Seminar 2

Fear of Service Outsourcing: Is it justified?

Background:

Outsourcing is referred to as the procuring of material inputs or services by a firm from

outside the firm. It can be domestic or international.

International outsourcing is the main focus in this case study. It is defined as the
procuring of service or material inputs by a firm from a source in a foreign country. It is
part of a country’s imports (of goods and services). Another commonly used term for
international outsourcing is offshoring.

This case study aims to “investigate and to establish what are the hypes and that facts
about service outsourcing.” The media has been giving attention to the negative effects of
outsourcing on jobs. There have been reports about jobs moving from industrial countries
like United States and the United Kingdom to developing countries such as India because
of the increasing amount of services outsourcing by developed countries to developing
countries.

Though outsourcing has been a part of international trade, increasing in service

outsourcing is considered new in today’s context. Based on the case, the effect of its
growth on job losses should be examined in closer details for certain reasons. They are:

1) Backslide in support for free trade policies, particularly among white-collar

workers. The fear of losing one’s job is of concern in itself, as it could lead to
lobbing for protectionist type policies.

2) Even though service outsourcing is expected to lead long term benefits, there may
be adjustment costs in the form of job losses.

A number of potential problems with our outsourcing measures should be noted as

below:

• Underestimate the value of outsourcing because the cost of importing services is

likely to be lower then the cost of purchasing them domestically

• Applying the same import share to all industries is not ideal, but given the
unavailability of imports by industry this is our ‘best guess’

• The total use of inputs by industry only includes those inputs purchased from a
different industry so services produced within the industry are not included, hence
the extent of outsourcing is unlikely to be precisely measured.

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Outsourcing trends in developed countries

Materials outsourcing intensities are significantly higher than service outsourcing in both
the United Kingdom and Unites States. In the United States it has been steadily
increasing but at a slower pace than service outsourcing. In sum service outsourcing is
much lower than material outsourcing but it is increasing at a faster pace.

Study on International outsourcing of material inputs’ effect on wage skill premium:

Showed that relocation of unskilled-intensive parts of the production process from
relatively skill abundant countries to unskilled-abundant countries leads to expected
increase in the relative demand for skilled labour in the skill-abundant country and hence
increases the skill premium.

Studies on Service outsourcing:

Different results for studies on different industries:

Sector: Study by: Country Result

Information Mann US IT hardware outsourcing led to drop in 10 – 30% of prices
Technology (2004) of IT Hardware.
IT software is more price elastic than IT hardware;
expected productivity gains should be much higher.
IT industries had exhibited high job growth, thus
international services outsourcing does not affect job
growth negatively.
Manufacturing Amiti and US Service outsourcing is positively correlated with labor
Industry Wei productivity but material outsourcing is insignificant.
(2004)
Electronics Gorg and Ireland Service outsourcing has positive impact on productivity,
Technology Hanley whereas material outsourcing has no significant impact.
(2003)
Nil Girma and UK Found positive evidence on labor productivity and total
Gorg factor productivity, but were unable to distinguish between
(2004) domestic and foreign outsourcing.

Management Mckingsey Nil Amount of job lost due to outsourcing is a relatively trivial
counsultants Global share of overall job losses during the normal course of a
Institute’s business cycle.
Report
(2003)
Management Brainard Nil Provided overview of Mckingsey Global Institute’s
counsultants and Litan Report.
(2004) Low paid jobs are the ones being replaced by higher paid
jobs.
Management Shultz Nil Indirect evidence on job losses related to services
counsultants (2004) outsourcing are provided – results are that the effects are
very small.

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Biggest Outsourcers / Insourcers Countries:

• Not entirely correct to say that Outsourcing is mostly about United States and other
industrialized countries, where the media reports.

• Using IMF international trade data, Balance of Payments Statistics yearbook:

a) Outsourcers:
i. Biggest outsourcers of business services in 2002 are:
o US, Germany, Japan, Netherlands, Italy and France
o Surprisingly, India and China that have been portrayed as the
biggest recipients of outsourcing by the media are significant
outsourcers as well, with rankings of 11th and 18th respectively.

ii. Biggest outsourcers of computer and information services in 2002 are:

o Germany, UK, Japan, Netherlands, Spain, US.
o As larger economies naturally trade more than smaller ones, it is
important to scale the value of the imports by the size of the economy
(e.g. local GDP) to get the sense of the importance of outsourcing for a
local economy.
o The results obtained becomes different, with none of the
mentioned countries ranking anywhere in the top-ten list at all.
Instead, the top countries are Angola, Republic of Congo,
Mozambique, Ireland and Vanuatu.

b) Insourcers
i. Biggest insourcers of business services in 2002:
o US, UK, Germany, France, Netherlands.
o India is ranked at 6th and china at 14th.
(Interesting point: though India is one of the 6 biggest exporters of
business services, there are five developed countries ahead of it.)
o After scaling the value of exports by the local GDP, the top are:
Vanuatu, Singapore and Hong Kong.

3) Developed countries will not be more likely to run into a deficit in services trade than
developing countries because:
o Largest surplus countries of combined computing and business
services in the world are UK and US
o Thus, if every country reduced its overall service outsourcing, UK and
US would be the biggest losers in terms of net dollars lost in service
trade. As the world outsourcers more to them than the reverse.

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4) Effects that service outsourcing has on employment depends on labor mobility.

a) Labour perfectly mobile

o lost of one job in one sector leads to gain in another
c) Rigidities present in labor market
o Outsourcing could lead to net employment losses, at least in the short
term. Small amount of outsourcing could thus lead to large job losses.

Does Service Outsourcing Reduce Jobs?

A recent anxiety in advanced economies over service outsourcing is the fear of losing
jobs at home.

However, outsourcing could also lead to job growth. Firms that have outsourced may
become more efficient and expand production, and expand employment in other lines of
work. If firms were able to relocate certain inefficient parts of productions to a cheaper
country, they would be able to expand their output. These productivity translates into
lower prices generating further demand and hence create more jobs. This job creation
effect could offset the direct job losses due to outsourcing.

In general, an increase in output would have a positive impact on employment demand.

On the other hand, increase in wages would lead to a negative effect. An increase in price
of other inputs would lead firms to substitute away from the more expensive inputs
towards labour.

Outsourcing can affect labour demand through two channels.

1) Substitution Effect
A fall in the price of services would lead to a fall in the demand for labour if labour and
services are substitutes.
2) Output Effect
Increase in outsourcing can make the firm more efficient and competitive, increasing
demand for its output and hence labour.

Effect on jobs depends crucially on the level of disaggregation.

• 450 sectors
A faster growth in outsourcing at a sector level was associated with a small negative
growth in jobs in that sector.

• 96 sectors
No correlation between job growth and outsourcing growth at the sector level.

At sufficiently disaggregated levels, every outsourced job is a job lost. Hence, job growth
and outsourcing may be negatively related. At the other extreme, for the economy as a

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whole, outsourcing is likely to change only the sectoral composition of the jobs, not
necessarily the aggregate level of employment.

Conclusion:

There is a tremendous amount of anxiety over massive job losses due to international
outsourcing of services in developed countries. This article suggests neither aspect of the
anxiety is well supported. In particular, most developed countries are not generally more
outsourcing intensive than many developing countries. Developed countries tend to run
surpluses – i.e. the rest of the world outsources more to them than the reverse.

Using 78 sectors in the UK, they found that job growth at the sectoral level is not
negatively related to outsourcing. They also find that there is a negative effect on
employment if the economy is decomposed into 450 sectors, but the negative effect
disappears when one looks at slightly broadly defined sectors. This evidence suggest that
workers who lose jobs in one industry manage to find jobs in other growing industries.

To conclude, the risk of service outsourcing dramatically reducing job growth in the
advanced economies has been greatly exaggerated.

By:
Karin Goh
Joyce
Shandy
Xiaolian