Who wins in offshoring

By Diana Farrell

Business process offshoring does not mean the US economy loses every time a job is sent to another economy. Rather, it's a win-win game. McKinsey Global Institute analysis shows that the US actually reaps significant economic benefits from offshoring that can be used to retrain workers for higher-skilled and higher-paying jobs.

The debate over American jobs, globalization and free trade is back in the headlines. This time, one of the reasons is the growing practice of offshoring, with unions and some politicians accusing countries like India of stealing American jobs as companies in a range of industries relocate to lower-cost regions everything from call centers to data entry to software development.

Several states are considering laws to prohibit or restrict offshoring, and unions are lobbying Congress to stop it. Just last month, a provision in the spending bill passed by Congress said that when the federal government decides to allow private companies to do work now being done by government employees, the private companies can't do the work outside the United States.

While a backlash over jobs is understandable, resorting to protectionism would be counter-productive. A study by the McKinsey Global Institute has found that offshoring benefits the American economy far more than previously thought. Many people believe that the US economy simply loses money spent for services abroad. But far from being a zero-sum game for the economy, offshoring is a story of mutual gain. It's no news that because of advances in telecommunications and computing, large firms can arbitrage labor costs globally. Still, the magnitudes are startling. Software developers who earn $60 an hour in the United States get $6 in India; data entry agents who cost $20 an hour in Topeka run $2 in Calcutta. Since service offshoring is so labor-focused, and doesn't require the massive capital investment of offshore manufacturing, these differences translate into outsized returns.

Beyond an individual company's mandate to maximize earning, the ability to capture cross-border labor efficiencies actually creates enormous value for the world economy, and disproportionately for American firms. Our study found that the United States receives 78 percent of the new economic value created by offshoring, versus the 22 percent that goes to the lower wage countries where these services are relocated.

Take the US-India example: We estimate that as much as $1.46 in new economic value is created for every dollar American companies spend offshore. Both countries win. Counting the advantages such new business brings Indian workers, firms and governments, the McKinsey Global Institute estimates that India gains a net benefit of at least 33 cents from every dollar the United States sends offshore. America, meanwhile, earns a benefit of at least $1.13 for every dollar spent.

Why are the US benefits so much greater? Offshoring creates value for individual American companies and frees US resources for activities with more value added. For example, firms pass cost savings on to consumers through lower prices and to investors through higher profits. Companies also get new sales from Indian firms that boost imports from the United States. Meanwhile, the US economy redeploys workers who lose their jobs from offshoring in ways that boost growth as well.

Going forward, as the United States ages and a growing share of the population retires, maintaining our standard of living will require some combination of increased innovation and ever-greater productivity gains including offshoring activities to where there are more workers or increased immigration. Offshoring will likely prove to be easier to embrace.

The difficulty with this global wealth-creation story is that people are hit disproportionately, and there prevails a static view of jobs in the economy, with each loss a vacancy forever. But focusing on job losses misses the bigger picture. The losses are part of an ongoing economic restructuring with which the US economy is well acquainted. Technological change, economic recessions, shifts in consumer demand, business restructuring, and public policy can and frequently do result in job losses.

According to widely cited figures, over the next decade the United States will lose roughly 200,000 service jobs each year thanks to the offshoring boom. While that sounds alarming, we have to put it in perspective. The US economy today employs more than 130 million people; in the last 10 years alone it has created 35 million new jobs. Even in good times, layoffs far exceed the job losses predicted from offshoring. In fact, because of the resilience and flexibility of the US labor market, displaced workers find new jobs here at twice the rate of other advanced nations. While this environment can cause pain and dislocation for families, overall it helps explain why our economy's growth and productivity outpace the rest of the world's.

For society, the offshoring controversy resonates in the broader debate over trade and globalization: What should we do when something that benefits most people also hurts some of them?

Several measures could ease the effects of the transition without great cost to the economy. Training programs, generous severance packages and enabling portability of health care are good examples. So are innovative insurance programs. The McKinsey Global Institute estimates that for a small percent of the savings from offshoring, for instance, firms could purchase insurance for their displaced workers that would cover their loss of wages until they gain new employment.

We must also set the short-term disruptions to people's lives against the larger consequences of resisting change. If US companies can't move jobs abroad, they will face great risks from global competition not just from other developed countries, but increasingly from companies in the developing world. This could ultimately weaken the economy and throw more people out of work, in addition to forfeiting the new economic value and the chance to create jobs with higher value added.

The openness of the US economy, particularly in its labor market, is among its greatest strengths. The threat today is that public policy will make the economy less flexible. To do so would endanger the well-being of the United States and of the global economy.

The writer is director of the McKinsey Global Institute, McKinsey's internal economics research institute.

This article originally ran in International Herald Tribune.

[Not to be reproduced without the permission of the author.]

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