countries, though it may take a long time. "Japan in 1959 was not that different from China today," Trefler said recently at a conference on offshoring at the Brookings Institution in Washington. "It had a skilled and disciplined labor force that was paid 10 percent of U.S. wages. Yet Japan was never able to dominate world manufacturing. Why? Because Japan succumbed to the comparative-advantage police by steadily revaluing the yen." He asserts that the same thing will happen to China. "It does not matter that they have hundreds of millions of citizens willing to work for next to nothing. If the yuan strengthens, Chinese wages will rise to a point that they are no longer dominantly competitive." Trefler also argues that institutional handicaps—corruption, weak legal and financial systems—could hamper the rise of new corporate powerhouses.
Even so, say analysts, Europe and America must develop better strategies to compensate the workers who lose in the global trade game—and crucially, boost education and training efforts so that their workers acquire the "skill premium" they'll need to get or stay ahead. Given the speed with which globalization is unfolding, there's little time to lose. "The premium on having an effective policy response is greater than it's ever been before, and nobody seems to be paying attention to it," says Catherine Mann, an economist with the International Institute of Economics in Washington.
Europe still needs more fundamental structural change. In 2000, at the Lisbon Agenda for structural reform, EU leaders essentially agreed to liberalize their labor markets. Five years later, that hasn't happened, mostly due to opposition from trade unions and others who cling to the notion of job security rather than employment security—which means the ability to find a new job. Europe's seemingly endless struggle to define its priorities only heightens the stakes—and the risk. Globalization is real, and the competition is coming.
With R. M. Schneiderman in New York, Karen Lowry Miller in Brussels and Ron Moreau and Sudip Mazumdar in New Delhi
© 2005 Newsweek, Inc.
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