The Reality of Outsourcing

Last week, Council of Economic Advisers Chairman N. Gregory Mankiw ran into a buzz saw. He committed a major gaffe, which in Washington means he spoke the truth, by defending the concept of outsourcing -- contracting with foreigners for information technology services. With a lack of job growth being the central economic issue in the country today, Mankiw's comments were assailed across the political spectrum. President Bush quickly distanced himself from his aide's remarks, House Speaker Dennis Hastert, R-Ill., repudiated them, and many Democrats called for Mankiw's dismissal.

There is at least one person in Washington who knows precisely how Mankiw feels: Federal Reserve Chairman Alan Greenspan. Back in 1974, Greenspan held the same position Mankiw now holds. Shortly after his confirmation in September of that year, Greenspan participated in an economic summit. At the time, the United States was in the middle of the deepest recession of the postwar period and inflation was rising rapidly. That year, the Consumer Price Index would rise 12.3 percent.

Greenspan was asked whether the Ford administration's policies were benefiting the rich over the poor. He replied: "If you really wanted to examine who, percentage-wise, is hurt the most in their incomes, it is Wall Street brokers. I mean their incomes have gone down the most."

Needless to say, Democrats had a field day attacking Greenspan for seeming to worry more about the problems of rich Wall Street brokers than those of common people. Although he quickly apologized, many observers believe that Greenspan was permanently scarred by the incident and forever afterward became far more circumspect in his public and even private comments.

Of course, when one gets caught in one of these Washington firestorms, there really isn't much one can do except apologize, hunker down and wait for the storm to pass. That is what Mankiw is doing. Unfortunately, the result is that debate on serious issues is often short-circuited and the political establishment draws erroneous conclusions. In this case, it may conclude that the issue of outsourcing is radioactive and everyone may rush to support ill-conceived legislative fixes with harmful economic consequences.

Here is the offending statement in the Economic Report of the President that has led to calls for Mankiw's head: "One facet of increased services trade is the increased use of offshore outsourcing in which a company relocates labor-intensive service industry functions to another country. ... Whereas imported goods might arrive by ship, outsourced services are often delivered using telephone lines or the Internet. The basic economic forces behind the transactions are the same, however. When a good or service is produced more cheaply abroad, it makes more sense to import it than to make or provide it domestically."

One would have a hard time finding a reputable economist anywhere who disagrees with this analysis. No nation has ever gotten rich by forcing its citizens to pay more for domestic goods and services that could have been procured more cheaply abroad. Nations get rich by concentrating on doing the things they do best and letting others produce those things they can produce better and more cheaply. It is called the specialization of labor, and it is the foundation for economic growth. That is why even Democratic economists like Janet Yellen, Laura Tyson, Brad DeLong and Robert Reich have come to Mankiw's defense.

What is different about outsourcing and why it has aroused so much protest is that it is affecting workers who thought they were immune from international competition. Blue-collar workers in manufacturing have been suffering from outsourcing for 100 years. It is worth remembering that textile jobs in South Carolina today were originally outsourced from Massachusetts. While in the short run, the transition was painful for Massachusetts textile workers, they soon found better jobs in new industries. That is why per capita income there is and always has been far higher than that in South Carolina.

It would be grossly unfair to say that it is OK to move manufacturing wherever production is cheaper, but wrong to subject information technology services to the same competition. It is mostly because of the Internet and the fact that IT people know how to use it that they are getting attention disproportionate to their numbers. Moreover, if we hadn't just gone through a painful economic recession, most of these people probably would have already found new jobs and the problem of outsourcing would not be worth writing nasty emails about to politicians and people like me.

In any case, even if the federal government tried to stop outsourcing, it cannot. We can put quotas and tariffs on goods that cross our borders, but it is impossible to stop people from importing software and data over the Internet. The only response that is possible is to adapt, innovate and stay ahead of the curve.

"In any case, even if the federal government tried to stop outsourcing, it cannot. We can put quotas and tariffs on goods that cross our borders, but it is impossible to stop people from importing software and data over the Internet."

This is the section of Bartlett's piece that struck a chord with me, primarily because I have been thinking the same thing. NAFTA and the recent trade agreements have been getting blamed, but it isn't clear to me that they have anything at all to do with the outsourcing trend.

Someone please tell me if I'm wrong, but it seems to me that income tax rates in this country play a major role in the outsourcing of services and production. The income and payroll taxes not only mean that employers have to spend more to put a certain number of dollars in their employees' pockets, but they also increase the cost of anything the employee would want to buy. If it weren't for the availability of tax shelters and outsourcing, money would be almost worthless since a very large portion of anything that got spent would get vacuumed up by the government.

Is there anything wrong in my thinking?

A politician in New Jersey is trying to pass a law that all companies that outsource IT jobs cannot get State contracts. So something can be done to discourage outsourcing. I am not saying this is a good idea; I happen to agree that from an economic standpoint outsourcing is probably a good thing.

Before everyone jumps on me, I am involved in IT myself and my business has taken a huge (hugh) hit the past 3 years. I am trying to learn new skills (can anyone say health care industry?) rather than bashing foreigners, however.

BTW, this month's Wired has a pretty good article on the subject.

Interesting. Thanks for posting this reasonable tome.

Many of my peers are huffy about IT outsourcing, as if they are too important to be replaced.

In the 80s and 90s, it was the Revenge of the Nerds, the guys who could navigate around a computer took over the workplace. They made us pay for not choosing them for basketball.

But did they think that only white college educated Americans could work a PC? They looked down their noses at blue collar "NFL" Americans all these years. Now it's their skill that has been cheapened.

How'z it feel... geeks?

While in the short run, the transition was painful for Massachusetts textile workers, they soon found better jobs in new industries.

Writers on this topic keep spewing this comment. They fail to observe that the outsourced jobs are in the new industries. None of them has managed to point to what "new" industries are prepared to employ the 4,000 to 6,000 people who get dumped on the street each day. They were not making buggy whips. They were employed at the forefront of technology. Most have 4 year degrees and many years of experience.

How'z it feel... geeks?

Just fine. When my software or hardware has a problem, I know how to fix it. It is just a tool over which I have total control. No need for outside assistance.

But did they think that only white college educated Americans could work a PC?

Many people can operate an appliance...as long as it doesn't break down.

Can you explain the consequence of priority inversion in a real time operating system? How about a quick exposition on the merits of FSK, PSK or QAM? Would you choose CSMA/CD or token passing for best deterministic response? How did Shannon improve upon Nyquist's sampling theory?

If any of that wasn't familiar then we aren't having a discussion between peers.

Incorrect, USA, 1776-1930's.

That's actually a very misunderstood notion. The USA did not "get rich" in that period by assessing tariffs on imports -- it got rich by taking advantage of an "accident of history" (the settlement of the frontier) that allowed us to secure land and resources at costs far below what First World nations would have had to pay.

It's no accident that the last part of the period you mentioned (the 1930s) also happened to be the first time in history that the average American had a standard of living that exceeded the standard of living of someone living in advanced European countries like Britain and Germany.

This is exactly why one of the most important facts about this issue is often the one that is most often overlooked . . . In order to maintain an export-based economy, the nation doing the exporting must always have a lower standard of living than its trading partners.

If IBM moves their call centers overseas, is the U.S. going to assess a tariff on every toll-free call to a call center in India?

A tariff of 10 cents per minute on satellite serviced voice calls would immediately level the playing field. It would probably also offset any current subsidy of telecommunications that is coming from the U.S. taxpayer. Few of the rockets that put the satellites into orbit were privately financed by the companies that now exploit them.

A tariff of 10 cents per minute on satellite serviced voice calls would immediately level the playing field.

Do you really believe that any government would be capable of actually collecting such a tariff?

It would probably also offset any current subsidy of telecommunications that is coming from the U.S. taxpayer.

As if the U.S. is the only country in the world that has launched telecommunications satellites into orbit . . .

1. you're right that we didn't "get rich " from tariffs -- as always, we moved money around with tariffs, a lot of it from the South to the North.

2. But, it wasn't just "an accident of history." Those resources were worthless until we applied ingenuity, sweat and freedom. The Indians had the same resources, and didn't do much with them.

3. I think most economists would say that we had caught up with the "advanced european economies" by the 1880s, if not the 1850s.

4. You can have an export based economy, even if you are very rich, if you have a great comparative advantage,either in making something, or having some resource that is peculiar to your location (oil in the middle east, hydro power in Norway, etc).

The U.S. Federal Communications Commission is the agency that regulates wireline, wireless and satellite communications. They certainly have the ability to regulate any and all telcom traffic that enters or leaves the United States.

I'm sure other countries have launched satellites. It doesn't really matter. The key technology that permits outsourcing of American jobs to foreign countries is cheap telecom. The U.S. government can regulate and tariff those communications paths as it sees fit. A tariff on the cheap telecom path takes all the cost advantage out of the cheap foreign labor.

Good post. I'm going to respond to a few of those points . . .

2. I describe the settlement of this nation as an "accident of history" because it was so unusual at the time. Because the U.S. was able to clear the land of its existing occupants at a relatively low cost (in essence, we simply took the land away from people who didn't understand our Western notion of "ownership"), we were effectively able to "start from scratch" in a manner that no other country in the developed world could possibly have done (particularly with regard to land titles).

3. I guess that is largely a function of how you define "catching up." I think it is safe to say that the U.S. caught up to Europe in terms of technological and industrial development by the period you described, but the average American had a lower standard of living than the average resident of the countries I identified well into the 20th century. In fact, the U.S. was still looked upon as an agrarian nation almost until the time of World War II.

4. How often does this kind of thing occur in the world today? I would even make the case that "peculiar" resource wealth may not be such a good thing, because the focus of a nation's economy is turned to the possession and protection of that resource (hence the constant civil wars in resource-rich countries in sub-Saharan Africa). Ironically, some of the countries in this world with the highest standards of living are those with no resource wealth at all (Japan and Singapore are good examples of this). This is because they are effectively forced into a position of high efficiency -- because the only real source of revenue their governments have is the taxation of their labor.

I think we're on two different planets here. You look at the U.S. government and see an institution that can assess tariffs on wireless phone calls from anywhere on the globe. I look at the U.S. government and see an institution that can't even keep a million Mexicans from pouring over our southern border every year, and couldn't even keep al-Qaeda from stealing four passenger aircraft and flying them into the World Trade Center and the Pentagon.

While we're at it, why don't we take away the "cheap transportation" component that allows countries like China and Malaysia to manufacture things so much cheaper than us -- by draining the Pacific Ocean.

Don't buy an HP printer or call HP for help if at all possible. My friend bought an HP deskjet printer and the CD was defective. So I went to the HP website and it even stated if "if you received an defective cd, call HP for assistance".

Called them a few times reluctant to give too information to the Indian voice at the other end. Each time I called, different voice, same Indian dialect. Finally, after giving up the information, the person asked to insert the CD in the drive and read the serial number. Almost joyfully, he responded "oh yes, that is a bad one, we'll have a new one sent in 24 hrs". Four days later, the disk arrived but still would not run properly but I was able to get the drivers off the disk. Funny thing, in big letters on the disk it said "Made in U.S.A."(...for now...).

Same planet. You've just changed the subject. The U.S. government isn't even trying to stop the Mexican invasion. If they were serious, we would have troops on the border. The "border patrol" is a grossly underfunded and understaffed "feel good" enterprise.

I lay much of the blame for the WTC disaster on the gutting of the CIA by Bill Clinton. You can't detect and stop an attack if you haven't put the resources in place to do the job.

The cheap transportation component shares something in common with the cheap telecom component. A ship is worthless if you don't allow it to dock and unload. Most of the goods produced in Asian markets arrive on the west coast of the U.S. and are transported via rail and truck. Items destined for the European market are moved by ship to the U.S. west coast, then by rail to the east coast, then by ship to Europe. Again, the U.S. controls the transport path...if they desire to do so.

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