The politics of offshoring: all talk, no action

Bob Kennedy Many of you whom I've been interacting with lately know I'm concerned by the degree of protectionism from some politicians and a handful of organizations; namely the TARP-funded financial services firms and a few from the healthcare sector.  We recently discussed many of these issues here. 

Professor Bob Kennedy, who heads up the William Davidson Institute, a non-profit research and educational institute that focuses on business and policy issues in emerging market economies, has been keeping very close tabs on these issues and I asked him to contribute his recent experiences and views with us.  Bob also has a new blog up and running entitled "Services Shift", and has recently released his new book, adorning the same name.  Over to you Bob…

Why No Regulation of Offshoring: Untangling the Gap Between Rhetoric and Action

Picking up on Phil’s April Fool’s day post, I wanted to share a few thoughts on why we see lots of anti-offshoring rhetoric from politicians, but (thankfully) very little actual policy.

There is certainly a heavy demand from the man on the street to “do something.” It’s easy to understand why. We have become accustomed to trade in manufactured goods and natural resources. But manufacturing accounts for only about 15% of US employment, and developing countries generally enjoy a fully-delivered cost advantage of 10-30%. This is disconcerting for developed country workers, and we frequently observe moves against trade in manufactured goods, such as spurious anti-dumping actions and “buy America” provisions in various pieces of legislation.

Services, by contrast, account for about 78% of U.S. employment, and developing countries enjoy delivered cost savings of 40-70%.

So developing countries’ advantage is much larger in services, and many more people are potentially affected. That explains the political heat and the politicians’ rhetoric, but not the lack of policy.

So, why haven’t we seen offshoring regulations? Because trade in services is incredibly difficult to regulate. Regulating trade effectively requires that two conditions exist:

1. The government can observe what actions firms are taking, and

2. Any proposed policy must be credible and enforceable.

To see why regulating offshoring is so difficult, consider the “offshoring” of auto components with that of IT services.

Auto parts. Trade displacement in manufacturing is easy to observe. If Delphi closes a component plant in Michigan and opens one in Mexico, it is easy to see what happened. 500 Mexican workers are now doing the same tasks in the same way that the Michigan workers did. Production from the Mexican plant now goes to the customers formerly serviced by the Michigan plant. It is easy and accurate to conclude that the Mexican workers replaced the Michigan workers.

Second, if the Congress chooses to regulate this trade, it is fairly easy to do. Don’t let trucks from the plant cross the U.S. – Mexico border, or slap a tariff on auto components from Mexico. (Note that 99% of economists would recommend that Congress not do this, but most politicians are immune to the logic of comparative advantage).

Offshoring IT services. IBM has been fairly aggressive about moving software support services offshore. In boom times, IBM is hiring many people in India and a few in the US. So, in 2006 and 2007, IBM hires SAP specialists, software testing, and wireless telecomm engineers in its India operation. These IT specialists work with other IBM teams in Australia, China, Japan, Germany, the UK, and the United States to service global customers.

Then, following the financial crisis in late 2008, IBM decides to lay off systems engineers, maintenance engineers, and COBOL programmers in the United States.

Is it in any way accurate to claim that the SAP specialists hired in India in 2006 displaced the systems engineers laid off in Philadelphia in 2009? Of course not. These are people in different functions, hired at different times.

IBM is a global firm servicing global companies. Except at the most aggregate level, the US government has almost no ability to independently observe whether IBM is “exporting jobs.” They could, of course, require that IBM report on what it’s doing. But there is no chance IBM would report in a way that indicts itself. There is simply no way a regulator could accurately observe what the firm’s 300,000 employees are doing, and who they are servicing.

Second, even if Congress wanted IBM to stop hiring people in India, what could it do? Would the Congress threaten to cut IBM off from the Internet? Or from communications satellites? Would Congress be willing to impose fines that are massive enough to cause IBM to withdraw from international markets, where it realizes 68% of its revenues? Unlike trucks crossing the US-Mexico border, regulators have no ability to monitor the bits and bytes zipping around the Internet, knitting various work teams together and allowing the firm to service global clients.

The bottom line is that politicians are nearly helpless in the face of offshoring. Firms have a tremendous incentive to locate service activities in low-cost, good quality locations. Doing so cuts costs, increases capabilities, and creates competitive advantage. Politicians would like to regulate this activity, but they can neither accurately observe what firms are doing, nor come up with regulations that can be credibly enforced.

So, expect lots more rhetoric and, perhaps, some efforts to require new reporting by firms. But the offshore trend will continue unabated, despite politician’s hopes. In the short run, offshoring will cause more dislocation and pushback. In the medium and long-run, it will continue to raise productivity and living standards in both the developing and developed countries.

Bob Kennedy (pictured) is the Executive Director of the William Davidson Institute and the Tom Lantos Professor of Business Administration at Michigan’s Ross School of Business. His new book The Services Shift: Seizing the Ultimate Offshore Opportunity, explores offshoring from a managerial and strategy perspective. He also has a new blog on offshoring entitled "Services Shift". 

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12 Comments

  1. Robert Powell
    Posted April 13, 2009 at 8:31 am | Permalink

    Professor Kennedy,

    Thanks for the excellent post. While you have made it abundantly clear that the government can do little to ban offshoring of US jobs, their efforts to push through policies such as Sanders/Grassley are creating a political taboo in many corporations that’s resulting in their insisting on using onshore resources for many business or IT contracts. How long do you see this going on for, and how powerful do you see this protectionist attitude impeding the development of global services?

    Robert Powell

  2. Karla Dixon
    Posted April 13, 2009 at 8:57 am | Permalink

    Thanks for the post. It got my thought processes going.

    You bring up an excellent point that political solutions to retaining jobs in the US are difficult if not impossible to implement. The interesting part to me is that the market forces of the situation have turned on US companies. At the beginning of the industrial age, those forces were in our favor with an abundance of relatively inexpensive resources – both raw and human – to work with. Now – partly because of government regulations – those forces are turned against us as the less expensive resources are available elsewhere in the world.

    The other side of that coin is the quality of those services available. So, initially, the US had the advantage in quality of services if not price point. More and more however, the quality services are becoming available through outsourcing as well.

    Ironically, it seems that the market is doing exactly what it should – finding the most efficient model. Unfortunately for us, we have become accustom to our lifestyle and would rather fight to keep that high standard than realize that we simply may not be the most efficient solution any more. In order to reclaim that title, we have to either increase our quality level or decrease our relative cost of providing the service.

    Market forces would be our best friend if we would work with them instead of continuing to try to artificially manipulate the system.

  3. Posted April 13, 2009 at 11:39 am | Permalink

    Prof. Kennedy
    A very thoughful perspective regarding outsourcing service jobs.

    Last year I ran through an exercise using employment data from the Dept.of Labor to define a market size of service jobs that could be offshored. Some service jobs, by the nature of the work, can only be completed onshore: auto mechanics, hotel cleaning staff, restaurant workers, etc. Other job categories that could lend itself to being offshored were included in my analysis. Even jobs that today may not be widely offshored (para-legals; graphic designers; accountants) but where there is a trend or evidence that these jobs can be off-shored were included in my analysis.

    The total addressable market came up to 20 million service jobs. As this analysis was based on employment data from 2006, it’s important to note that some of these jobs have since been taken offshore. In addition, service jobs off-shored prior to 2006 are not included in this employment data.

    It’s interesting to note the job categories that are the largest potential (Financial jobs; Office and Administrative; Sales related) as the most larger areas for offshoring.

  4. Posted April 13, 2009 at 11:50 am | Permalink

    Thanks for the comments. I’ll address Karla’s post first. I’ll get to Robert after lunch (sorry, time is short).

    Karla: I generally agree with your analysis, but you have one blind spot. The thing to remember is that trade is not a zero sum game, at the level of countries. The standard of living in the United States (or EU) is determined primarily by how productive the country is (as individuals and collectively). You don’t come out and say it, but it seems implicit that you want to “save” jobs.

    The best way for us to maintain a high standard of living is to be productive and creative. Some of that will be in tradeable sectors (software, aircraft, higher ed), but much of it will be in the non-tradeable sectors (personal trainers, chefs, etc). If US society is, overall, quite productive, then much of that wealth will flow to people even in the non-tradeable sectors.

    Remember, barbers and bartenders in the US make 50-70 times as much as their counterparts in India. It’s not because they are 50 times as productive, or have 50 times higher quality. Its because they live in a country that is — overall — 50-70 times as productive, and much of that wealth flows around and around through normal market transactions (not talking about govt redistribution here, just voluntary exchange).

    The crucial thing to keep in mind is that India getting richer DOES NOT make us worse off. It most likely makes the US better off because they will now purchase more and more of the things we are good at making.

    While offshoring (and all trade) cause dislocation in the short run, in the long run they lead to increased national productivity and, inevitably, higher standards of living. So I don’t agree that we will decline.

    The best response is to increase quality here, innovate, and control global supply chains. That ultimately raises everyone’s living standards.

    More later. Have to run,

    Bob Kennedy

  5. Posted April 13, 2009 at 2:01 pm | Permalink

    Robert: You raise two issues — how long will the political pressure last, and will it impede the development of global services.

    1. I’ll start with the second point. The Sanders/Grassley amendment was a really stupid bill. While claiming to “protect” American jobs, it actually makes them less secure. By way of explanation, the amendment to the second half of the TARP program makes it more difficult for firms who receive bailout money to hire H-1B visa workers. I wrote about this in the Detroit News a few weeks ago (link: http://www.detnews.com/apps/pbcs.dll/article?AID=/20090220/OPINION01/902200304/1008).

    The summary is that nativists present a false choice. They’d like us to think that the choice is: should firms hire well qualified Americans or low-quality, low-cost foreigners?

    But that’s not the real choice facing managers. The H-1B visa program is designed to help fill skills gaps in US-based teams when firms can not find local talent. The H-1B visa regulations require that firms pay prevailing wages for any position, so the argument that they cut wages is spurious. If firms are doing this, they should be turned in to the labor department and they will be fined.

    The real choice facing firms is: when they can’t find local talent, should they bring the talent to the US to work with the existing team, or should we move all the work offshore where they can staff the entire team?

    My conclusion is that these types of policies actually accelerate global sourcing, not hold it back. If the work moves offshore, there is no one here to complain. The policies make it less likely that firms will talk about it in public, but the firms I know are reacting by accelerating the effort to get loose of stupid regulations like this.

    2. How long will it last? My guess is a few quarters. Trade will never be popular. But the backlash really strengthens during times of economic duress. When the economy stabilizes and starts growing again (probably this summer or fall), the intensity of the backlash will diminish. The backlash will still exist, and will flair up from time to time. But it will be a non-issue most of the time.

    Bob

  6. Posted April 13, 2009 at 4:21 pm | Permalink

    Thoughts on Robert P’s comment below:

    He raises two issues:

    1. How long the current backlash will last, and;

    2. Whether efforts like Sanders/Grassley will impede the trend toward global services.

    — —

    On the first, the current backlash flows primarily from uncertainly resulting from the financial crisis. Trade is never popular, but opposition always ratchets up in times of crisis. That’s what we’re seeing now.

    As the economy stabilizes, the heat will dissipate and we will return to normal. Trade won’t be popular, but outbursts of this type will be infrequent.

    I expect the economy to start growing again in summer or fall.

    On the second issue, my view is that these policies are quite ineffective. In fact, some (like the H-1B visa restrictions) may actually accelerate offshoring (see my article in the Detroit News, http://www.detnews.com/apps/pbcs.dll/article?AID=/20090220/OPINION01/902200304/1008)

    As mentioned in the blog post here, policymakers want to do “something,” but it’s generally ineffective, or even counterproductive.

    What has happened over the past few months is that firms are even more reluctant to discuss offshoring, but financial pressures are pushing them to accelerate plans to do so.

    At the end of the day, the PR/political effect will be quite small and will do little to slow the trend toward offshoring.

    Bob Kennedy

  7. Posted April 13, 2009 at 4:31 pm | Permalink

    Re: Robert Laity’s post:

    I think you’re on to something. The Haas School at UC Berkeley did an analysis a few years ago that came up with an estimate of 15 million positions “affected” by offshoring. So you’re in the same ballpark.

    Two things to remember, however:

    1. Not all of the affected positions will go offshore. Those are simply the ones that could go offshore. It’s much more likely that workers will respond by lowering wages or bundling their offshorable activities with non-offshorable tasks.

    2. There is a high amount of natural churn on the US labor market.

    - there are about 140 million jobs in the US.

    - there are about 35 million annual job switches, the vast majority of them voluntary

    - using 10 year averages, there are about 3.5 million new positions created each year and about 2.1 million positions eliminated each year.

    Bottom line is that 15 or even 20 million jobs affected — if it occurs over 10-20 years — is something that is in the normal realm of experience for the US labor market.

    Good discussion. Looking forward to more.

    Bob Kennedy

  8. Posted April 13, 2009 at 5:24 pm | Permalink

    Professor Kennedy,

    Thanks for the insight and a way of thinking about the situation that is different from our politicians who use scare tactics about job losses.

    I count myself among the politically liberal Silicon Valley folks, who work hard at creative entrepreneurship and at the same time pragmatically support free trade. I consult with many high tech companies that design in Silicon Valley and then manufacture in Asia.

    The difference is that we think of the world as a global economy…we manufacture where it is most effective to manufacture. This is a more strategic way to look at global supply chains and global customers than simply a matter of trading dollars and goods between companies.

    My clients are typically thinking about where to manufacture in terms of cost, efficiency, quality and proximity to customers. For example, if you make semiconductors, you want to be close to your customers i.e. electronics, consumer goods, etc. that are assembling thier products in Asia. This is a natural progression and an appropriate economic decision.

    Rosemary Coates
    Blue Silk Consulting – Silicon Valley

  9. Posted April 13, 2009 at 6:19 pm | Permalink

    Rosemary,

    I agree. The responsibility that firms have to their shareholders (and other stakeholders) is to create value. This is best done by figuring out the best combination of cost, quality, capabilities, and logistics. If the firm can manage its supply, manufacturing, and distribution so as to create value, every one eventually benefits (see my references below to earnings for bartenders and barbers).

    I have always been surprised that people get so uptight about national borders. Few people complain when New York City “offshores” work to New Jersey or South Dakota. If the move is voluntary and creates value, everyone is better off. The same logic applies to sending work to Mexico or India.

    Raising productivity grows the pie. Arguing about national borders and trying to “save” work and jobs ends up shrinking the pie.

  10. Shekar Panchapakesan
    Posted April 18, 2009 at 1:17 pm | Permalink

    Actually, I believe there may already be a model for how the government can influence offshoring. State governments provide tax incentives and subsidies to companies on the condition that these companies will create a certain number of jobs in the state (e.g. the Texas Enterprise Fund) – and this is rightly termed an ‘incentive’ rather than ‘protectionism’.

    When companies that participate in these programs create jobs in those states, they do so by making a choice – e.g. creating the jobs in TX instead of CA – and that doesn’t detract from them being national companies. In exactly the same way, if the US provides TARP funds to companies in return for job-creation targets, those companies would make the positive choice to create those jobs in the US rather than India.

    Personally – as an offshore outsourcing specialist – I don’t advocate this. But it occurs to me that this is a logically sound model for how government can influence offshoring.

  11. Posted April 18, 2009 at 3:07 pm | Permalink

    Shekar,

    I agree that a positive incentive program like you describe can work. But those programs fall into a completely different category of policy than I was discussing in the post.

    The blog post was about attempts to directly regulate offshoring. These attempts are largely futile for the reasons discussed — observability and enforement.

    If you pick up my book (and I hope everyone reading this blog does: http://www.amazon.com/gp/product/0137133502 :) ) you will see that I devote an entire Chapter (#6) to discussing policy issues. My recommendations for promoting employment and development in the rich countries are all similar to the program you describe — improve education, use broadly defined employment incentives, improve technical education, make changes to unemployment insurance and retirement programs to make them more economically rationale.

    My point is not that all policy is impotent. It’s that policy should focus broadly on making a state or country an attractive place to do business. Punitive policies (like those often proposed in Congress) will not work in this sector — because of the observability and enforcement problems.

    Thanks for the comment. I’ve enjoyed the discussions here.

  12. Posted April 18, 2009 at 3:38 pm | Permalink

    Shipping jobs overseas is killing the companies customer base. You can have cheap labor, but if US workers don’t have jobs, they can’t buy your cheap goods.

    Read this post at my blog http://allenandson.blogspot.com/2009/04/open-markets-create-customers-for-us.html greater detail.

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