The allure of outsourcing too powerful for U.S. companies to resist

One of the predominant economic issues of our day has to do with the “offshoring” or “outsourcing” of American jobs overseas, particularly to developing economies like India and China where costs of labor are significantly less, thereby undermining efforts to reduce the stubbornly high U.S. jobless rate (currently at 9.6 percent)

Outsourcing is actually a natural outcome of globalization, the rise of multinational corporations and increased foreign direct investment -- a complex process that began two or three decades ago and will only intensify in the coming years.

Robert Preziosi, a professor at Nova Southeastern University’s Huizenga School of Business and Entrepreneurship in Fort Lauderdale, Fla., said that while it is difficult to ascertain how many U.S. jobs have been lost due to outsourcing, clearly at least “hundred of thousands” of such jobs have moved overseas.

Stephen Bronars, a labor economist at Welch Consulting in Washington D.C, estimates that during the downturn of 2001-2003, anywhere from 500,000 to 1 million U.S. jobs were sacrificed to outsourcing.

According to recent data from the U.S. Commerce Department, employment at foreign subsidiaries and affiliates of U.S. multinational companies climbed by 729,000 jobs to 11.9 million from 2006 to 2008. Meanwhile, over that same span, domestic employment by these companies declined by 500,000 jobs to 21.1 million.

In a recent column in the Wall Street Journal, Craig Barrett and James P. Moore Jr. explained that companies outsource for two principal reasons.
“The first centers on the nature of the global,” they wrote.

“In today’s world, outsourcing can save companies money, reduce the time it takes to deliver products and services to customers, and provide access to skilled employees unavailable in the U.S. Outsourcing also allows companies to capitalize on incentives offered by foreign governments to attract investment.”

The second reason U.S. companies outsource is that “our own government pursues policies that drive investment and job-creation offshore: excessive taxes, needless regulations, lengthy permit processes, a decreasing supply of U.S. citizens with technical and engineering degrees, and a general governmental misunderstanding of how to support private-sector jobs.”

For example, Barrett and Moore cited that taxing new U.S. corporate investment at 35 percent – when the world average is just over 18 percent – pushes U.S. companies to invest offshore to increase return to shareholders.

[Barrett is the former CEO and chairman of Intel (NASDAQ: INTC); Moore is a former U.S. assistant secretary of commerce for trade development.]

The massive spread of the Internet and soaring telecommunications capacity has in particular enabled U.S. companies to easily transfer computer-based work to places like India, China and, increasingly, the Philippines, which offer a large pool of highly-educated (and, of course, cheap) workers.

“We have probably seen the most pronounced growth of outsourcing in the services sector, which cuts across a wide swath of businesses,” Bronars said. “It is estimated that since about 1992, the number of services-related jobs outsourced overseas has tripled.”

Preziosi noted that if one calls the customer service department of a bank or mortgage company or a credit card firm, one is now likely to reach someone in Mumbai or Manila, rather than Memphis or Minneapolis.

Bronars indicates that medium-skill positions in the services sector are the most likely to be heavily outsourced.

“Jobs in computer support, database administration, engineering services, computer programming, statistical analysis, and almost anything computer-related can be easily and cheaply replaced by foreign labor,” he said.

“Also, tasks like record-keeping, bill-processing and such business-support jobs (which one can find in virtually every different sector) can be outsourced.”

Manufacturing has also lost a huge number of jobs to outsourcing, everything from the making of heavy equipment and airplane parts to shoes and basketballs.

Although manufacturers and technology companies are most intimately associated with outsourcing, a broad array of American firms have taken advantage of moving certain operations overseas.

According to a recent article in the Los Angeles Times, such diverse companies as CKE Restaurants, JPMorgan Chase (NYSE: JPM), hotelier Hilton Worldwide, and accounting firm PwC have recently transferred some duties to foreign countries.

From the companies' point-of-view, the rationale for outsourcing is stunningly clear: lower wages and lower overhead translate into fatter profits and higher stock prices.

However, some experts (including the companies themselves) have expounded on the idea that by moving certain routine operations overseas at lower cost, these firms can pursue more value-added businesses here in the U.S. – a measure that would presumably open new job opportunities for American workers.

“There is an upside to outsourcing, which most Americans do not see,” Bronars said.

“The idea behind outsourcing is that we outsource low-cost tasks, so we can focus on more high value-added activities here in the U.S. But this is generally not well understood. Consequently, there is a populist movement against outsourcing.”

While the pace of outsourcing is likely to accelerate, or at least remain stable in the coming years, some types of jobs cannot be outsourced.

For example, it would be difficult to outsource a doctor or nurse since they have to be at close proximity to their patient.

Similarly, a construction worker or a carpenter cannot be outsourced – although a company could certainly replace them by importing cheaper immigrant labor (another type of 'outsourcing').

Jobs like sales, advertising, marketing, law, and upper level management are much less likely to be outsourced, Bronars added.

Moreover, outsourcing has become such a toxic issue in the U.S. that just the unspoken 'threat' of outsourcing has probably kept wages depressed in many industries (especially in the kind of businesses in which outsourcing would be easy to undertake).

Despite gaining substantial cost-savings from outsourcing, there are some risks involved for the company.

“When you outsource you have less quality control, less company loyalty, management has less direct control over employees, plus you might have some security issues that you would not face stateside,” Preziosi said.

“In China, for example, quality is a big problem. In addition, transportation costs are increasing in some of these foreign countries.”

Indeed, as the LA Times piece also pointed out, some American companies have chosen to forgo outsourcing and open up new offices within the U.S. They cited Allstate Insurance Co., which opened a call center in San Antonio, Tex. in June and expects to hire 600 employees by year-end.

Perhaps the biggest issue facing outsourcing companies is that wages, while still low in the developing world relative to the U.S., are nonetheless rising.

“While labor costs in the U.S. are essentially flat, they have skyrocketed about 500 percent in China in the past few years,” Preziosi noted.

Indeed, the very reason for outsourcing (low foreign wages) could ultimately vanish, thereby rendering the move unnecessary.

But Bronars contends this process (of rising wages in the emerging markets) will take many years, perhaps even decades.

“I see nothing that will reverse the current trend of outsourcing US jobs overseas,” he said. “But the point to remember is that we will probably always have outsourcing in one form of another.”

Indeed, since we will always have wealthier countries and poorer countries (and the resultant disparity in labor costs), companies in the more advanced countries will have strong motivation to outsource.

But it may take a different form in the future. Twenty or thirty years from now, perhaps China and India themselves will be outsourcing jobs to other countries.

It's an evolving story as the global economic landscape continually changes.