The Hindu Business Line : The economic fallout of outsourcing

IT IS a horror staring at US professionals these days: Receiving pink slips and their jobs going to lowly recruits abroad. They blame it all on outsourcing. Indeed, there are reasons for their despondency.

Leading journals have been writing on "global white-collar migration", "the new job shift", and so on, and giving details of job losses in several areas, which are increasing in number. Companies include many in the Fortune 500.

A heated debate is going on in the US among academics and politicians. Bills seeking to restrict outsourcing have been introduced in several States as also in the Senate. Against these developments, it is difficult to deal with the issue dispassionately. Unwittingly, Dr Gregory Mankiw, Chairman of the President's Council of Economic Advisers, was caught in the crossfire over his remarks that outsourcing is "probably plus for the economy in the long run". His remarks sounded so impolitic in an election year that the President, Mr George Bush, distanced himself from him.

However, Dr Mankiw did not resile from his academic stand. In his reply to the Speaker of the House of Representatives, he admitted "that any economic change, whether arising from trade or technology, can cause painful dislocations for some workers and their families," but added that there should be policies to help workers prepare for the change.

The Federal Reserve Chairman, Mr Alan Greenspan, joining the debate a few days later, said that protectionist cures might worsen the situation. He hopes that US would manage to replace lost jobs to lower wage foreign competition with jobs in advanced industries as it had done in the past. The poser is, "Can it do it?" For an answer, there is need to go into the political economy of outsourcing.

Global sourcing or outsourcing is as old as the East India Company. Management theorists and economists have analysed the factors that promote outsourcing. The rise of the multinational corporations (MNCs) would not have been possible without outsourcing.

No company can hope to produce all its requirements in-house; it has to procure raw materials, components, and so on, from other parties. There are risks attached to contracts, especially if proprietary assets such as knowhow, patents and brand names have to be safeguarded. Prof Ronald H. Coase, a Nobel Laureate in Economics, explained that there are "transaction costs" attached to contracts and contracts invariably fail. It becomes necessary to `internalise' the assets to appropriate the rents in full. Branches and subsidiaries are floated abroad under common ownership subject to control and co-ordination. In such a situation, commodity flows across countries turn into intra-company flows.

The post-War years saw relocation of manufacturing from developed to developing countries in areas such as light engineering, shoes, apparel, and so on. Manufacturing was segmented globally and labour-intensive parts were located in low wage destinations.

Companies such as Nike and Adidas were known for this style of operation. They were managers who provided designs for component manufacture in hundreds of locations and co-ordinated component-assembly in convenient countries. They were footloose in that they arbitraged on tax and labour regimes. These manufacturing patterns led to frictional unemployment in home countries. Those displaced could, however, be re-trained in other skills. In the process, within a reasonable time, they went up the food chain. The burgeoning service sector absorbed many of them.

The model described above held good even around the time electronics revolution took over in the post-war era. Electronics had its own special features and lent itself ideally to segmentation. Pioneers such as Intel and Texas Instruments followed the FDI strategy of assembling chips in wholly-owned subsidiaries in China, Malaysia, Hong Kong. Even as low-wage locations concentrated on low-skill segments, the labour back home worked on high-value hardware.

Successive reductions in the price of hardware generated continuing demand and sustained higher levels of growth and production. Wages rose in the Silicon Valley more than proportionately. High levels of consumption sustained the economic boom. Outsourcing was, thus, the driving force behind the global computer development. There was common cause between workers in East Asia and those in the Silicon Valley. It is doubtful whether similar symbiosis could be replicated, as there is no new technology in sight, which might bring about a paradigm shift as in electronic years. Computer technology has plateaued except for incremental additions in the manufacture of new chips with higher capacity. Moreover, the convergence of information and communication technologies (ICT) distorts the structure and patterns of production when combined with the current economic recession.

The driving force behind outsourcing in the ICT sector is for global labour arbitrage. As Stephen Roach put it, it is "... a by-product of IT-enabled globalisation that is now acting as a powerful structural depressant on traditional sources of job creation in high-wage developed countries such as the US." It is overlaid on the earlier jobless recovery contributed, again, by ICT.

US companies under financial stress began their cost-cutting pilgrimages and took to digitisation as the road to Mecca. If in earlier years, US companies segmented production chains and shifted labour-intensive parts to low wage locations now, they would digitise them and accesses services from abroad through wires. They would get the service at 20 per cent of US wages. The revolution is that digitisation converts labour or service, which was considered non-tradable from the days of Adam Smith, into tradable.

For those in the developing countries, it started in a big way in the late 1990s when the Y2K fever gripped the world. Thousands of professionals entered the US. By 2000, the fever was over. It also coincided with the dotcom collapse. There began a backlash against foreign professionals. The US responded by denial of visas to professionals. Unfortunately, it coincided with the bursting of the stock bubble and the financial bankruptcy of many established firms. Those on survivor kits had to undertake fierce cost-cutting programs and digitisation provided a way out. They decided to jump the visa walls and export the jobs to cost-effective locations such as India.

Initially, the services were restricted to back-office functions such as call-centres, help desks, and customer support, coming under the category of BPO. From BPO to other IT-enabled services such as engineering design, architecture, radiography, and so on, it was a short hop. The most exciting developments are in research programmes where companies such as GM and Siemens locate global centres.

The demand dimensions are mind-boggling. Earnings for companies such as Infosys, Wipro, have been increasing at unprecedented rates and volumes. Unctad's Report (E-Commerce and Development Report 2003) provided optimistic estimates of earnings drawn on the assessment of US consulting firms. It predicted a market of $300 billion by 2004.

Nasscom, the software industry association in India, predicts in its Strategic Review 2004 an earning of Rs 33,010 crore, up 24.4 per cent from 2003. In the same way, the estimates of job losses create panic in the US; the employment and earning estimates cause euphoria in our country. These lamps light a good part of `India Shining'! However, there is need for caution.

For the US, a projected job loss of 3.3 million by 2015 is a small fraction against its employment level, which is presently 132 million. The size of the earnings is also small against GDP. However, the middle-class in the US feels threatened and it has made it an issue in the presidential election. There will be pinpricks. There is no way that the US Congress can prevent the efforts of its corporations to become globally competitive.

It is also a hot issue for our public and politicians. For India, the stakes are high. The earnings, even if they get reduced over time, are valuable additions to the economy. The country reaps the benefits of its past investment in higher education. It mitigates the problem of educated unemployment.

However, prudence would suggest that it is not a remedy for all our ills. It is only peripherally linked with the mainstream economy. There is fear that it creates ``islands of affluence' amid a sea of poverty in the country.

There is a moral to this account. Erstwhile `free traders' in the US may turn to protectionism.

We should safeguard our interests in more critical areas than ITES in the larger context of WTO negotiations.

(The author, a former Finance Ministry official, has experience in international, financial and trade issues.)