Outsourcing to low cost countries will destroy the U.S. economy.

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Outsourcing to Low Cost Countries will Destroy
the U.S. Economy

• Princeton Williams
• Vikram S BhadauriaShahinur Rahman

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Definition

• Outsourcing is a term that refers to the practice
  of one company hiring another to perform tasks
  that used to be done in-house.
• The term does not necessarily indicate
  nationalityfunctions can be outsourced to either
  domestic or foreign workers.

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Definition

• Offshoring refers to substituting foreign workers
  for U.S. labor.
• A company may hire its own employees abroad
  (offshoring) or it may outsource the work to
  another company operating abroad.

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Is Outsourcing Offshore really good for Business?
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The savings can cost a lot

• Need to keep large inventories
• Higher Administrative costs
• Higher quality assurance costs
• Higher transportation expenses
• Tariffs
• Slower to respond to market demand
• Can not achieve economies of scale at home
• Under-utilization of existing capacity
• Lose valuable customers at home

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Do you really save much on labor?

• Workers in less developed countries sometimes
  tend to be less productive than Americans.
• Labor represents only about 15 of the cost of
  making a product, 5-10 for electronic items.
• There are greater opportunities to save money in
  administration, inventory control, marketing, RD
  and distribution.

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Youll hollow out the corporation

• Lose ability to innovate
• No way to make rapid design changes
• Collaborators become competitors
• Example
• Hitachi is now competing with Motorola

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The advantage doesnt last

• Offshore manufacturing can work only if
• Dollar is strong
• Foreign wages are low
• Trade barriers are absent
• None of these are within a companys control.

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You may get trapped!

• The host government may begin to pressure
  management to
• Transfer more advanced technology
• Support local spin-off industries
• Have higher domestic content.
• Example Mexico has 60 domestic content
  requirement for cars produced for the domestic
  market and 30 for cars made to export.

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Youll lose valuable friends at home

• Labor unions at home are less likely to cooperate
• Labor dissatisfaction can be expensive
• There can be pressure from the society that may
  result in government regulations

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Is Outsourcing the only option?

• Japanese companies have managed to stay
  competitive over the years without resorting to
  off-shore manufacturing. Why cant we?
• The few Japanese companies that went offshore did
  so either in response to
• American Consumer demand,
• Gain market knowledge and market proximity,
• Supply their export markets, and to get around
  trade restrictions

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Is Outsourcing the only option?

• Increasing number of U.S. companies are
  responding to the import threat by creating a
  long term competitive advantage at home.
• Example
• Kodak reduces overhead by trimming middle
  management level positions, revising wage
  dividend plan, cutting operating and expense
  budgets, increasing RD expenditures, etc.
• Black Decker Modernized plants, standardized
  models, consolidated operations to achieve
  economies of scale and eliminated 100s of
  administrative positions to stay competitive.

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Why Outsourcing is Bad for the U.S. Economy?
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Losing its lead

• Manufacturing was the "old economy," The American
  future was in the "new economy" of high tech
  knowledge jobs.
• But now, because of IT Outsourcing America's high
  tech economy is eroding.
• Can a country maintain a technological lead when
  it did not manufacture?

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Transfer of technology

• But America will stay in the lead because it
  will keep the design and innovation, as was
  believed earlier
• Now, even R D is outsourced.
• Dell, Motorola, and Philips put their brand names
  on complete products that are designed,
  engineered, and manufactured in Asia

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No new jobs

• Economists think whatever is being lost is being
  replaced by something as good or better.
  .really?
• the Bureau of Labor Statistics reports a net loss
  of 221,000 jobs in six major engineering job
  classifications.
• A country that doesn't manufacture doesn't need
  as many engineers

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Unemployment in Hi Tech Sector
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Jobless Recovery
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American Wages Fall

• It's not really about trade but about labor
  arbitrage
• The U.S. loses jobs and also the capital and
  technology in setting up offshore centers
• this loss of capital results in a reduction in
  wages.
• With less income but the same mortgages and
  debts, upward mobility collapses

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Lack of Consumer Demand

• Whether they realize it or not, US corporations
  have written off the US consumer market.
• People who do not participate in the innovation,
  design, engineering and manufacture of the
  products that they consume lack the incomes to
  support the sales infrastructure of the job
  diverse "old economy."

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Trade Deficit

• As more employment is shifted offshore, goods and
  services formerly produced domestically become
  imports.
• Foreigners have acquired 3.6 trillion of US
  assets since 1990 as a result of US trade
  deficits.
• key chokepoint industries like cement is 81
  foreign owned and movies now 70 foreign owned.

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Trade Deficit

• GDP Far Overstates the True Economic Health
• 70 of GDP is consumer spending - dollars that
  now go largely to imports or products made
  domestically by foreign-owned companies
• (e.g., Hyundai cars produced in Alabama).
• Rising GDP Only Increases US Trade Deficits

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Trade Surplus of USA
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Devaluation of Dollar

• According to Bloomberg (March 10), Japan's
  unrealized losses on its dollar reserve holdings
  have reached 109.6 billion.
• A study by the Bank of International Settlements
  concluded that the ratio of dollar reserves held
  in Asia declined from 81 in the third quarter of
  2001 to 67 in September 2004.
• India reduced its dollar holdings from 68 of
  total reserves to 43.
• China reduced its dollar holdings from 83 to 68.

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How will US Ever Repay its Debts?

• 400 Billion per year internal Government budget
  deficit plus 600 Billion per year external
  trade deficit!
• How can we fund new growth and repay debts to
  foreign countries if our industries and their
  profits are owned by those very countries?

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Law of One Price
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Comparative Advantage

• CA may no longer be the optimal model.
• Ricardo assumed fixed conditions of production.
• Increasing mobility of resources and technology
  undermines this assumption.

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Comparative Advantage doesnt work anymore!

• Today, acquired knowledge is the basis for most
  tradable goods and services
• Outsourcing is driven by absolute advantage.
• the capitalist incentive to seek the lowest cost
  and most profit will seek to substitute cheap
  labor for expensive labor.
• India and China gain, US loses

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Law of One Price

• The Law of One Price provides important insights
  into the outsourcing debate.
• Homogeneous goods will sell for the same price.
• Homogeneous factors of production will eventually
  sell for the same price.

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Factor Price Equalization

• While the assumptions of one global price for
  labor and other resources seem to be heroic, two
  facts should be considered
• Other countries workers continue to improve
  their skills and training
• Jobs will leave the US until full equalization
  occurs in similar jobs.

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Other Factors Leading to Outsourcing

• Besides seeking low-cost production, businesses
  see a strategic importance to global production.
• Asian production and the resulting economic ties
  could be crucial to a companys ability to
  compete effectively in the rapidly expanding
  Asian markets.

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The Threat of Outsourcing

• The US faces a significant economic threat from
  the job loss and wage equalization from overseas
  production. Three facets should be considered
• The Mobility of Production
• The Start-Up Costs of Production
• The Role of Wages in Non-Traded production

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Mobility of Production

• Production is a multi-step process, and one or
  more steps can be outsourced.
• Technological innovations (e.g. transportation
  and communication) allow larger and larger
  portions of the production process to become
  mobile and subject to outsourcing.

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Mobility of Production

• As production processes become mobile, the forces
  of wage equalization comes to bear in more and
  more jobs.
• US is harmed as large portions of the production
  process moves overseas and wages related to these
  tradable goods begin to fall.

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Job Scenario in Software Industry
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Residual Benefits of Trade

• How much of the value of the production resides
  in the US?
• Consider the case of Nike shoes
• 60 shoes which are produced for 6
• Other High Value Production
• Call centers
• Programming and software design

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Initial Set-Up Costs

• Set-Up costs associated with production provide
  at best a temporary safeguard for the US economy.
• These costs are one time only and do not
  represent a continuing advantage to the US.

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Non-Traded Goods

• Full wage equalization would eventually stem the
  job losses in the US.
• However, workers in the US must demand high wages
  just to exist in the US economy.
• Thus, the adjustment process is prolonged by the
  rigidity of prices and wages in non-traded
  sectors of the economy which are not affected by
  global competition.

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US Advantages

• Inertia
• Geography
• Resources
• Political and social infrastructure
• Wealth
• Control of residual benefits of trade

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A Long Run Scenario

• Larger and larger portions of the production
  process move overseas
• At some tipping point, the organizers of the
  trade will move from the US
• Significant depreciation of the US
• Falling wages in the production of non-tradable
  goods and services

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A Long Run Scenario

• As wages fall and and exchange rate adjustments
  take place, unequal pressures are brought to bear
  on various segments of the US economy
• Conflict between various segments undermines the
  social institutions which have been the basis of
  the economic system.

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References

• Colander, David, The Long-Run Consequence of
  Trade and Outsourcing, Challenge (2005).
• C. Markides, N. Berg Manufacturing Offshore is
  Bad Business, Harvard Business Review (1988).
• http//www.epi.org
• http//www.economyincrisis.com

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Questions?