Hard Times for LaborPublished: March 25, 2004 in Knowledge@Wharton
Aron: Corporations are migrating processes to captive centers, outsourcing them to third parties or forming joint ventures with firms in India, China and the Philippines for a variety of reasons. What is your reaction to this trend? What concerns should people have in this context?
Courtney: America's leading high-tech companies such as Microsoft and IBM are exporting our country's best-paying high skilled jobs in order slash labor costs. This trend will only increase job insecurity, lower wages and mean fewer benefits for America's white-collar professionals. As IBM told its HR managers, it means that workers will begin looking at organizing into unions to fight this trend, because the government alone cannot protect their economic interests.
Hira: My reaction to the trend is that this phenomenon has gained considerable steam in the past six months. For me, the telling change is that it is no longer a niche business. Earlier, it was Indian IT companies such as Infosys, TCS, Wipro, etc. and some smaller U.S. based IT companies such as Cognizant and IGate that were the major players. Now, it is the who’s who of U.S. technology firms announcing that they plan to expand offshore operations and even financial services and insurance companies. Of course GE has been in India for a long time, but that was the exception, not the rule. It is also telling for the future that GE set up shop in India to sell to the local market, but figured out that off-shoring was a better prospect. Another telling sign is the new type of position that has been created within many companies: people who act as liaisons for off-shoring activities. The phenomenon is being institutionalized.
The concerns that people should have will vary depending on who they are. Managers in U.S. firms will have to figure out how to effectively establish operations offshore and/or contract relationships with third parties. How will they protect sensitive data and proprietary company information? How do they on the one hand appease equity analysts by claiming that they are cutting costs by moving offshore and at the same time keep the news quiet to their own U.S. workers who might get quite angry?
Have U.S. firms opened a Pandora’s box by creating their own future competition? IT user firms and IT service providers will face different challenges, but since I’m a policy person I’ll let someone else address these issues in more detail.
For U.S. policymakers, the issue is how to measure the scale and scope of the offshore movement and, most importantly, how it might impact the U.S. labor market and innovative capacity. Will kids shy away from pursuing engineering careers because of poor career prospects? We are already seeing this at my institution – enrollments in IT degrees is far below last year’s. How will a smaller pool of U.S. technical professionals impact the U.S.’s ability to innovate for economic growth and military security?
Another crucial issue involves how the U.S. will compensate domestic workers who are displaced by the offshore outsourcing trend. Most agree that the losers in trade should be compensated, but the reality is that this is much more difficult than most economists and politicians understand. First, it is difficult to actually identify who has been affected by off-shoring, especially when companies are misrepresenting what they are doing. Many workers are sworn to secrecy as a condition of receiving their severance package. Even if one could identify the displaced workers, how does one determine the appropriate compensation? Will a 45-year-old engineer with a master's degree realistically re-train to become a nurse? Perhaps we will begin to see that happen more.
As for U.S. workers, we are inching towards all workers being temporary contractors/consultants. Industry’s mantra has been agility when it comes to hiring and firing workers. It was only about 10 years ago that IBM laid off its first employees – what was once a big deal has become routine. U.S. workers benefited from the lack of loyalty between employer and employee during the boom times of the late 1990’s. They switched positions, received signing bonuses and companies printed money for them through stock options. That boom time masked the real and radical changes going on in employment in the U.S. We are now at a stage where workers need to view themselves as free agents, working for themselves and not the company. This will lead to potentially greater rewards and surely greater risk for workers.
This change is ironic since we have heard so much about the “knowledge economy” and how important “human capital” is to economic growth. We now have a human capital paradox where worker knowledge is terribly important, but companies have a great disincentive to investing resources in those workers: Why should a company train a worker who will leave in short order?
Aron: Who are the prime beneficiaries of this trend? Whose interests are adversely affected? Why?
Courtney: The immediate beneficiaries of this trend are corporate executives and other corporate decision makers because it further consolidates their control in regards to labor markets and allows them to leverage economic power across transnational borders in a new and more significant way.
The interests that are impacted most adversely by this trend are the employees and the communities which are losing jobs that move overseas. For example, in Seattle with Microsoft and Boeing both beginning to ship engineering jobs abroad -- Boeing commercial airline design to Moscow, and Microsoft software development to India -- that means fewer engineering jobs are going to be created in this area. That will also mean fewer other jobs such as testing, documentation, etc. will also be created in this area. For students who want to enter the engineering field, it will mean reduced economic opportunity.
I have yet to find any compelling argument from pro-globalization cheerleaders that can point to how in the long run this will create more jobs and greater opportunity. If exporting jobs creates more jobs or saves jobs, why does our manufacturing sector continue to decline in employment? Seattle has one of the highest education rates of any metropolitan city in the country. Our high-tech industry is not growing right now. Exporting more jobs is only going to threaten a potential turnaround.
Furthermore, because the primary driver of this job migration is cheaper labor costs in other countries, the immediate winners of the trend today will soon be tomorrow's losers, because another country will come along and undercut the labor costs. We are already seeing this. I have seen articles where Indian outsourcing firms are already trying to partner with Chinese firms; they are fearful that China will out-compete the Indian firms because they can leverage cheaper labor costs.
Aron: How does the globalization of services differ from the globalization of manufacturing? If firms have transferred work to locations where it is best performed for more than 20 years now, why this sudden fear? Is this concern something that will go away once the recovery starts generating jobs? Is there a deeper malaise here that goes beyond business cycles? Why?
Courtney: Service globalization is different in two ways. First, we are talking about our best-paying and highest-skilled jobs that require in many cases a BA degree or more. That wasn't the case with manufacturing jobs. We have long believed in the U.S. that the more skills and education you have, the greater opportunity to escape the negative impacts of globalization. This is obviously no longer the case. Second, unlike manufacturing jobs which were around in the U.S. for several generations or more, we are talking about jobs that in many cases are less than five years old that are getting exported overseas.
The argument behind exporting manufacturing jobs was that the U.S. comparative advantage was going to be in services. Let the manufacturing jobs go, and we will focus on this higher value-added services economy and job creation in that sector will make up for jobs lost in manufacturing. Now, with the exporting of service jobs in a growing list of occupations such as technology, financial analysis, and so on, what jobs could we create here in the U.S. that could not be replicated in another country that could do things cheaper? We need to create an economy that supports economic security for its workforce. A global economy that increasingly is built upon the cheapest labor costs undercuts that value, and that is helping drive the concerns of employees.
No, these issues are not going to go away. Yes, it is a significant structural change that is taking place. Again, exportation throws out the window the notion of comparative advantage, and we will just create jobs that are higher up the value-added food chain. We are talking about the highest value added jobs in the economy right now. Some time ago I talked with a woman who held bachelor's and master's degrees in electrical engineering from one of the nation's top universities. She is concerned that her department will get off-shored.
In the long run the U.S., to compete in an increasingly technical and global economic environment, needs to create and keep the strongest possible base of high-tech jobs at home.
Hira: The primary difference between the services discussion now and the manufacturing competitiveness debates in the 1980’s is that the current phenomenon is affecting U.S. workers and not U.S. companies. In the 1980’s U.S. firms lost major market share not only in the auto and steel industries, but also in semiconductors. Companies hold a lot more sway in Congress than individual workers, and in the 1980’s the semiconductor firms received many subsidies and concessions from the U.S. government. Voluntary quotas, and increased anti-dumping enforcement actions were only some of them.
Individual services workers are not well organized and may not be aware of the larger trends. Even if they are aware of what is happening, they may not know how to take any action.
Your question assumes that the recovery will generate jobs; we’ve been in the recovery for some time and jobs are not being created. I am cautiously optimistic that at the macro level jobs will be created eventually, but pessimistic about the quality of those jobs. Focusing on aggregate statistics masks what goes on in critical sectors. I don’t believe that flipping burgers and designing application-specific integrated circuits provide the same benefits to the economy even if they pay the same.
There were major technology shifts that fueled the enormous technology job growth in the late 1990’s: PC maturation and shift from mainframes to client-server; shift from function-based programming to object oriented; shift from stovepipe business software to Enterprise Resource Planning systems; the Y2K bug; and most importantly, the impact of computer networking through the Internet. Each one of these shifts was pretty radical, and it takes time for workers and companies to learn how to adjust to them. It is not clear what the next “killer app” or shift will be, and it seems to be highly unlikely that we will experience many shifts at one time.
It remains to be seen whether the promises of biotechnology (bioinformatics) and nanotechnology will really be major employers.
Aron: Let us look into another aspect of outsourcing. When the cost of production (of goods and services) falls, companies are often forced to differentiate their service and product offerings in order to compete. Let us take the financial services sector: in the period between 1973 and 1998 the cost of corporate computing declined with the widespread adoption of client-server technology. Between 1998 and 2003 the cost of reaching large segments of the markets has declined as a result of the Internet. We would therefore expect to see a proliferation of financial products and services. Indeed there are far more services available in the retail financial services sector today than were available 30 years ago.
For instance, brokerages, banks, personal financial services and wealth management firms have all increased the range of services that they offer to the market as compared to the early 1970s, thus validating empirically the predictions of economic models. Each of these services creates new jobs. Some of these are front-end jobs that cannot be outsourced, while others are back-end jobs that may be automated, migrated or outsourced. There will also be managerial work categories created as a result of increasing specialization of products and services.
So the question is, will curbing outsourcing not result in greatly reducing the creation of new products and services and the resulting creation of entirely new occupational categories? Isn’t this a prescription for an economy to be denied the benefits of specialization and innovation?
Hira: This question fails to clarify whether we are talking about offshore outsourcing or just buy/make decisions by firms. The question also doesn’t differentiate between the types of jobs that are migrating overseas. Who doesn’t want better efficiency? But shouldn’t we also consider the distributional costs and benefits of achieving that efficiency? Shouldn’t we also tackle that issue?
Aron: A concern often expressed is that when manufacturing jobs were lost, these were compensated by employment gains in the service industry. If service jobs are lost, there may be no saviors left. Some observers have pointed out that just because we do not know what other sectors will register an employment gain that does not mean there will be no growth sectors. For instance, at the height of the public outcry about lost jobs in manufacturing in 1991, few would have imagined there would be several new kinds of occupations such as web-based graphics designers and multimedia content creators in less than 10 years. Could it be simply the case that we do not know what is waiting around the corner and are therefore, afraid of the market’s ability to drive rapid change?
Hira: What, when, where, how many? What technology? Nano? Bio? When will that technology actually turn into real products? Where will the people who produce those products reside? How many people will be employed in those technological sectors? Who will be employed in that sector? Nanotechnology is still very much in its infancy, and it isn’t clear when a large stream of products will start to be produced. If companies can now move design, production and even R&D offshore, what keeps nanotechnology jobs in the U.S.? There are some good reasons why those jobs might stay on-shore, but there isn’t enough time to discuss that here.
The government has played an enormous role in computers and networking (the Internet). These industries don’t come out of thin air.
Aron: As I pointed out in my previous question, we do not know what occupational categories will emerge as new employment generators. In 1991, the same questions could have been asked – what, when, where and how many – nobody would have thought of web-site designers or streaming audio content creators as new occupational categories waiting around the corner. What is a constant is that our ability to predict what is round the corner is limited.
Let us turn to another issue. I often hear an argument from senior executives who favor outsourcing. They maintain that in many cases, migrating some operations to lower-cost labor regimes actually results in saving jobs. That argument runs thus: When some jobs move to lower-cost centers, that move makes other parts of the company viable and results in saving several other jobs. For instance if a retail bank with a 1,400 person back-end operation that supports product lines that are barely profitable (or are unprofitable) moves 400 seats overseas to contain and manage its costs better, then the remaining 1,000 jobs are saved. If the company is forced to run all its operations from within the U.S., then it would have to withdraw from several product lines because it is unprofitable to compete in those markets.
This would have a two-fold impact: First, workers would be laid off from those unprofitable product lines, and second, consolidation would occur. A few large financial services companies (retail and corporate banks, insurance firms, brokerage houses) would grab most of the market share. As we know, the direct impact of such consolidation is the loss of jobs through centralization of operations. Outsourcing of services allows firms to stay competitive and saves several jobs that remain. How do you react to these observations?
Hira: This probably does happen in some cases, but my sense is that this is the exception and not the rule. I’d love for someone to actually collect statistics on this and give me a real and verifiable example. Companies have obvious interests in all of us believing that this is the norm rather than the exception. I’m willing to bite if provided a better sales pitch, but I doubt that is coming.
It is likely that the more common practice is to move the work offshore and lay off the domestic workers. I personally know a number of very well qualified electrical engineers who have faced this situation. In a small number of cases they have been offered the opportunity to re-locate abroad with, of course, reduced pay. Companies are also often not up-front with their plans and some workers have been forced to sign non-disclosure agreements or risk their severance pay. These engineers I know work for major, Fortune 100, technology companies.
The same companies that are expanding their workforce abroad are cutting back here. The customers are still here in the U.S.
Aron: The question I raised was about the back-end operations of a retail financial institution, such as a bank. It is about service workers such as those found in banking operations –people who do jobs such as invoice processing, transaction processing, account reconciliation, etc. Electrical engineers (or engineers in general) do not execute these functions. These functions are generally executed by non-specialist information workers (as opposed to IT workers). The impact of the costs of running a service operation on the industry structure is pretty significant in the financial services sector. So my question deals specifically with the impact of operational costs on the industry.
My research into the business implications of process migration and outsourcing shows some important trends: Firms can cut costs on the volume of processes transferred anywhere from 30% to 70%. Often they outsource processes or migrate them to a captive center to cut costs and then deepen the relationship due to higher quality of process execution and finally commit to scope (higher-end work) for a combination of strategic gains (better service, faster turn-around and greater flexibility in customizing service offerings). I have personally met with senior managers of firms in the U.K. and Singapore that have moved processes out of their current locations and are in the process of significantly expanding the scale and scope of outsourcing.
I have two questions for you in this context: If by some regulatory measure or through the escalation of pressure through public opinion you significantly curb U.S. corporations from transferring processes, will you not leave them at a competitive disadvantage against foreign institutions from say, the U.K. and Singapore? Will this not lead to a loss of business revenues, market share and therefore to job losses?
Hira: Yes, it may. But then again, it may not. Whom are they competing against? Perhaps another scenario may arise -- such as Infosys, Wipro, TCS and other outsourcers becoming so smart about doing business that they start to steal market share from the big U.S. IT firms.
If IBM had to do it over again, would it outsource the microprocessor and operating system for its PC?
Aron: Again, let me remind you that what we are talking about is transferring process execution off-shore. We are discussing the movement of back-office jobs – where the locus of production of services shifts to an off-shore location. So competition from these firms - Infosys, Wipro, TCS – can only be a threat if they were to enter retail banking or the financial services industry and compete with U.S. firms (firms in the financial services sector, not IBM) that outsource these processes to them. I don’t think that this is a very likely scenario.
Aron: Let us now move to identifying solutions to the problem of job losses. What solutions do you favor to keep U.S. jobs from being shipped out?
Hira: We should do at least four things:
1. Start to count the movement of jobs offshore so that we can have a more intelligent discussion about the phenomenon. This should include a concerted and honest effort in examining how many jobs have been created in the U.S., and how much the U.S. then exports to those offshore destinations.
2. Tighten the H-1B and L-1 visa regulations – they have accelerated the shipping of jobs overseas. These regulations govern the ability of foreign workers to work in the U.S.
3. Don’t accede to any WTO GATS (General Agreement on Trade in Services) negotiations that loosen the H-1B and L-1 regulations.
4. Invest serious money in our workforce and infrastructure in the U.S.
Aron: There may be a problem with taking the regulatory intervention route. Trade in services will soon come under the purview of the WTO, perhaps as early as 2005. When GATS is covered by the WTO, these legislative hurdles may well be considered as being beyond the standpoint of the trade agreements that can be enforced under the ambit of the WTO. The recent steel tax is a case in point. What are your thoughts in this context?
Hira: The U.S. already has specific commitments in GATS from the Uruguay round that cover the H-1B and L-1 visas. This list is easily accessible from the U.S. International Trade Commission website.
The trade policy process is the most opaque and undemocratic U.S. government process that I have personally experienced, and I teach public policy. I philosophically favor free trade and understand that it requires tough choices and that there will be losers from those choices. But the current process by which the U.S. Trade Representative (USTR) receives input needs some serious overhaul. A narrow set of special business interests seems to carry disproportionate weight in helping the USTR shape negotiations.
So, yes, the WTO scares me, not because I went to Cancun to protest, but because it is philosopher king rule, and democracy seems to be a better form of governance.
Aron: Economists have long claimed that the outsourcing of any work -- be it manufacturing or services -- has a major desirable effect on the economy that does the outsourcing (for instance, U.S., U.K., Singapore). It lowers the cost of production of goods or services and in doing so keeps prices in check. When lower costs of production are combined with aggressive competition (in a sector of the economy), the consumer captures these benefits.
We have seen this happen with PCs, notebooks, network equipment, apparel, toys, retail banking and discount brokerage to name just a few sectors. When you restrict the ambit of cost reducing techniques (such as outsourcing) that are open to firms, you impose higher prices on all consumers. This acts like a tax on consumption to protect jobs. Protectionist economies are, for this reason, high-cost economies. How do you react to the claim that curbs on service outsourcing could well be a way of forcing consumers to subsidize the jobs of some information workers.
Hira: I am not in favor of protectionism, so I have no reaction to this except to wonder why I’m in this group.
Labels like “protectionist” or “free trade” are clever tools that some people use to try and make complicated issues seem simple and straightforward. Of course no one wants to be labeled as “protectionist”. Everyone wants to be labeled as a “fair trader.” There are plenty of shades of gray out there, and it isn’t very helpful to use broad-brush terms like these.
Aron: Are there other measures such as extended health coverage and extending the Trade Adjustment Assistance program to cover information workers that you would recommend?
Hira: Yes, major new initiatives in actually helping displaced workers. This takes serious money and new institutions, maybe even a new government agency. The current system is thoroughly incapable of helping these types of people. As LBJ used to say, the best way to kill a new program is to put it in an old agency.
Those who advocate free trade, like myself, have to close the deal properly and ethically by devising ways in which to compensate the losers.