Foreign Affairs on Outsourcing

[via Dan Gillmor] Foreign Affairs is one of the most influential publications in government circles. It has an article by Daniel Drezner on what has rapidly become a hot political issue in the US:

Critics charge that the information revolution (especially the Internet) has accelerated the decimation of U.S. manufacturing and facilitated the outsourcing of service-sector jobs once considered safe, from backroom call centers to high-level software programming. (This concern feeds into the suspicion that U.S. corporations are exploiting globalization to fatten profits at the expense of workers.) They are right that offshore outsourcing deserves attention and that some measures to assist affected workers are called for. But if their exaggerated alarmism succeeds in provoking protectionist responses from lawmakers, it will do far more harm than good, to the U.S. economy and to American workers.

Should Americans be concerned about the economic effects of outsourcing? Not particularly. Most of the numbers thrown around are vague, overhyped estimates. What hard data exist suggest that gross job losses due to offshore outsourcing have been minimal when compared to the size of the entire U.S. economy. The outsourcing phenomenon has shown that globalization can affect white-collar professions, heretofore immune to foreign competition, in the same way that it has affected manufacturing jobs for years. But Mankiw’s statements on outsourcing are absolutely correct; the law of comparative advantage does not stop working just because 401(k) plans are involved. The creation of new jobs overseas will eventually lead to more jobs and higher incomes in the United States. Because the economy — and especially job growth — is sluggish at the moment, commentators are attempting to draw a connection between offshore outsourcing and high unemployment. But believing that offshore outsourcing causes unemployment is the economic equivalent of believing that the sun revolves around the earth: intuitively compelling but clearly wrong.

Should Americans be concerned about the political backlash to outsourcing? Absolutely. Anecdotes of workers affected by outsourcing are politically powerful, and demands for government protection always increase during economic slowdowns. The short-term political appeal of protectionism is undeniable. Scapegoating foreigners for domestic business cycles is smart politics, and protecting domestic markets gives leaders the appearance of taking direct, decisive action on the economy.

Protectionism would not solve the U.S. economy’s employment problems, although it would succeed in providing massive subsidies to well-organized interest groups. In open markets, greater competition spurs the reallocation of labor and capital to more profitable sectors of the economy. The benefits of such free trade — to both consumers and producers — are significant. Cushioning this process for displaced workers makes sense. Resorting to protectionism to halt the process, however, is a recipe for decline. An open economy leads to concentrated costs (and diffuse benefits) in the short term and significant benefits in the long term. Protectionism generates pain in both the short term and the long term.

Two more stories on outsourcing:

WSJ: “U.S. companies sending computer-systems work abroad yielded higher productivity that actually boosted domestic employment by 90,000 across the economy last year, according to an industry-sponsored study…The study’s premise is that U.S. companies’ use of foreign workers lowers costs, increases labor productivity and produces income that companies can use to expand both in the U.S. and abroad. It was commissioned by the Information Technology Association of America, an industry membership and lobbying group, which hired the economics consulting firm Global Insight Inc. of Lexington, Mass…The study claims that twice the number of U.S. jobs are created than displaced, producing wage increases in various sectors. The report takes a rather narrow focus, tracking the outsourcing of computer-services jobs, but not other work increasingly being done abroad such as manufacturing, call centers or medical X-ray reading.” “The U.S. technology industry’s demand for offshore services is apparently beginning to drive up pay rates in India, raising questions about the long-term benefits of outsourcing work to that country…India’s wage inflation, which approached an estimated 14 percent last year, is a natural byproduct of a classic supply-and-demand scenario.”

A historical perspective on outsourcing is provided by another WSJ story:

Losing skilled jobs to low-wage foreign competition is as old as the Industrial Revolution. In the 1830s, the British textile industry became so efficient that Indian cloth makers couldn’t compete. The work was outsourced to England, with disastrous consequences for Indian workers. “The misery hardly finds parallel in the history of commerce,” India’s governor general, William Bentinck, wrote to his superiors in London in 1834.

As Americans grapple with the fallout of shipping hundreds of thousands of jobs overseas, history echoes with many similar episodes — and lessons. Trade and technology can boost living standards for many people, by creating lower-priced goods. But those same forces can destroy skilled jobs that workers thought never would be threatened.

Competition from foreign labor hurt huge classes of American workers in the 19th century but eventually helped ease wage disparities between nations. And during these upheavals, history shows that politics can arrest what seems like unstoppable technological progress.

Here are four lessons from history that help illuminate today’s debate:
– Even high-skilled, good-paying jobs are vulnerable.
– Trade liberalization often works with technology to undermine powerful interests.
– Domestic workers are always vulnerable to competition from foreigners willing to work for less.
– Politics can slow down the transforming effects of new technology.

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Rajesh Jain

An Entrepreneur based in Mumbai, India.