Economic and social impact of outsourcing and off-shoring work

Outsourcing production and off-shoring service work offers cost advantages to a multinational Company, but can lead to criticism in its home country. Discuss the arguments for and against this strategy, paying particular attention to its economic and social impact.

The assignment should be submitted by Friday 21st May 2010.

ABSTRACT. The United States has experienced an increase in the offshore outsourcing in both the manufacturing and in the service industry. This recent increase has raised a debate about the socio- economic impacts it has on the American economy. Those who oppose off shoring believe it takes away American jobs, lowers wages, causes a decline in America’s standard of living and that any benefits from off- shoring are unevenly distributed. While those in support of off-shoring believe it has a long-term positive economic effect on the American economy. And that off shoring in the service industry has not negatively affected the United States. Their claim is that off-shoring in the service industry has a net benefit to the American society.

TABLE OF CONTENTS

INTRODUCTION ———————————————————————————————4

TRENDS IN OUTSOURCING—————————————————————————————-4

THE DEBATE ABOUT OFFSHORE OUTSOURCING ———————————————————8

ECONOMIC IMPACT OF OFFSHORE PRODUCTION—————————————————8

POSITIVE IMPACT (HOME AND HOST COUNTRY)————————————————–8

NEGATIVE IMPACT (HOME AND HOST COUNTRY)———————————————–10

SOCIAL IMPACT OF OUTSOURCING PRODUCTION————————————————-11

POSITIVE IMPACT (HOME AND HOST COUNTRY)————————————————-11

NEGATIVE IMPACT (HOME AND HOST COUNTRY)———————————————-12

ECONOMIC IMPACT OF SERVICES OFFSHORING WORK——————————————13

POSITIVE IMPACT —————————————————————————————-13

NEGATIVE IMPACT ————————————————————————————–14

SOCIAL IMPACT OF SERVICES OFFSHORING ——————————————————–15

POSTIVE IMPACT———————————————————————————-15

NEGATIVE IMPACT——————————————————————————–15

CONCLUSION————————————————————————————————15

REFERENCES————————————————————————————————-16

Introduction

This essay examines the socio-economic impact of offshore outsourcing production and off-shoring service work in both the home and host countries, with particular attention to the two major sectors of the American economy; the goods producing sector and the service producing sector.

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The study concentrates on offshore outsourcing production and off-shoring service work using the United States of America as a case study; while China and India will be used as outsourcing centers (host countries). However, this study does not attempt to resolve the differences in views of those for and against offshore outsourcing.

Trends in outsourcing:

The ever- growing pressure for increased productivity and profitability of the American Companies coupled with the availability of potential low cost labour of developing countries such as China and India have drove many companies towards offshore outsourcing. This is because these companies found the prospect of a significantly lower cost labour pool an irresistible enticement to move towards offshore outsourcing. Thus, the pressures to reduce costs and improve productivity are the main factors that influenced the beginning of offshore outsourcing. For example, the main advantages to move production to China are the low labour costs, cheap raw materials, and relatively low cost of transportation. Hence, today outsourcing has become an attractive and powerful strategy for companies to reduce cost and improve performance.

The term “Outsourcing” is generally used when Companies contract out certain business functions to an external supplier, eliminating the need to maintain internal staff necessary to perform that function. Outsourcing does not necessarily imply that jobs and production are relocated to another country (Vander, 2006)

However, offshore outsourcing is the contracting of these business functions to companies in lower cost, primarily developing nations such as India, China, Malaysia, Singapore and Philippines. Offshore outsourcing refers to trade with an unaffiliated party, while off- shoring refers to trade with an affiliated party (Houseman, 2008).

An example of offshore outsourcing production is the Intel ® and Apple ® in the United States of America. Intel and apple two of the world’s leading manufacturers of computer, networking and communication products based in the United states resorted to “Turnkey contract manufacturing” with their entire manufacturing process being outsourced to oversea manufacturers such as India and China. This has given these chip manufacturing technology giants the leverage to allocate their assets on future marketing campaigns and branding strategies.

“Off-shoring” is used to describe multinational corporations relocating work from their domestic sites to foreign locations. It means relocating of jobs and production to a foreign country. The relocated jobs and production could be at a foreign office of the same multinational company or a separate company located abroad (Garner, 2004). Off-shoring could also be either manufacturing or services off shoring (Norwood, 2006).

On the other hand, off-shoring services work refers to exporting of services that provide knowledge-intensive inputs to the business processes of other organizations. Lower production costs in foreign countries are the major cause of service-sector off shoring. The KIBS sector consists of firms who have emerged precisely to help other organisations deal with problems for which external sources of knowledge are required (Miles, 2005). They provide basic information, advice, and intermediation services. They also help in training client staff.

A company may offshore services either by purchasing services from another company based overseas or by obtaining services in-house through an affiliate located overseas. For example, a U.S multinational company investing in its overseas affiliate to render accounting and payroll services to other companies abroad might do so without affecting its production and employment level in the U.S. An example of off-shoring service work is the IBM consulting services, from a different sector moving in to offer more KIBS- type services. In 2003, IBM signed a ten-year $400 million deal with the Proctor and Gamble Company to manage P&G’s employee service, providing services that include payroll processing, benefit administration, compensation planning, expatriate and relocation services, travel and expense management and human resources data management. Thus, IBM business services support 98,000 P&G’s employees in nearly 80 countries. Some KIBS firms operate as lead suppliers and service integrators or coordinators, subcontracting others to provide specific inputs to their clients (Toivonen, 2004)

Importance of outsourcing

Outsourcing today has become an essential revenue and growth strategy for almost every existing corporation. It creates flexibility in the company, ensuring the maximum utilization of available resources within the company. It also offers corporations cost advantages and help free up their management resources.

More importantly, outsourcing helps firms to be focused. Since the most valuable resource within management is time, once a process is successfully outsourced, the management gets more and effective time to explore new revenue streams, time to accelerate other projects and time to focus on customers. Traditionally executives spend 80 percent of their time managing details, and only 20 percent on planning and customer relations, in other words, a successful offshore outsourcing process can help reverse this ratio.

Outsourcing can also help companies to have access to new technologies that might not be used in their company. This is mainly because the offshore outsourcing destinations use the latest state-of-the art technologies to serve their international clients. And this might also increase the chances of rapid migration of these companies to new technology. Offshore outsourcing also helps multinational companies to exploit the time zone advantage, by reaping the benefit of 24-hour development cycle. Receiving round the clock service benefits as well as providing it to their customers when needed.

Figure 1: demonstrates the difference between outsourcing and off shoring.

(Figure 1, from GAO, 2004)

The debate about offshore outsourcing:

Despite the fact that offshore outsourcing production offers cost advantages to a multinational Company in the form of availability of potential low cost labour pool, it is still being criticized in its home country. The controversy is that many people see offshore outsourcing as dangerous to the American economy and have expressed concern over the number of high paying jobs that are filled by non-Americans workers in other countries. Whereas others see this type of outsourcing as a form of trade and strongly believe that trade generally benefits society, and that any form of restrictions against it harms the economy. Both sides of the debate have valid points, but approach the topic from different points of view.

Economic impact of outsourcing production:

Positive

Proponents of offshore outsourcing are those in support of free trade. They are often economists who approach the topic by looking at long-term economic effect. Their basic claim is that international outsourcing has potential long-term economic benefits. They believe that offshore outsourcing lowers costs and encourages competiveness (Rajan and wei, 2004). According to them, the cost reductions stemming from this process will eventually lower product prices, and the increased demand and profit derived from this process could be used for employee benefits as workers may now produce more per hour, thereby driving up real wages. Furthermore, a study by McKinsey found that two thirds of the economic benefits from off-shoring spills back into the United States economy (Schroedder and Aepeal, 2003). The economic benefit is seen in lower prices of goods and services, expanding markets for American goods and increasing profits for American firms.

Moreover, the large amount of relatively high quality jobs created in the host countries, mainly less developed countries through off shoring may provide these countries with substantial economic benefits. They can build a stronger economic base, increase domestic consumption and therefore foster imports from developed nations like the United States.

Garner (2004) emphasized that offshore outsourcing benefits the economy as a whole. He stated that outsourcing has helped to drive down costs of high-tech goods and sped up the adoption of new technologies. This in turn has a knock on effect of creating secondary demand for software, which in turn helps create more jobs in the software programming sector. The same hold true for mobile technology devices. An industry report, Global insight stated that the cost savings and use of offshore resources lowers inflation, increases productivity and lower interest rate, thereby boosting business and consumer spending and increases economic activities (CNNmoney.com, 2004). With an increase in production, firms are able to produce more goods and services at a lower cost which increases the profits. Moreover, outsourcing helps companies to concentrate on their core business areas, access world class technology at lower rates; skilled manpower at affordable prices, and competitive advantages.

Consequently, most of the developing Asian Countries such as India has immensely gained from the booming off shoring business. Apart from generating gainful employment for millions of its highly qualified technical personnel, offshore outsourcing has catapulted India to the forefront of the IT world making India the hub of software development services industry. Developed nations like the USA, Germany, Australia and England are looking to India for their outsourcing jobs because of the geographical location, ideal Time Zone and the low cost of operations. India is fast metamorphosing to be the final destination for off shoring and other such IT-enabled services, owing to the manifold off shoring benefits of India.

Negative impact

One of the major concerns about offshore outsourcing is the loss of American jobs. Some fear that if jobs continue to be transferred to foreign countries, there will not be any jobs left at home. Jobs lost to outsourcing are likely to be permanent (Garner, 2004) people are worried about the unemployment rate and believe that the rate is rising because of the increase in offshore outsourcing. For instance, American high-tech firms shed 560,000 jobs between 2001 and 2003, and expect to lose another 234,000 in 2004.” (IEEE-USA March 2004)

ELA Survey June 2004 stated that 58% of American workers believe that companies outsourcing work that could be done by Americans to offshore contractors should be penalized by the US government. A poll taken in July, 2004 found that 72 percent of respondents believed that offshore outsourcing was a bad trend because off-shoring took jobs away from American workers (Program on International Policy altitudes)

Lower wages is another concern people have about off-shore outsourcing. People feel they now have to compete with workers in other countries who are willing to work for lower wages than Americans. American workers believe they will have to settle for lower wages or risk losing their jobs to foreign workers. Some believe being forced to accept lower wages is unfair to American workers because the cost of living is much higher in the United States compared to developing countries.

Another concern about off shore outsourcing is the unequal distributional effects of trade (Poole, 2004). Many Americans believe free trade primarily benefits the businesses doing the off shoring and the wealthy. In a poll taken in January 2004,

51 percent of respondents

believed that international trade had a positive effect on businesses

45 percent of respondents

believed it had a negative effect on workers

59 percent of respondents

believed that international trade was good for American business

64 percent of respondents

said it was bad for the job security of the American workers

In another poll taken in July 2004,

Source: Program on International Policy Altitudes.

The common belief is that the rich get richer, while many domestic consumers feel they are not seeing the benefits of outsourcing reflected in the prices they pay.

Another significant concern is the declining standard of living. This issue is connected to the concern about lower wages. If American workers have to accept lower wages in order to keep their jobs, their standard of living is going to fall. They are no longer going to be able to afford the consumption they had at the higher wages. Thus, to avoid financial troubles, people will have to cut their consumption thereby lowering their standard of living.

The growing trade deficit in goods and services is also a major concern of off shore outsourcing in the United States. People are concerned that the American economy will suffer if it increases its imports in the services industry. People are anxious about the trade deficit increasing. Again the track record for the reemployment of displaced American workers who lost their jobs due to outsourcing is extremely bad. Many who have lost their jobs often learn that the creation of higher paying jobs to replace ones that are lost has not occurred. And many of those who are lucky enough to find jobs take major pay cuts. And providing further training and unemployment benefits to workers until they find other employment is expensive.

Furthermore, outsourcing weakens the American economy as it contributes to trade deficit and the loss of American consumers who buy these products and services. This is because employees displaced by foreigners and left unemployed or in lower paid job have a reduced presence in the consumer market.

Social impact:

Positive

Amiti and Wei (2005B) found that outsourcing has a positive effect on productivity in the United States. By relocating some jobs to other less expensive parts of the world can easily save costs, save the company, save most people’s jobs, keep prices down and offer great services. On the host countries, any job created in these developing countries can create many others as new money flows into the national economy, and is spent on local goods and service.

Negative

The laying-off of employees as a result of offshore contracts can pose big problems for companies. Layoff causes major moral problems among in-house survivors, and may lead to dissatisfaction and work slow down. Moreover, offshore outsourcing causes workforce to have less opportunity for learning because of knowledge transfer. Again unemployment has negative effect on poverty, happiness, family life, crime; drug and alcohol use and the prospects of children of unemployed people. Unemployment is also a strong predictor of relationship break-up. Unemployment predicts partnership dissolution. And the lives of children are badly affected by unemployment. Children with unemployed parents are far more likely to live in poverty and to miss school.

The extreme impact of parental unemployment for children are illustrated by a comprehensive study of census data which concluded that the death rate for children of parents classified as never worked or long-term unemployed was about 13 times higher for children whose parents worked in higher managerial or professional occupations. Moreover, lacking a job often means lacking social contact with fellow employees, lacking a purpose for many hours of the day, lack of self- esteem, mental stress and illness, and of course the lack of ability to pay bills and to purchase both necessities and luxuries. This last point is especially serious for those with family obligations, debts and/ or medical costs especially in the U.S where the availability of health insurance is often linked to holding a job.

Furthermore, with the increasing rise of offshore outsourcing firms will become hollow, mere virtual organisations with little responsibility to the home country in which they operate and unaccountable to the society, Thereby ignoring their corporate social responsibility.

Again, as workers attempt to maintain their standard of living on lower wage rates in lesser status jobs due to off shoring outsourcing, they may be forced to work longer hours to earn the same total wages. This may have the unfortunate direct effect of workers spending less time with their family and loved ones, thereby causing adverse sexual effect, divorce, and domestic violence.

Offshore outsourcing further raises the question of quality. This is because most products are outsourced to countries with obvious history of substandard or inferior goods, thereby raising questions about quality. For example, when an auto dealer company, Ateco Group in Australia first looked at launching Great Wall Motors (GWM) Pick-up trucks in Australia last year, the GM, Ric Hull considered rebranding them, worried that their obvious Chinese origin would raise questions about their quality (Malaysian insider, May 2010)

Economic impact of service off shoring:

Positive

Off shoring in the services sector has a positive economic impact on the United States economy. Given the strength of U.S services, increased trade in services is actually more likely to record trade surplus for the country. By exporting services to China, India and the rest of the world, jobs are created for U.S young college graduates and skilled white collar workers. Secondly, the United States runs a trade surplus in the services sector more than any other country. This means that the U.S exports more services than it imports (Little, 2004). For example, in 2003, the USA ran a surplus of close to $60 billion in services alone (Garner, 2004). It has the worlds most developed and productive service sector and continues to hold comparative advantage in these knowledge based industries, unlike manufacturing sector. For example, U.S banks, law firms, accounting firms, IT integrators, and consultants are global competitors.

Off shoring service work attracts foreign direct investment (FDI) in the host countries. A long-term view of off shoring services promote a healthy and stable world economy particularly in emerging markets through foreign direct investment. Foreign direct investment by multinational companies is one of the best ways to promote private sector growth, which according to a study by the McKinsey global Institute is the best way to alleviate poverty.

Negative

Off shoring in the services sector has been criticized in the U.S as being responsible for the weak rate of job creation during the current economic recovery. These critics are concerned that exporting the American knowledge base to other countries could weaken the Americans leadership in technology and innovation, a threat that has a serious implication for the national security as well as the economic competiveness of America. According to Michael Porter’s Diamond Model (1990), competitive advantage theory suggests that nations and businesses should pursue policies that create high quality goods to sell at high prices. The model states that productivity growth is the main focus of national strategy. In other words, the exportation of knowledge outside the country that would have been engaged in a meaningful productivity in American economy compromises the strategy and may lead to the loss of competitiveness.

Social impact of off shoring services

Negative

Service off shoring is a relatively recent development in international trade and its impact on the American economy is not yet fully known. However, services off-shoring has caused a significant job turn over. This is because of the creation and destruction of jobs in the American economy. U.S workers especially college graduates and skilled white collar workers are more likely to switch industries as their industry exposure to off shoring services to developing countries rises. While off-shoring of white-collar work may provide benefits to individual firms, if it becomes widespread enough to lead to rapid productivity gains in sectors in which the United States is a prime exporter, the U.S. terms of trade could deteriorate enough to cause actual income losses for the country. Even if this does not occur, the terms of trade effect could still lean against any efficiency gain from off shoring, leading to a smaller economy wide effect than suggested by the firm-level analysis of MGI

Conclusion:

The examination of the debate on the pros and cons of outsourcing for both the home and host country in terms of economic and social impact cannot be generalized. The benefit and draw backs for either must be seen on a country to country basis (the outsourcer and outsourcee) as every destination country has different PESTEL factors to be considered. In conclusion therefore, one must be careful when talking about this topic because benefits for outsourcing are for the public as a whole. Those who have lost their jobs overseas may have trouble seeing the benefits and they may have a justified reason to be concerned about outsourcing. On the other hand, many good things have occurred because of outsourcing. Although the media enjoys focusing on the bad and talking about how many jobs are lost and forgets to ask how many jobs are created. Offshore outsourcing may not be the only cause of unemployment in America, since the economy has suffered recession in recent years. In other words, the unemployment may also be the effect of recession. However, an ideal solution would be to derive economic gains but not at the expense of negative social impacts. It must not be a zero sum game.