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CHAPTER 23

WHAT’S TO LIKE ABOUT OUTSOURCING?

The Influence of International Labor Markets

On February 9, 2004, Greg Mankiw, Harvard economist and chair of the president’s Council of Economic Advisers (CEA), described the outsourcing of jobs from the United States to other countries this way:

Outsourcing is just a new way of doing international trade. More things are tradable than were tradable in the past, and that’s a good thing.

Two days later, Senator Hillary Rodham Clinton (D-NY) responded this way:

I don’t think losing American jobs is a good thing. The folks at the other end of Pennsylvania Avenue apparently do.

U.S. Representative Donald Manzullo (R-IL) called for the resignation of Mankiw, saying

I know the president cannot believe what this man has said. He ought to walk away, and return to his ivy-covered office at Harvard.

President George W. Bush was a believer after all, as he explained in a speech on March 11, 2004:

People are saying, well, we’ll stop jobs from going overseas by making sure we put up walls and barriers between the United States and the rest of the world. That’s lousy policy. Consumer prices will go up if we wall ourselves from the rest of the world. Economic isolationism is bad economic policy, and it will cost people jobs.

This chapter investigates the outsourcing (or offshoring) of jobs and the reasons why Mankiw describes this phenomenon as “the latest manifestation of the gains from trade that economists have talked about at least since Adam Smith.”¹

¹ See www.useu.be/Categories/Trade/Feb1304JobOutsourcing.html.

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In a typical year, the United States imports about $1.8 trillion worth of goods and services that were produced elsewhere. Most of these items could be produced domestically, and many of them had been produced here in the past. Chapter 28 includes a discussion of the more general issue of who benefits from foreign trade. This chapter examines the particular effects of the decisions by various U.S. companies—including Delta Airlines, American Express, Sprint, Citibank, IBM, and Levi’s—to move call centers, manufacturing, or other operations to other countries. CEA chair Mankiw suggested that the outsourcing of jobs is beneficial to the United States. Was the ivy really pulled over the Harvard professor’s eyes? And why would economists from Bill Clinton adviser Martin Baily to former Fed chair Alan Greenspan agree that outsourcing isn’t something to be feared? Economists seldom concur on something so controversial; might Mankiw’s message have merit?

Some people may view outsourcing as a way to help people in developing nations. Those who seek world peace may see that trade and the exchange of jobs provide strong incentives for civility among nations. Followers of some religions labor to love their neighbors as themselves. Stockholders may relish the efficiency gains for their corporations. But what about those of us who simply want to keep our jobs?

There is a perception that the United States is hemorrhaging jobs as a result of outsourcing, but much of the economic research is reassuring. The current unemployment rate of about 5 percent is comfortably below the 50-year average of 5.8 percent. Rates could always be lower, but of course we’re recovering from a recession, a dot-com bust, and a string of corporate ethics scandals. After all that, businesses are slowly regaining the self-confidence they need to take risks and create jobs. Federal Reserve chair and former Princeton economist Ben Bernanke estimates that during the past decade, about 15 million jobs have been lost in the United States each year, that about 17 million jobs have been created each year, and that outsourcing was to blame for only 2 percent of the jobs that were lost. “In other words,” Bernanke notes, “for the typical job loser during the past 10 years, the chances are 98 percent that some factor other than competition from imports was the principal reason for displacement.”² In concurrence, the U.S. Department of Labor reported that 2.5 percent of the “mass layoffs” (50 or more people laid off for at least a month) in the first quarter of 2004 resulted from outsourcing. Seventy percent of the nonseasonal layoffs in the Department of Labor study were attributable to internal restructuring, including changes in ownership and bankruptcies.³ These findings suggest that to blame other countries for our unemployment woes is to lose focus on more relevant problems at home.

² See www.federalreserve.gov/boarddocs/speeches/2004/20040330/default.htm.

³ See http://offshoregroup.com/pressnew.asp?idnew=60.

Fears about outsourcing are nothing new. Since at least the 1950s, there has been talk of losing low-wage jobs to foreign rivals, first to Japan, then to Mexico, China, India, and a host of other Asian countries. The actual damage was not as expected. With improved trade and commerce in developing countries came higher wages and a growing appetite for goods and services from the United States, not to mention an improved standard of living here and abroad. Japan is now a high-wage country that imports more than $50 billion worth of goods and services from the United States each year and operates more than 2,000 of its own manufacturing operations in the United States. Toyota alone has created more than 100,000 U.S. jobs.

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The international labor market allows firms to make better use of the world’s array of workers with varying availability and skills. As explained further in Chapter 27, when workers in one country can produce something at a lower opportunity cost than workers in another country, the first country enjoys a comparative advantage, and it is more efficient for goods to be made where such a comparative advantage exists. For example, textile manufacturing and other labor-intensive jobs tend to migrate to labor-abundant places, which makes sense if you think about it. Meanwhile, the world’s most productive workforce continues to draw more and better jobs to the United States, where 30 percent of global output is produced by 5 percent of the world’s labor force.⁴

⁴ See www.jsonline.com/news/editorials/sep04/256511.asp.

To begin with, remember that what goes around comes around. Foreign trade enlivens developing economies and gives their consumers the ability and desire to import products from us. For instance, the United States has lost manufacturers, such as Fruit of the Loom, to Mexico, but Mexico buys more than $100 billion worth of U.S. products every year, including computers and electronics, transportation equipment, chemicals, food, plastic and rubber products, machinery, and paper. The United States exports more goods and services than any other country in the world.⁵ If policymakers in the United States create barriers to trade and job creation overseas, our trading partners will do the same. A protectionist stance would harm 6.4 million U.S. workers who get their paychecks from foreign firms, and these insourced jobs pay 16.5 percent more than the average domestic job.⁶

⁵ See www.whitehouse.gov/news/releases/2002/05/20020517-13.html.

⁶ See http://www.ncpa.org/pub/ba/ba480/.

There is understandable concern that outsourcing will diminish domestic employment opportunities, but considerable evidence points in the opposite direction. A study by Global Insight concludes that information technology (IT) outsourcing results in a net gain of jobs in the United States.⁷ India’s finance minister, Shri P. Chidambaram, makes the point this way: “What do [Americans] outsource? They outsource low-end jobs, call centers, and help centers. What do they insource? They insource orders for capital goods, for technology, for design, for brands, for trademarks, for intellectual property.”⁸ The McKinsey Global Institute finds that for every dollar spent on outsourcing to India, the U.S. economy gains at least $1.12.⁹ The dollars saved by outsourcing bring consumers better prices and allow companies to invest in research and development—a critical factor because mature industries do relatively little for job creation; innovation is the real engine for job growth. The United States also gains jobs from trade in services, such as health care, tourism, and education. For example, the state of Kentucky currently welcomes 5,018 international students to its college campuses, and they and their families contribute about $85 million to the state’s economy yearly.

⁷ See www.globalinsight.com/About/PressRelease/PressRelease855.htm.

⁸ See http://washingtontimes.com/upi-breaking/20041213-095125-4941r.htm.

⁹ See www.mckinsey.com/mgi/publications/win_win_game.asp.

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Consider the effect that higher trade barriers would have on U.S. prices and global competitiveness. Fundamentally, firms that don’t minimize costs are swept away by those that do. As an example, Kent International, Inc., of Parsippany, New Jersey, sells bicycles made overseas (mostly in China) through Wal-Mart, Toys R Us, and more than 1,000 other U.S. retailers. One of their road bikes sells for about $150. U.S.-made bicycles are available from such domestic manufacturers as Trek and Cannondale for prices starting at about $1,000. What would happen if Kent’s 1,000-plus retailers switched to strictly domestically produced bikes or if policies prevented them from purchasing bikes from companies that outsource bike production? Few bikes would be sold, many jobs at Kent and its retailers would be lost, and many American would-be cyclists would be out of luck. Dartmouth College economist Matthew Slaughter found that as U.S. affiliates of multinational corporations, such as Kent, added 2.8 million workers to their payrolls overseas between 1991 and 2001, that didn’t mean that they lost 2.8 million domestic workers in an example of substitution; rather, they actually added 5.5 million U.S. employees to their payrolls.¹⁰ This lose-one–gain-two effect on jobs suggests, again, that the efficiencies of outsourcing create benefits all around.

¹⁰ See http://mba.tuck.dartmouth.edu/pages/faculty/matthew.slaughter/MNE%20Outsourcing%200304.pdf.

Some job loss is part of any healthy economy. Outsourcing, like computerization and automation, eliminates jobs for some but improves the employment picture for most workers. The U.S. Bureau of Labor Statistics anticipates the creation of 18.9 million new jobs in the United States during the next 10 years, a majority of which will be in occupations that pay more than the average U.S. salary of about $30,000.¹¹

¹¹ This salary figure is adjusted for inflation. See http://www.bls.gov/oco/oco2003.htm and www.whitehouse.gov/ask/20060407.html.

In response to these strains and the dislocations [outsourced jobs] cause, a new round of protectionist steps is being proposed. These alleged cures would make matters worse rather than better. They would do little to create jobs; and if foreigners were to retaliate, we would surely lose jobs.

—Alan Greenspan, former chair of the Federal Reserve¹²

¹² See www.federalreserve.gov/boarddocs/speeches/2004/20040312/default.htm.

If economic theory and the evidence previously described is to be believed, outsourcing is a win–win situation for the countries involved. In the short run, however, it is a win–lose situation for domestic workers who lose their jobs. When the Ohio Art Company closed its plant at 1 Toy Street in Bryan, Ohio, and began producing its Etch-a-Sketches and Betty Spaghetti dolls in China, about 190 workers remained to work in the corporate offices. Some other workers moved to other departments or plants, and a few were ready to retire. But about 100 workers lost their jobs and may have had difficulty transferring their skills to existing positions, making them structurally unemployed.¹³ Regardless of whether more jobs are created than are lost as a result of outsourcing, those who become unemployed are dealt a difficult and unfortunate card.

¹³ See www.careerjournal.com/columnists/inthelead/20031022-inthelead.html.

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One would hope that the society that benefits from international trade and the outsourcing of jobs will want to supplement its trade policy with safety nets for those who do become unemployed as a result. Several provisions are already in place; more, particularly for educating and training the unemployed, are needed. Unemployment insurance provides most workers with about two-thirds of their weekly incomes (up to a maximum amount determined by each state) for 26 weeks or longer. The Trade Adjustment Assistance (TAA) program provides up to 2 years of retraining and financial aid to eligible manufacturing workers, farmers, and fishers who have lost their jobs because of outsourcing or foreign competition. President Bush tripled the funding for TAA between 2002 and 2004, bringing it up to $1.3 billion. Funding decreased slightly in 2005; moreover, the program currently is not open to service workers.

Proposals for additional avenues of support are on the table. Six members of Congress, including U.S. Representative Adam Smith (D-WA), have introduced variations of the Trade Adjustment Assistance Equity for Service Workers Act that would provide tuition assistance, job training, extended unemployment benefits, and health-care assistance to service workers who lose their jobs to outsourcing. As part of the Jobs for America Act, former Senator Tom Daschle (D-SD) proposed that employers who offshore 15 or more jobs should be required to provide at least 3 months’ notice of their intentions to terminate domestic workers. Additional concerns include inadequate public transportation for workers whose new jobs require commutes, the continuation of health-care and pension benefits, and the cost of child care that stands in the way of retraining for many parents. Efficiency dictates that the benefits from outsourcing are worthwhile only if they exceed all these associated burdens. With most employment transitions being relatively short lived, and given the prospects for employment growth, lower prices, and improved living standards as the result of outsourcing, economists, including Greg Mankiw, foresee a net gain.

Workers are the heart of any economy and a top priority in the eyes of voters and policymakers. As employers come and go, job losses must be minimized and safety nets promoted, including unemployment insurance, training and education programs, trade adjustment assistance, and transferable health and retirement benefits. Outsourcing to dodge environmental regulations, human rights standards, or taxes is deplorable. But barriers to appropriate matchmaking between employers and workers are chiefly counterproductive and hurt the country and its workforce. President Herbert Hoover learned this lesson well after his administration attained a pinnacle of protectionism with the Smoot-Hawley tariffs of 1930: A firestorm of retaliatory strikes ensued, wounding the economy and deepening the Great Depression.¹⁴ Policies that allow outsourcing are critical to efficiency, affordability, and competitiveness. They force difficult adjustments for some workers, but the size of the threat is often exaggerated, and the alternative of economic isolation is far worse for everyone involved.

¹⁴ Perhaps the most damaging retaliation came from our largest trading partner, Canada, in the form of “countervailing duties” on 16 products imported from the United States. For more on the Smoot-Hawley tariffs, see www.state.gov/r/pa/ho/time/id/17606.htm.