Don't be afraid of offshoring

Diana Farrell of the McKinsey Global Institute takes a close look at the workforce in China and India and says US workers have little to fear.

Diana Farrell of McKinsey Global Institute takes a close look at the workforce in China and India and says U.S. workers have little to fear

Both India and China have profited handsomely from their young, able, and seemingly unlimited workforces over the past two decades. India has built itself into a global services powerhouse, moving from simple customer help lines to more complex tasks such as software design, investment banking research, and medical diagnosis. And while far more Chinese work in factories than services operations, a number of pharmaceutical companies and software houses have recently set up research operations on the mainland.

The legions of college grads in both countries suggests they can meet demand for services for years to come—to the delight of multinationals wanting to buy those services, and to the alarm of white-collar workers in North America and Europe. But a closer look at the numbers tells a somewhat different story.

First, labor pools in China and India are not nearly as deep as they seem. Although policy changes in both countries could ensure they fill up faster, that shouldn't unduly worry workers in rich countries. Only a small percentage of jobs in many fields could possibly be performed overseas, and employers only plan to send a a fraction of those offshore. The upshot is that offshoring in Asia can continue, boosting Asian economies, while its effect on average wages and employment in high-wage countries remains negligible.

Paper Tigers
Research carried out by the McKinsey Global Institute found that in 2003, China had roughly 9.6 million professional graduates with up to seven years work experience, and an additional 97 million people who would qualify for support staff positions.

On paper, they all look like strong candidates for jobs in the nine occupations we studied: engineering, finance, accounting, quantitative analysis, life-science research, medicine, nursing, and office support. But on average, fewer then 10 percent of these potential job candidates in China were suitable for work in a foreign company, according to our survey of 83 HR professionals.

China has 1.6 million young engineers, more than any other country. But we found that the pool of young engineers considered suitable for work in multinationals is just 160,000 – no more than in Britain. The main drawback to Chinese engineers, our interviewees said, is the educational system's bias toward theory. Compared with engineering students in Europe and North America, who work in teams to solve practical problems, Chinese students get little experience working on real projects as teams.

Hard To Reach
For other occupations, poor English was the main reason our interviewees gave for rejecting Chinese applicants. Only 3 percent of them were considered suitable for generalist service positions. Overall communication style and cultural "fit" are also difficult hurdles.

Another, more practical complication is that it's hard for multinationals to reach Chinese graduates. Well over 1,500 colleges and universities produced the 1.7 million students who graduated in 2003. But fewer than a third of those have studied in any of the top 10 university cities. Just one quarter of all Chinese graduates live near a major international airport.

India's pool of young university graduates is deeper, but even so, shallower than it seems, and for similar reasons. Estimated at 14 million, India's supply of young professionals is 1.5 times the size of China's, almost twice that of the U. S., and topped up by 2.5 million new graduates every year. But our HR professionals judged that only between 10 percent and 25 percent of the country's graduates would be hired by multinationals, with the proportion varying by field of study.

Talent Shortage?
Only about 10 percent of Indian students with generalist degrees in the arts and humanities is suitable, compared with 25 percent of all Indian engineering graduates. The graduates' different levels of skill reflect the varying quality among India's universities. The best are superb, but many of the rest are indifferent, and the best graduates from the top schools often emigrate.

We have found that both countries already face a shortage of talent in certain key management occupations. China needs all the multinational-savvy graduates it can muster to satisfy its own growing domestic demand, let alone fuel the growing offshore sector. And India's domestic economy is still largely shielded from global competition, so few older graduates or middle managers have the international experience to switch to multinationals.

India has more experienced managers than China, but they are also more in demand because offshoring has grown so fast: Over the past decade, the number of middle managers it employs has expanded by more than 20 percent a year on average, and even more briskly in some cities.

More Each Year
New entrants often lure qualified managers from existing businesses, and sometimes poach across borders. Rapidly rising salaries in key offshore locations are evidence of middle managers' scarcity in India. Annual wages for project managers in India's export-oriented IT sector, for instance, have increased, on average, by 23 percent a year over the four years to 2005, while the salaries of programmers have risen by 13 percent a year.

Look closely at the dynamics of supply in China's and India's markets for graduate talent, and it soon becomes clear that the coming squeeze by no means spells doom for their offshoring sectors. To start with, both have huge surpluses of graduates in other disciplines suitable for employment at multinationals: India has around 370,000 quantitative analysts, almost as many as the United States.

China has around 200,000 young finance and accounting professionals. And they're turning out more and more suitable graduates every year. For instance, the number of qualified engineers in the United States is growing by 2 percent a year, compared with 6 percent a year in both China and India.

Benefits For All
Their talent pools could fill much faster if policymakers were to concentrate on improving the quality rather than the quantity of graduates. China should invest more in raising standards in schools outside of Beijing and Shanghai, and to improve English-language instruction throughout the country.

India, on the other hand, needs more graduates with degrees that employers want, like engineering, rather than generalist degrees. Both countries can also call on the skills of former countrymen living around the world with their rich reserves of management talent. None of this should alarm white-collar workers in developed economies. Our study of the emerging global labor market found that only 11 percent of all service jobs could, in theory, be performed remotely, and that companies plan to offshore only 1.2 percent of service jobs now performed in high wage countries by 2008.

Though these are significant numbers, offshoring is a relatively small phenomenon in the scheme of total employment in any occupation, likely to have limited impact on average employment and wages in mature economies. Of course, this is of little comfort to those white-collar workers who do lose their jobs. But if companies and policymakers in developed countries help them retrain and find new work, the benefits of offshoring could be shared by all. .

Diana Farrell is the director of the McKinsey Global Institute, McKinsey's economics think tank.

This article originally ran in Businessweek.

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