Friday, October 29, 2004

On Outsourcing

On Outsourcing

There is increasingly a climate of resentment against the trend in outsourcing. While India is getting a modest boost in economic well-being and enjoying a newly created slice of civil society (IT related professionals) which is bringing prosperity and libertarian values to some parts of India, we also note that America is in a sluggish, jobless recovery.

That the state of the US economy may be the outcome of a myriad factors such as overinvestment (spare capacity), the propping of the US dollar by China and Japan which keeps US exports uncompetitive, wasteful subsidies to the sugar/steel industry and shady deals with Halliburton, political risk in the specter of terrorism, and tax reform that has largely benefited the wealthiest who have the least marginal propensity to consume, is largely ignored by the popular media and little understood by the average American. All of these factors have downstream effects on the growth in jobs/wages but the media/masses are largely content in blaming direct effects where the causality is seemingly obvious – outsourcing being the chief one.

It is especially annoying to see fools like Lou Dobbs each night engaged in demagoguery and fear mongering – because we can see his prejudice resonating in people around us. It is of little consolation that Dobbs often ends up a lump of oozing, impotent emotion when he cannot articulate his prejudices with a veneer of reason. It is almost amusing to see him crazily ramble on, ostensibly phrasing a question to a guest only to abruptly end the interview without permitting any counter.

When the economy was doing well, Lou Dobbs was ‘Managing,’ now he is railing on outsourcing. The elite of America were all for trade and globalization when it was to their obvious advantage; now the advantages of trade are less obvious (but present nonetheless) and they have changed their tune. The racism stinks: the ‘regional design center’ in Germany or Israel is purportedly to harness the best talent of the world while the ‘outsourcing’ to India is a theft of a hard-working American’s job. Could you think of anything that screams “double-standard” any louder?

Work the numbers
There is a great survey on India in the February 21st, 2004 issue of The Economist. In the argument that outsourcing is harming the US economy, the numbers just don’t bear out. Nasscom forecasts that by 2008 IT and IT enabled services will account for $77B of India’s GDP. Even if all of this output is destined to the US, it is still only about 0.7% of US expected GDP in 2008. The doomsday seers are fussing over a 0.7% loss to US income over the course of 4 years - this is a laughably trivial effect.

The other way to look at it is in terms of jobs. Forrester Research projects that 3.3 millions service jobs will be lost to outsourcing by 2015. To put this in context, the US economy churns 2 million jobs a month; this roughly means that aside from cyclic effects of booms and busts, the economy creates and destroys 2 million jobs a month. The total job loss due to outsourcing is worth only 1 ½ months of churn and then over 11 years. This effect is almost imperceptible.

A thought experiment
J. Bradford DeLong, a UC Berkeley economist, has on his website an analysis on what outsourcing means to an economy. He lays of a couple of scenarios, but the one that is relevant to the current outsourcing issue is the one in which a minority of white collar workers find their jobs threatened with overseas competition. In this scenario, US IT workers find their wages are competed down which does have the effect of reducing national income. But everyone in the population benefits from cheaper IT services – they can use their savings to consume more of some combination of IT services and other goods; this counteracting effect more than compensates for the loss of US IT workers and the net result is a boost to the national output.

American Competitiveness
Consider the parallel to Bush’s steel tariffs. In the words of Palkhivala, a celebrated Indian jurist, in economics there are no miracles, only consequences. When Bush imposed tariffs on steel imports in blatant contempt of international trade agreements, he hurt not only foreign steel producers, but also hurt domestic consumers of steel – the appliance industry for instance found itself in distress when foreign appliance makers using steel from non-US sources had a cost advantage. Tariffs are not a panacea, as many a nation has discovered over and over.

In the context of outsourcing many a US electronics maker could find itself uncompetitive if it is forced to hire US firmware engineers, when the German competitor is using cheaper Indian ones. How does it help the US economy when the US firm goes bust or completely moves out of the US because it cannot be profitable using 100% US labor? When the whole world is using Indian IT services because they are the best value for money, America can be the exception only at its own peril.

Spread liberty through trade
Many an American is filled with hubris about the superiority of the American way of life, the centrality of liberty to the American way (the Patriot act notwithstanding), the fruits of capitalism and so on. The Iraq quagmire is now sensitizing many a thinking American to the contradiction in spreading liberty through oppression. This provides a timely basis to the argument that a more effective way to evangelize the world to the benefits of the market system is through trade. When nations are interconnected through commerce, there is an entrenched business interest which will counteract the nature of politicians to engage in jingoistic escapades.

There has to be some way to pay for this sort of world-improvement, better so in the form of a few lost jobs due to trade rather than the futile bloodshed of Americans in ‘ungrateful’ Islamic lands.
Protectionism is contagious and hence devastating
When a small, marginally consequential economy erects barriers to trade, it imperils itself. It cannot avail of the benefits of trade such as the comparative advantage in production, the discipline of the international market etc. But it hurts itself the most. It has more to lose than gain, because it risks provoking other, more powerful economies to retaliate against it specifically. Hence, small economies (with notable exceptions like North Korea) normally see the sense in keeping borders as free as possible.

But if the pre-eminent economy raises protectionist barriers, the smaller economies see no downside in also raising barriers. When there is no customer left who will retaliate, what prevents them from protecting their domestic market? Protectionism by the economic leader is contagious and leads to worldwide contraction – in a world dangerously afflicted with AIDS and radical Islam, trade and economic well-being is one of the few stabilizing counters left.

Shareholder capitalism
In America, that bastion of shareholder centric capitalism, of all places people should understand that companies do not exist for the philanthropic purpose of bringing purpose and income to individuals - that is but a by-product of the firm’s pursuit of delivering returns to shareholders. If costs can be lowered by employing cheaper resources, the firm MUST do so – anything else would be a violation of the management’s fiduciary duty to shareholders. Keeping jobs in America is the firm’s discretion – it is not within the government’s charter. Valid as this is, there are really two America’s (if not more): the small elite finance class that truly has internalized this notion, and the vast majority that pats itself on the back for its practice of capitalism, but at the first hint of layoffs castigates greedy corporations and ‘Benedict-Arnold CEOs.’

The cheapest resources are invariably brought into the production of any good. Outsourcing is inevitable. In the case of agriculture, America has a whole parallel labor economy – in this case other assets of production are not alienable from America (land/proximity to markets). In the case of technology there are no inalienable assets; Americans have to choose whether they want to liberalize the labor market (a truer globalization) and let all the Indians come in who want in – something America has rejected with its draconian immigration system which has kept the inflow of hitech workers on a tightly controlled spigot and has made the very subsistence of poor Mexican farm laborers a crime – or watch as the jobs leave to India. But America can’t have it both ways.

[As an aside, the consensus view of globalization is farcical. There are broadly three markets, the market for goods and services, the market for capital and the market for labor. While there is plenty of popular support for the goods market, and the jury appears to be still out on the market for capital (generally a good idea, but there are some valid concerns with regard to speculative capital that causes a good deal of near term distress to developing economies), there is little popular support for a free market in labor. Immigration restrictions in particular and nationalism in general are severe inhibitors of the labor market and do a great disservice to the welfare of humankind. Nationalism is a counter-productive and out-dated concept – it creates wars and artificial conflicts, but now I really digress.]

In summary, outsourcing helps developing nations tremendously, makes America better off too (due to the benefits of trade), and is a better way to spread cherished American values of liberty around the world than imposing ‘democracy’ at the end of a gun barrel.

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