Outsourcing

The politics (and economics) of outsourcing

In the concluding piece of her two-part series, Sanjivani Vaze says that in a WTO-world, sans trade barriers and tariffs, outsourcing is here to stay

The 1990s saw large-scale outsourcing of IT services to India and the 21st century opened the floodgates for ITeS outsourcing. The prime driver for domestic outsourcing is specialisation, which in turn leads to production efficiency requiring fewer resources to produce the same quantity of goods or services. The resources (land, labour and capital) thus saved can be used to produce additional quantity of goods or services. This theory works reasonably well in practice though it is hardly painless, and here is why. Not all workers who are made superfluous due to increased productivity can be utilised in other industries as the skills required are often different and not everybody can be retrained. Usually, older workers suffer the maximum in such situations. Additionally, as production techniques and methods improve, high quality education becomes a crucial factor in getting a well-paid job. In societies where education is privatised and market forces determine the fees, only the upper middle class and rich can afford high-quality education. The government, to an extent, can alleviate these adverse effects of “job churn”—old jobs getting destroyed and new jobs getting created—through policy decisions provided there is a strong political will.

The situation gets murkier when outsourcing crosses the national boundaries. In addition to specialisation, the cost factor also comes into play now. The company that outsources to vendors from another country usually obtains the goods or services at a cheaper rate and hence gains a competitive advantage. As the firm passes some of the gains to customers by lowering prices, its rivals are forced to reduce the price. Competition now has two options, either live with a lower profit or resort to international outsourcing to reduce the cost. If a company chooses the former, its financial performance suffers and its shares often lose value making their owners unhappy. For example, when insurance major AIG routes claims processing to India, its overall cost reduces enabling it to reduce the policy premium i.e. price of its product. To stay competitive, its rivals like State Farm or Aetna are also forced to lower premia.

What happens to domestic firms that are suppliers of the outsourced goods or service? They often find it hard to match the prices of offshore vendors and are forced to either close down or to switch to products or services that are not conducive to offshoring. The former is hardly an option and the latter requires painful transition that can take time to fructify. Some firms therefore follow the principle “if you can’t beat them, join them” and open offices or factories in these countries! This is precisely why global IT service providers such as EDS, Accenture and global BPO operators like Convergys and Sykes have been forced to open units in India.

What are the repercussions for the people of the country whose corporations are busy moving work overseas? It depends upon which hat one is wearing. As a consumer, one would be happy because the prices of goods and services are lower. As a shareholder, one would be pleased because the company’s financial performance is better. As a borrower one would be glad because lower prices means lower inflation, which generally means lower interest rate on loans. But what if you are a worker in the industry that is being offshored? Then the worker might end up losing his job and since the trend is industry wide he has little chance of finding work unless he is ready to retrain.

This is the reason why different sections of society react differently to outsourcing and politics of it is not as simplistic as the pro and anti-free trade dichotomy suggests. As far as the US presidential election is concerned, it gets further complicated because of the idiosyncrasies of the system and concentration of specific industries in certain states. A case in point is the steel industry, which is concentrated in Ohio, West Virginia and Pennsylvania. To win the election it was imperative that Bush win in these states (it was the victory in Ohio that finally put him in the White House) and many critics feel that Bush imposed duty on steel imports in early 2002, despite being aware that the WTO will penalise the US for this, in order to gain support of steel barons and steel workers in these states. The irony is that imposing duty on steel increased the cost of production for industries such as the automobile sector putting companies like General Motors and Ford in a weak position vis-à-vis their overseas (read Japanese) competitors and the jobs in these industries were put at risk. This made Bush unpopular with voters in Michigan, which was also crucial for his victory.

Even though free trade and offshoring is nothing but international trade, it is politically controversial, this is one subject on which most economists agree most of the time, which is quite a rarity. Trade when unencumbered by distortions such as duties, subsidies, and quotas and regulations such as licenses and certifications, enable production to take place where it is most cost-effective resulting in the most efficient use of scarce resources viz. land, capital, and labour. For an economist this is pure bliss. Jokes apart, when we use resources efficiently, we can produce maximum possible quantities of goods and services and the world, as a whole, is better off. The challenge lies in dividing these goods and services evenly amongst the peoples of the world and that is where politics comes into play.

Depending upon one’s viewpoint, politicians are fast losing control of the trade policies and rules as they are increasingly being framed by the WTO. Continuing with the US steel imports story, the EU appealed to the WTO against the import tariff, won the argument and was allowed to impose additional duties on $2.2 billion of US exports to the EU giving rise to protests from US exporters. Bush eventually withdrew the import duty on steel in December 2003. Another difficulty arises because of the blurring of national identity of corporations and products. Can we call Satyam an Indian company when foreign investors own over 50 percent of its equity? Is Dell an American product if it is assembled in the US from parts that are made in China, Japan, and Taiwan? Other factors that make politicians less effective are the high mobility of capital, lower shipping costs for goods and inexpensive delivery of services over the wired world. If corporations don’t like the economic regime in one country they can easily move to a “business-friendly” country. This is why we don’t really have much to worry about who is occupying the White House or which party has a majority in the Lok Sabha, outsourcing will go on.

The thing that we as Indians should be concerned about is, how significant is the services outsourcing industry (IT and ITeS combined) for our economy and people? According to a 2002 report by Nasscom-McKinsey, the projection for year 2008 is as follows: share of GDP is 7 percent, share of exports, 33 percent. These numbers are revealing but only partially. They do not mention the loss of revenues because IT exports are exempt from income tax and land and other infrastructure are provided at a discount to the industry by the government. It also does not talk about the investment cost of building the infrastructure that the state and central governments have to provide to attract investment. It does not reveal the import share of the industry. The industry argues that it creates jobs. The same Nasscom-McKinsey report estimates that by 2008 the (IT and ITeS) outsourcing industry would create 4 million jobs. The number looks impressive but it would be a small fraction of the total labour force (8 million join the labour force each year). Moreover, can the outsourcing industry absorb the poorly educated, computer illiterate, non-English speaking, Indian culture-oriented army of workers from small owns, not to mention the villages?

I think we must focus on how outsourcing can benefit our urban and rural poor rather than worry about political happenings in the US.