Offshoring

▪ 2005

Introduction

by Christopher O'Leary

      By 2004 offshoring—the practice of companies outsourcing operations overseas, usually to less-developed countries (LDCs) with the intention of reducing costs—had already become one of the major economic controversies of the decade. While the ultimate impact of offshoring had yet to be measured, surveys estimated that in 2004 some 14 million Americans, 10% of the nation's workforce, held positions that could be outsourced.

      Offshoring jobs and infrastructure to countries with more lax regulations and far lower standards of living was nothing new. Many manufacturing jobs, for example, were exported from the U.S. to nations such as China during the 1960s and '70s. What had changed, however, was the nature of the work being exported. With the advent of Internet-based communications technology and improved education in many LDCs, increasing numbers of highly skilled jobs in such areas as information technology (IT) and financial management were heading overseas each year.

      The practice had its proponents, who claimed that offshoring's impact was being overstated and that employers, able to use offshoring to reduce overhead costs, were then able to free up capital for new investment and thus create new jobs. Some advocates of this argument included the president of the U.S. Chamber of Commerce, Thomas Donohue, and Federal Reserve Chairman Alan Greenspan. Detractors, however, claimed that the practice had greatly hurt the working class and could decimate the American middle class.

      Unsurprisingly, the issue became a battleground in the 2004 presidential election. Sen. John Kerry, the Democratic Party's candidate, denounced CEOs whose companies engaged in outsourcing as traitorous “Benedict Arnolds.” He introduced a bill that would require call-centre employees to disclose their physical locations to consumers and proposed a plan to eliminate all tax breaks to American companies that export jobs. Kerry's proposals had parallels at the state legislative level; as analysts estimated that at least 13 bills that would ban some form of offshore outsourcing had been introduced in states, including New Jersey, Michigan, and Indiana. Pres. George W. Bush, while a far-less-severe critic of offshoring than his opponent, also felt political pressure to slow its pace. In January the president signed an appropriations bill that contained an amendment forbidding some government divisions to use foreign companies when outsourcing work.

      Actual data about offshoring's impact on the U.S. economy was preliminary and at times contradictory. In 2004 general estimates were that 250,000–300,000 jobs were leaving the U.S. annually, while some surveys found that about 240,000 technology jobs had gone offshore since January 2001 and about 830,000 general service-sector jobs would have gone overseas by the end of 2005. Some studies were quite grim in their future predictions; Forrester Research Inc. estimated that 3.4 million service-sector jobs (which included most IT positions) would leave the U.S. by 2015. Although outsourcing was not as far advanced in Europe, especially in non-English-speaking countries, Forrester reported that spending on offshoring by European businesses was expected to increase from €82 billion (almost $100 billion) in 2002 to some €129 billion (about $156 billion) in 2008.

      A report released in June by the U.S. Department of Labor downplayed offshoring's effects, stating that in the first quarter of 2004 offshoring represented only 2.5% of the total U.S. job losses posted in that period. Critics said that the report understated the impact of offshoring because the study's results came from asking companies if their layoffs were due to offshoring—something many executives would not care to disclose publicly. The same month, a joint survey by Roland Berger Strategy Consultants and the UN Conference on Trade and Development revealed that more than 40% of the European companies canvassed planned to offshore jobs, primarily to save money.

New Frontiers.

      Perhaps the most contentious area of offshoring was in IT, which had been one of the best-paying and fastest-growing job sectors in the U.S. during the previous 20 years. Ironically, massive IT job transfers overseas were possible only because of the advances made by the technology industry in the past decade. Technology consultants estimated that 10% of American computer service and software jobs would have moved offshore by the end of 2004, while other surveys predicted that up to 25% of all IT jobs in Western countries would relocate offshore by 2010.

      In the past, companies had focused their outsourcing efforts mainly on transplanting low-skilled jobs, including customer-service call centres. More recently, companies were tapping the growing pool of university-trained technology graduates in countries that included India, the Philippines, and Malaysia for such tasks as software engineering, computer chip design, and code writing. For example, General Electric Corp. offshored about 70% of its technology needs; Motorola was increasing the staff in its technology research operations in Beijing, while Intel was doing the same in Russia. Aetna planned to cut up to 10% of its IT staff while likely increasing outsourcing agreements with Indian companies such as Infosys Technologies Ltd. Even Infosys CEO Narayana Murthy (see Biographies (Murthy, Narayana )) was compelled to address the issue.

      A major factor driving IT offshoring was the vast disparity between highly paid U.S. tech workers and their counterparts in LDCs. Analysts estimated that the average Indian IT worker earned roughly $10 per hour, 13% of his or her American counterpart's salary.

      Similar factors were spurring offshoring's growth in the financial services industry, ranging from banking to insurance to securities trading. Within the past year, financial institutions in North America and Europe had increased offshoring to an average of 1,500 positions per firm, a massive increase from the 300-positions-per-firm average estimated in 2003. Surveys calculated that 80% of the world's largest financial institutions—those companies with market capitalizations of $10 billion or greater—currently had offshore operations or agreements. Among the top financial institutions with offshore operations were GE Capital, which had roughly 15,000 employees in India; HSBC, with 8,000 employees scattered around the Pacific Rim; and Citigroup, with 3,200 employees located in India, according to estimates from research firm Celent Communications.

      Some observers predicted that by 2010 more than 20% of the financial industry's global cost base, approximately $400 billion, would have been outsourced to LDCs. Analysts estimated that about 2.3 million jobs in the banking and securities industries were at risk for offshoring in the next six years and predicted that in the same period about 30% of the banking industry's operations and technology spending would shift to offshore locations. Again, the wage disparity between Western nations and LDCs was enormous. In 2003 the average Indian financial service industry employee with an MBA earned roughly 14% of his or her American equivalent's wages. Analysts estimated that the financial and insurance industries had saved $11.6 billion in the past four years via offshoring.

Is Offshoring Inevitable?

      Given offshoring's potential to generate massive savings, it seemed unlikely that the practice would fade any time soon. Offshoring's future was not entirely assured, however, and not every business was enamoured of the practice. Companies such as Capital One and Lehman Brothers had canceled outsourcing contracts with Indian firms, citing poor employee training, inadequate support levels, and security concerns, among other reasons. Furthermore, if more and more job losses could be attributed to offshoring practices, pressure would certainly increase for politicians to enact antioffshoring legislation.

      As the standard of living improved in countries to which Western firms had exported jobs, however, that improvement in turn could diminish the savings companies gained. For example, India's daily wages were expected to rise by more than 150% by 2007, and in 2004 Indian call-centre companies were already facing high attrition rates and were being forced to raise wages and improve employee conditions. While these rising costs had made rival countries such as China (where English was mandatory in all schools) and West African nations such as Ghana more attractive offshoring prospects, American and European companies also were finding that the farther down the economic-development scale they went, the greater the potential for cultural conflicts, government corruption, and employee inefficiency.

      Thus, in 2004 the practice of offshoring stood at a crossroads—it could become a primary method of doing business in the U.S. and could radically reshape the American labour market, or it could simply be a limited cost-cutting trend that at some point would stop making economic sense. The years ahead would determine which scenario would prove true.

Christopher O'Leary is Assistant Managing Editor of Investment Dealers Digest.

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▪ economics

      the practice of outsourcing operations overseas, usually by companies from industrialized countries to less-developed countries, with the intention of reducing the cost of doing business. Chief among the specific reasons for locating operations outside a corporation's home country are lower labour costs, more lenient environmental regulations, less stringent labour regulations, favourable tax conditions, and proximity to raw materials.

 The offshoring of jobs and infrastructure became a significant factor in global economic development in the mid-20th century. Companies initially focused their outsourcing efforts on low-skilled or unskilled manufacturing jobs and simple assembly tasks (see maquiladora). By the early 21st century, however, the work being exported increasingly included skilled jobs. As communications technologies advanced and educational opportunities increased, many developing countries were able to provide sophisticated labour forces. Corporations around the world began tapping these new workers to staff customer-call centres and to fill jobs in financial management and information technology (IT). In countries such as India, the Philippines, and Malaysia, a growing pool of university graduates in technology quickly became capable of managing complex tasks that included software engineering, computer chip design, and code writing.

      A major factor driving IT offshoring has been the vast disparity in both salaries and cost of living between U.S. technology workers and their counterparts in less-developed countries. In the early 21st century, analysts estimated that the average Indian IT worker earned roughly 13 percent of his American counterpart's salary. Similar factors spurred the growth of offshoring in the financial services industry and brought new jobs in banking, insurance, and securities trading to a global workforce newly qualified to handle the tasks.

      Although offshoring has produced economic benefits, it has also created some problems: for example, work performed in remote locations may fail to meet the quality standards expected by a parent company; exploitation of workers may occur; and lower environmental standards, especially in developing countries, may damage the local environment or pose health threats. One of the more vocal criticisms of offshoring originates from workers in developed countries who claim that the number of jobs available to them has been reduced by the practice of hiring cheaper labour in other countries.

Christopher P. O'Leary

 

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