Tuesday, August 3, 2004

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The New Yorker does outsourcing

I got a lot of e-mail requests to discuss John Cassidy's New Yorker story from last week on offshore outsourcing. I resisted them because Cassidy's essay was not on the New Yorker website, so it seemed like it would have been weird. But the e-mails kept coming. So here goes:

What's weird about the piece is that it reads like Cassidy wrote it back in April and then put it in a desk until The New Yorker had some pages to fill. For example, the estimate Cassidy cites from Forrester Research on the number of jobs that will be outsourced was revised upwards in May -- which would bolster Cassidy's point -- but the older figure is used.

This paragraph is emblematic of the problems with the story:

While outsourcing isn't the only reason that business are so reluctant to hire American workers -- rising productivity and a lack of faith in the recovery are others -- it is certainly playing some role, a fact that corporate executives are much more willing to admit than economists are. Moreover, economists tend to overstate the theoretical case for outsourcing, arguing that trade liberalization is always and everywhere beneficial, which simply isn't true.

OK, let's skip over the fact that 70% of those corporate execs have said they have no immediate or future plans to outsource. What's important is that Cassidy's small caveat about productivity gains allows him to commit a major fudge, blaming outsourcing for the larger, lackluster employment picture. This simultaneously ignores the importance of productivity and conveniently ignores the fact that the employment data doesn't back Cassidy up.

Don't take my word for it, though -- Charles L. Schultze has more on this in a Brookings Institution policy brief. Schultze makes important caveats about the official data, but nevertheless concludes:

If the disappointing employment growth of the past several years came about because America's production needs were being met to an increasing degree by production from foreign rather than American workers, as Americans increased the share of consumer and capital goods they bought from abroad, or as domestic firms expanded the share of their operations located abroad, this should show up as a rise in the inflation-adjusted value of imports relative to GDP. During the 1990s the import share rose steadily, but apart from some short-term fluctuations the share leveled off thereafter. It is difficult from this data to see how changes in the combination of import substitution and offshoring could have played a major role in explaining America's job performance in recent years.

The estimates on imports of goods come from relatively comprehensive U.S. customs data. Conceivably, the surveys of business firms used by the Department of Commerce to collect data on service imports may be missing some of the increase attributable to offshoring.... But the absolute size of any such errors in the import data cannot realistically be anywhere near large enough to alter the earlier conclusion that the speedup in productivity growth was by far the dominant factor behind the disappointing job growth. (emphasis added)

Both Schultze and Cassidy state that outsourcing and productivity gains can cause the gross destruction of jobs. However, Cassidy wants the reader to believe that outsourcing is the real villain -- Schultze shows that it isn't.

Cassidy closes with the following paragraph:

If the United States is to meet the challenge posed by a truly global economy, it will have to insure that its scientists are the most creative, its business leaders the most innovative, and its workers the most highly skilled -- not easy when other nations are seeking the same goals. A truly enlightened trade policy would involve increasing federal support for science at all levels of the education system; creating financial incentives for firms to pursue technological innovation; building up pre-school and mentoring initiatives to reduce dropout rates; expanding scholarships and visas to attract able foreign students and entrepreneurs to these shores; and encouraging the development of the arts. In short, insuring our prosperity involves investing in our human, social, and cultural capital. But don't expect to see that slogan on a campaign bumper sticker anytime soon.

Brad DeLong has his own problems with this closing. For me -- beyond the dubious linkage between arts funding and outsourcing -- what's missing from the Cassidy piece is a recognition of American strengths in innovation for the future. Hell, even the Progressive Policy Institute -- in a policy brief on offshoring by Richard Atkinson that reads like Cassidy's wish list no less -- recognizes this fact:

The next wave [of innovations] is not just about technology. It is also about innovative new business models, which the United States is particularly well positioned to develop because of its unique combination of information technology (IT) talent, entrepreneurial energy, and flexible capital markets. India boasts high-level computer programmers, but innovative companies that combine IT with creative business models, such as Yahoo!, Amazon.com, Akami, and Google, were all developed in the United States.

When the Progressive Policy Institute agrees with the former head of the McKinsey Global Institute, it does suggest that this is kind of important.

Also on this point, Tammy Joyner has a long Atlanta Journal-Constitution story on the hidden costs that can come from offshoring -- in large part due to the infrastructure deficiencies that Cassidy elides in his essay.

Two other offshoring stories worth checking out:

1) Bruce Bartlett has a policy brief on insourcing vs. outsourcing.

2) William Bulkeley has a Wall Street Journal story on how IBM is adopting new policies to reduce layoffs due to offshore outsourcing. Key line: "IBM is increasing employment for the first time in three years. Earlier this year it said it expected to boost world-wide employment by 15,000 to 330,000 in 2004, including a net U.S. employment boost of up to 2,000, despite offshoring."

posted by Dan on 08.03.04 at 02:45 PM


Isn't the PPI pretty staunchly pro-trade?

posted by: praktike on 08.03.04 at 02:45 PM [permalink]

Immigration is the right answer to outsourcing. Immigration will reduce wages and consequently wage gap but also reduce produce and service costs. Overall effect should be beneficial. See my blog for more detailed take on this.

posted by: Ashish Hanwadikar on 08.03.04 at 02:45 PM [permalink]

I will step right into it here.
Economists are out of touch theorists who are destroying this country by wanna-bes giving credence to their fallacious outdated theories. (No, am not on Progressives side.

For one aspect, increased productivity as key? Get real. People are working two jobs and fifty hour weeks. Or double income couples are grabbing double higher incomes for themselves. (Maybe, just maybe, the yuppie and bobo women should have stayed home with the kids and only worked part-time to eliminate the social problems we had to deal with and maybe assist in the allocation of good jobs for main income earner in a family) So much for the inivisible hand and rational choice theories. Housing sucked up what should have been used for genuine investment in techoological prowess and industrial prowess. (all the yuppies and bobos are buying cheap foreign made products from Home Depot, etc.) due to taxing schemes. So much for the benefit of the invisible hand.

So-called American corporations are producing products on foreign shores at dirt cheap wages and then importing. American what and how? Growth of jobs? How many have been overbenefited govt. employee/univ. spots, and attorneys, who all bleed an economy?

I won't even get into the funny moneys across this so-called economy.
Enough at this time.

posted by: Alex on 08.03.04 at 02:45 PM [permalink]

Immigration is the answer? Oh, sure it is.
As if we don't know what has been done to the U.S. job market, etc. due to all the visas by now?

What is it with the advertising for Outsourcing and Visas going on here over the last few days?

posted by: Alex on 08.03.04 at 02:45 PM [permalink]

When the Progressive Policy Institute agrees with the former head of the McKinsey Global Institute, it does suggest that this is kind of important.

The link here leads to the full version of this post. (I'm reading the Power of Productivity right now, so I'm interested to see what you had to say.)

posted by: Bob McGrew on 08.03.04 at 02:45 PM [permalink]

Arrggh... fixed now.

posted by: Dan Drezner on 08.03.04 at 02:45 PM [permalink]

The most significant outsourcing trend has less to do with coding projects than with the divestiture of traditional non-core cost centers such as HR, F&A, customer care, claims processing etc.

With few exceptions (state employment and tax filing aspects of HR, for ex.) these functions can and should be automated to a far greater extent than most F1000 companies are doing. Millions of paper-pushing, redundant back-office workers creating duplicate spreadsheets and silos of data know that most of these non-core jobs are redundant and should not exist within a lean and efficient corporation.

The grand benefits of outsourcing these cost centers include not merely a reduction in cost but an overall increase in productivity. Employees who used to engage in redundant back-office processes may be transferred into line positions that can actually contribute to generating revenue.

Where this is not possible, an F&A or HR employee with any significant experience who's laid off can often find a job quickly with a new outsourcing company, often at a higher salary, as an expert designer or supervisor of that company's service offering or delivery.

It helps to view this development in terms of the difference between in-house counsel and external law firms. For most companies, a small in-house legal staff suffices today, and in the future this will be true also of in-house expenditure on HR, F&A, claims processing, customer care and any number of standardized processes in which huge efficiencies are to be gained by aggregating a service and related expertise for multiple clients.

Outsourcing these processes is nothing but good news for the US economy. It will maintain our edge in the next economic front: the battle to gain cost efficiencies and enhanced product development and service delivery from revolutionized business processes.

posted by: lex on 08.03.04 at 02:45 PM [permalink]

In terms of IT, the biggest trend in the last three years has been the collapse of pay rates. Overseas outsourcing seems largely to not be a success in IT, but outsourcing has been happening within the US, in IT, since the latter 1990's. For example, Nortel Networks announced that they were outsourcing their business IT function to CSC in late 1999.

Immigration has been a factor, as companies like Tata have been importing programmers on an L1 visa who are paid at Indian scale, but get expenses. An Indian friend of mine (who is a US citizen) says that they are abusing the L1 visa, as it was not meant to be used this way.

US IT consulting companies have trouble competing on price, because those of us who live here don't want to accept rates too low (when we were receiving twice the pay, in 2000 and early 2001). the going rate in Dallas for experienced people is lower than it was in 1992.

That is a big issue in this field, although it is not clear that politicians can do anything but harm about it.

posted by: Jim Bender on 08.03.04 at 02:45 PM [permalink]

"US IT consulting companies have trouble competing on price, because those of us who live here don't want to accept rates too low (when we were receiving twice the pay, in 2000 and early 2001). the going rate in Dallas for experienced people is lower than it was in 1992."

Tough. The world does not owe them a thing. The rest of us are obligated merely to look at the resulting drop in prices to the end user. Productivity gains will always hurt some people earning a living in specific industries. They must, though, get their act together and perhaps find another way to earn a living. Do I sound cold and unfeeling? I'm sorry but this is the only way that a society becomes more affluent. If anybody tells you something different---they are either fools or liars.

posted by: David Thomson on 08.03.04 at 02:45 PM [permalink]

Productivity numbers, like lots of other things, are dependent on accurate measurement of inflation. I'm getting increasingly suspicious about the CPI as an even approximate measure of inflation...housing prices are done on an "imputed rent" basis, which seems problematic, and there are lots of other strange-seeming things in there as well. Anyone else have any concerns or insights on CPI validity?

posted by: David Foster on 08.03.04 at 02:45 PM [permalink]

David T - amen. There's nothing magical about programming jobs, folks. In fact the vast majority of them demand skills that are no more complex than the skill demanded of your average just out-of-college financial analyst. There is absolutely no reason that most programming jobs cannot be done as well or better by young Russians or Indians who, in most cases, have far better math and computer science training than Americans who drifted into IT from previous careers in (teaching English as a second language)(surfing)(rock and roll criticism).

Where the Wipros and Infosyses of the world cannot compete with US firms is in the very high value-added consulting areas that demand deep knowledge of industry-specific business processes. These also happen to be the jobs that are charged out at rates an order of magnitude greater than the charge-out rates for your garden-variety Java jockey.

The lesson is exactly the same as in any other area of economic activity: if you want higher pay (and greater security), then migrate up the value chain. Otherwise, you run the risk of becoming commoditized.

posted by: lex on 08.03.04 at 02:45 PM [permalink]

Another dirty little IT industry secret for y'all: Wipro and Infosys win contracts today not so much because their charge-out rates are lower but because they deliver higher-quality work.

Think: Toyota vs GM. Or maybe (ten years from now) Hyundai vs Toyota vs GM....

posted by: lex on 08.03.04 at 02:45 PM [permalink]

lex, sounds like you're in law having cited the legal business monopoly with its monopoly practices which permits no alterntative form of competition (and you don't want some of my prime examples) its monopoly price fixing and wasting reams of paper with convoluted circular baloney to produce fees, costs, and waste people's time as an example of productivity?

As for wiping out back office positions of Americans...what do you want to do put them all out of work? Yes, wages and benefits needed to come down, but can't as a nation put so many out of work, especially while the smug bobos, etc. skim off the top due to machinations and lobbyists. These are not just numbers on paper to be x'd out.
Even aware what the Japanese have done for years so that everyone can have some type of a job and maintain their basic dignity?

posted by: Alex on 08.03.04 at 02:45 PM [permalink]

lex, to followup last two comments--
I had best not tell you what I really think of you and your outright prevarications-- which were made very obviously against the best interests of and in disdain for Americans.

And, from all I've read of what went on in IT and what your guys didn't know, but gained through machinations and some idiots over here pandering in their idolatry of fallacious free enterprise.

No more will I waste any time on you other than to --unless I choose to waste my time to mock and scorn you in your disdain of Americans.

posted by: Alex on 08.03.04 at 02:45 PM [permalink]

"...but can't as a nation put so many out of work, especially while the smug bobos, etc. skim off the top due to machinations and lobbyists."

The economic illiteracy revealed by Alex’s comments is an eye opener. They also represent a very high percentage of John Kerry’s supporters. Such views will be difficult to marginalize if the Massachusetts senator wins the election. People like Howard Dean and Alex will ceaselessly scream into Kerry’s ear. Does any sane person really want to embolden these individuals?

posted by: David Thomson on 08.03.04 at 02:45 PM [permalink]

Hi Alex - outsourcing's my business. What's yours?

posted by: lex on 08.03.04 at 02:45 PM [permalink]


Without actually knowing, I think that Alex's criticism was coming from the right and not from the left. Talking about the value of traditional families and the threat to American society. Sounds more like Pat Buchanan than Howard Dean. Don't forget that politicians playing the populist game from both sides of the political spectrum come out opposed to trade and immmigration.

Also, Regarding investment in the Arts:

I think this really is one part of the future of the American economy. We are going to lose a lot of jobs that can be standardized and done by cheaper labor than what we have in the US. That is just a fact of life. It is happening in manufacturing and in business processing.

But we are not going to lose the jobs that depend on proximity to markets and to customers. These jobs might be advanced programming, but they also could be custom building of furniture and other products.

As a larger number of Americans have more disposable income (which is happening because we still control the means of production and are the best at organizing that production...even if it is overseas) people are going to be less satisfied with the same products as their neighbors. People are going to want goods that reflect their individuality. Instead of spending $3000 on a motorcycle built in China that is the same as every other motorcycle you are going to see more people spending $75,000 on a motorcycle custom built. Instead of spending $200 on a table that is the same as lots of other tables in Ikea a group of people are going to spend $5,000 on a table that is different from any other table built.

This customization of mass produced goods is about the arts and it will be an area of job growth for years to come. Sure the adjustment will be rough, but we are going to have more interesting (i.e. goods that provide a higher utility) and the production of these goods is not going to move overseas because it is the customization that is the value.

My only point here is to not sell the arts short.

posted by: Rich on 08.03.04 at 02:45 PM [permalink]

Virginia Postrel makes the same point. Clever, cool, unusual design-- or else niche functionality-- is crucial to adding value to products that otherwise become commoditized.

If you can't figure out a way to avoid commoditization, then best to find another business. To tell our people otherwise is to cruelly delude them about this iron law of the global economy.

posted by: lex on 08.03.04 at 02:45 PM [permalink]

Re: The arts

Here's something interesting to note. The maximum number of movies in the world are produced not in Hollywood, but in Bombay (Bollywood). The Bollywood movies tend to vary from tolerable to awful, the movie industry has more mob ties than 60s Vegas Casinos, but they're popular around the world.

There is no reason to assume that many entertainment jobs (movies, TVs) etc. are immune to being outsourced or facing competition. The Bollywood industry is getting more professional, with the help of American film school trained directors.

Also, New Zealand seems to have become a popular destination for shooting movies.

posted by: Jon Juzlak on 08.03.04 at 02:45 PM [permalink]

Yes, but our movie industry in the age of Moore is capable of creating entirely new genres such as Merry Prankster Agitprop and Comic Pseudo-Documentary.

posted by: lex on 08.03.04 at 02:45 PM [permalink]

"But we are not going to lose the jobs that depend on proximity to markets and to customers"...need to be a little careful with this one. If you're selling and servicing robotics, for example, you indeed want to be in proximity to your customers--who may well be in India or China (since your customers are manufacturing plants.) Even if you're selling customer-service software, you may find that your customers (the people who run the customer service centers) are in India or wherever.

In the case of consumer products for the American market, the case is stronger.

posted by: David Foster on 08.03.04 at 02:45 PM [permalink]

"Another dirty little IT industry secret for y'all: Wipro and Infosys win contracts today not so much because their charge-out rates are lower but because they deliver higher-quality work."

Not sure about this. While Wipro and many of the Indian Outsourcing firms are certified at high CMM levels I don't think they necessarily deliver higher quality work due to differences in language, expectations, and culture. Even in Wipro the joke is that Indians cannot refuse (apparently it's against their culture), and they are only saying "yes I can do this" out of common courtesy.

Indian (and other nations like China) IT's main attractiveness to American businesses today is still the price and not quality. In about 5 years this might change as the current batch of Indian IT professionals move from junior to senior and higher levels. That is when the American IT market will really feel the squeeze.

posted by: blah on 08.03.04 at 02:45 PM [permalink]

What ethereal world --or ivorty towers--do some of you who agree with D.T. live on? D.T., I am not econ. illiterate because I do not agree with your outdated econs. as religion. I have learned to write in terse as much more efficient. You're way off base in tagging me as either a follower of Dean or Buchanan.

The IT disaster has already hit the fan. Thousands of software engineers and IT American profs. and techs are out of work.

The Immigration mess has already hit the fan--in too many ways to discuss here and now. If you are not aware of the problems and costs of immigration you are out of touch with real world and again dealing in the theoretical.

posted by: Alex on 08.03.04 at 02:45 PM [permalink]


I'm relating what our clients tell us. The Indians' processes are tighter, they deliver on-time and above expectations far more often, and of course they're cheaper.

posted by: lex on 08.03.04 at 02:45 PM [permalink]

“Without actually knowing, I think that Alex's criticism was coming from the right and not from the left. Talking about the value of traditional families and the threat to American society. Sounds more like Pat Buchanan than Howard Dean.”

I’m appalled at the reactionary economic views of both men. They are equally dangerous and need to be marginalized. Those on the political fringes often start sounding alike. Pat Buchanan represents the old “I’ll take my stand” conservatives who despise capitalism and prefer a static society where changes were few. Most Republicans have little use for such silly thinking---and that’s why Buchanan eventually left the party.

posted by: David Thomson on 08.03.04 at 02:45 PM [permalink]

Alex is right to say that libertarian/neoclassical economics is outdated. The cutting edge is in behavioural and NIE. There's just to much irrationality, too much cronyism, to many ethnic networks, to account for.

That is truly why America is losing. We are up against caste based actors (think overseas Chinese and the Indian caste system) who will pool resources to improve the odds for their genetic kin. Anglosaxons, on the other hand, will sell each other out in a heartbeat. Exhibit A, lex (assuming he is an anglo-American). Also, what absolute B*llocks about 'deep understanding of intricate business processes'. Man, sounds like you take your own 'pitches' seriously.

posted by: stari_momak on 08.03.04 at 02:45 PM [permalink]

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