McKinsey Global Institute

Can Germany win from offshoring?

While Germany's companies benefit from offshoring, its economy could lose unless German leaders deal with labor policies and product market regulations that stifle competition and innovation.

European companies have joined the movement to offshore service jobs to low-wage nations. A new perspective by the McKinsey Global Institute analyzing the impact of offshoring on Germany—Europe's largest outsourcer after the UK—suggests that while companies enjoy enormous savings from offshoring, European economies could lose out rather than benefit from the practice unless they undertake structural reforms.

This mixed outcome stands in sharp contrast to the impact of offshoring on the United States. MGI has found that every dollar of corporate spending that US companies outsource to India generates as much as $1.14 in new wealth for the US economy. Offshoring leads to cost savings, revenue gains, increased exports, repatriated earnings, and the creation of new, higher value-added jobs that generate more wealth for the US than is lost.

Germany sees fewer benefits

A similar analysis shows that German companies save less than their American counterparts because language and cultural issues add extra management costs to offshoring projects. In addition, they frequently offshore to Eastern Europe, where wages and infrastructure costs are higher than in other low-wage offshoring destinations such as India. Germany misses out on many of the high tech exports that offshoring can spark because American firms now dominate that industry, and it misses out entirely on the repatriated earnings of offshoring providers abroad.

The key difference, however, lies in the limited ability of German workers to find new jobs. If the rate of re-employment matched that in the US—nearly 70 percent—offshoring would create €1.05 of value for the German economy for every euro of corporate spending offshored. MGI estimates, however, that re-employment rates could be as low as 40 percent, meaning that Germany recaptures only €0.80 for every euro offshored.

Offshoring as catalyst for change

Protectionism is not the answer. Offshoring to low-wage nations enables companies to reduce costs, offer new products and services, and become more competitive. Moreover, Germany's aging population and low birth rates will reduce the total number of workers in the coming decades, making offshore labor necessary to supply the low-cost goods and services the country needs to maintain or improve its standard of living. Rather than viewing offshoring as a threat, Germany's leaders must instead view it as the catalyst for undertaking the structural reforms the economy has long needed.

Germany's case offers a cautionary tale for other EU economies that share similar labor issues. To ensure European economies win from offshoring, policymakers must make labor markets more flexible and rethink regulations that stifle competition and innovation.