Offshoring
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Offshoring can be defined as relocation of business processes to another country, especially a country overseas. This includes any business process such as production, manufacturing, or services.
Offshoring can be seen in the context of either production offshoring or services offshoring. After its accession to the WTO, China emerged as a prominent destination for production offshoring. After technical progress in telecommunications improved the possibilities of trade in services, India is a country leading in this domain.
The economic logic in offshoring is the same as in the division of labor in general. Between workers having different skills, letting workers focus on their skill set means more goods and services for all. If some people can use some of their skills more cheaply than others, then those people have the comparative advantage. That is the idea that countries should freely trade the items that cost the least for them to produce. In theory, this will provide for more goods and services for all, and at a lower cost.
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Frequently used terms
Offshoring is defined as the movement of a business process done at a local company to a foreign country, regardless of whether the work done in the foreign country is still performed by the local company or a third-party. Typically, work is moved due to a lower cost of operations in the foreign location. Offshoring is sometimes contrasted with outsourcing or offshore outsourcing. Outsourcing is the movement of internal business processes to an external company. Offshoring is similar to outsourcing when companies hire overseas subcontractors, but differs when companies transfer work to the same company in another country.
Related terms include nearshoring, which implies relocation of business processes to (typically) lower cost foreign locations, but in close geographical proximity (e.g. shifting US-based business processes to Canada/Mexico); inshoring, which means picking services within a country; and bestshoring, picking the "best shore" based on various criteria. Business Process Outsourcing (BPO) refers to outsourcing arrangements when entire business functions (such as IT, Customer Service, etc) are outsourced.
A further term sometimes associated with offshoring is bodyshopping which is the practice of using offshored resources and personnel to do small disaggregated tasks within a business environment, without any broader intention to offshore an entire business function.
Production Offshoring
Production offshoring of established products involves relocation of physical manufacturing processes to a lower-cost destination. Examples of production offshoring include the manufacture of electronic components in Taiwan, production of apparel, toys, and consumer goods in China, etc.
Product design, and the research and development process that leads to new products, is relatively difficult to offshore. This is because research and development to improve products and create new reference designs requires a skill set that is harder to obtain in regions with cheap labor. For this reason, in many cases only the manufacturing will be offshored by a company wishing to reduce costs.
However, there is a relationship between offshoring and patent system strength. This is because companies under a strong patent system are not afraid to offshore work due to the fact that their work will remain their property. Conversely, companies in countries with weak patent systems have an increased fear of intellectual property theft from foreign vendors or workers, and, therefore, have less offshoring.
Production offshoring got its big push when the NAFTA made it easier for manufacturers to shift production facilities out of the USA to Mexico. The trend later shifted to China, which offered cheap prices through very low wage rates, few workers' rights laws, a fixed currency pegged to the dollar, cheap loans, land, and factories for new companies, few environmental regulations, and huge economies of scale based on cities with populations over a million workers dedicated to producing a single kind of product.
Services Offshoring
The growth of services offshoring is linked to the availability of large amounts of reliable and affordable communication infrastructure following the telecom and internet expansion of the late 1990s. Coupled with the digitization of many services, it was possible to shift the actual production location of services to low cost countries in a manner theoretically transparent to end-users.
India first benefited from the offshoring trend as it had a large pool of English speaking and technically proficient manpower. India's offshoring industry took root in low-end IT functions in the early 1990s and has since moved to back-office processes such as call centers and transaction processing. In the late 1990s, India's abundant and cheap software engineering talent combined with massive demand from the Y2K problem helped to move India up the value chain to attract large-scale software development projects for US based customers. Currently, India's engineering talent has made India the offshoring destination of American high-tech firms, including Intel, AMD, Microsoft, Oracle, and Cisco. Each of these companies has promised or is in the process of investing at least $1 billion in India, to supposedly retain market share in the face of competition and cost-cutting measures of rivals and industry in general, at the expense of investment in the United States.
As a result of the offshoring boom, India has seen double-digit wage growth for much of the 2000s. Consequently, Indian's operations and firms are concerned that they are becoming too expensive in comparison with competition from the other offshoring destinations listed below. They are now diversifying and attempting to branch out to other high-end work in addition to software and hardware engineering. These jobs include research and development, equity analysis, tax-return processing, radiological analysis, medical transcription, and more.
Other offshoring destinations include Philippines, Ireland, Argentina, and Eastern European countries.
CAFTA made nearshoring destinations out of Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and the Dominican Republic.
Transfer of Intellectual Property
Offshoring is often enabled by the transfer of valuable information to the offshore site. Such information and training enables the remote workers to produce results of comparable value previously produced by internal employees. When such transfer includes protected materials, as confidential documents and trade secrets, protected by non-disclosure agreements, then intellectual property has been transferred or exported. The documentation and valuation of such exports is quite difficult, but should be considered since it comprises items that may be regulated or taxable.
Debate
Offshoring has been a controversial issue spurring heated debates, some of which overlap those related to the topic of free trade. It is seen as benefiting both the origin and destination country through free trade, providing jobs to the destination country and lower cost of goods and services to the origin country. This makes both sides see increased GDP. And the total number of jobs increase in both countries since those workers in the origin country that lost their job can move to higher-value jobs in which their country has a comparative advantage.
On the other hand, job losses in developed countries have sparked opposition to offshoring. Further, people argue that the quality of any new jobs in developed countries are less than the jobs lost overseas and offer lower pay. Further still, they argue with some economists' assertions that more education is the key to producing higher-value jobs since a great deal of highly-educated workers such as software engineers, accountants, radiologists, and journalists have been displaced by highly-educated and cheaper workers from India and China. Traditionally "safe" jobs in R&D and the Science, Technology, Engineering, and Mathematics (STEM) fields are now perceived to be endangered as higher proportions of workers are trained for these fields in developing nations. This has raised questions regarding whether developed countries can maintain any comparative advantage given the losses in both low and high-value jobs. In other words, if workers in developing countries can do all jobs cheaper, then what work will be left for workers in developed countries? And why should workers in developed countries support the offshoring of their own jobs for the sake of lower priced goods, especially when they'll have less or no money to buy those goods?
Some would argue this stems of a complete misunderstanding of comparative advantage. They say this advantage always exists for every country as if it were a mathematical fact, denying the possibility of absolute advantage. There may be some workers in developed countries who lose more than gain. But, then others in developed and developing countries then gain even more and the sum is positive. However, economists such as Paul Samuelson have pointed out that comparative advantage as a rule may not always exist.
For decades, the labor force have been moving from manufacturing to services in developed countries. This has caused a falling employment in manufacturing and much fear among industrial workers, although the total employment has been rising in many countries. The effect of this has been shown to be much higher than that of offshoring or foreign investments, which has nevertheless been accused of being the cause of unemployment, since big offshoring projects are more visible than the slow change from an industrial society to a post-industrial society. Even so, economists have been unable to determine the reasons why job creation and wage growth was lax during the 2000-2005 period in developed countries. Some attribute that to offshoring.
Level-of-Service Concerns
With the offshoring of call-center type applications, debate has also surfaced that this practice does serious damage to the quality of customer service and technical support that customers receive from companies who do it. Call centers have sprung up in India, Pakistan, Canada and even the Caribbean. Many companies, most notably Dell and AT&T Wireless, have caught much public ire for their decisions to use Indian and Pakistani labor for customer service and technical support; mostly because of the apparent language barrier that it creates. While India, for example, has a high level of younger skilled workers who are capable of speaking English as well as their native language, their English skills have caused debate in North America.
Criticisms of outsourcing from much of the American public have been a response to what they view as lackluster customer service and technical support being provided by overseas workers attempting to communicate with Americans in broken or incomprehensible English.
Worker Exploitation
Workers in third world countries often do not have sufficient legal protection to avoid exploitation. Companies, in fact, have moved to these countries specifically to avoid these laws. Lack of health benefits for workers, lack of child labor laws, lack of OSHA or EPA costs or restrictions, lack of worker retirement benefits or pension costs, lack of federal or state unemployment tax, and circumventing or avoiding organized labor all reduce labor costs.
However, external pressure against sweatshops make some domestic companies offer a higher salary and better working conditions to their foreign employees than otherwise seen in their labor market. Therefore, these companies directly give third world countries better jobs and also increase the competition on the foreign labor force, which forces companies to raise their bids on these workers.
Supply Chain Concerns
Companies lose control and visibility across their extended supply chain under outsourcing, creating increased risks. A 2005 quantitative survey of 121 electronics industry participants by Industry Directions Inc and the Electronics Supply Chain Association (ESCA) found that 69% of respondents said they had less control over at least 5 of their key supply chain processes since the outsourced model took hold, while 66% of providers felt their aggregate risk with customers was high or very high. 36% of providers responded that they felt an increased risk of uncertainty compared to their uncertainty risk prior to the rise to prominence of the outsourced model. 62% of respondents described as "problematic" at least two core trading partner management practices, which included performance management and simple agreement on results. 40% of all respondents encountered resistance to sharing risk in outsourced partnership agreements, according to the research.
Legal Concerns
In April of 2005, Indian Citibank workers in Pune employed by Mphasis BFL Group were arrested on charges of defrauding four Citibank account holders living in New York, USA, for the amount of $350,000. Citibank had no prior knowledge of the theft until the customers noticed suspicious transactions in their accounts and notified the bank.
In September of 2005, Intel fired 250 workers in India after alleging they falsified their expenses claims. The firings followed an internal audit. The report implied fraudulent employee practices such as "faking bills to claim your allowances like conveyance [and] drivers’ salaries" were endemic not only with the Indian Intel employees, but in Indian business overall. NASSCOM, which is a forum of IT and ITeS companies, has attempted to address these fraud concerns in India by creating the National Skills Registry. That database contains personal and work-related information, enabling employers to verify a staff member's credentials and allowing police to track the background of workers.
Other concerns are the theft of intellectual property given the lax enforcement of intellectual property laws in overseas locations such as China. Domestic companies doing business overseas may have no legal recourse if problems arise. Such problems include domestic companies finding cosmetically near-flawless copies of their goods sold for less than the legitimate goods. These fake goods have even been returned to the legitimate manufacturer for a refund at the legitimate price. Even if IP laws were in place and enforced, tracking down the overseas fake producer is often extremely difficult. In other problems, a foreign government intercepts sensitive trade secrets for use by the foreign government, including use in the foreign military.
Corruption
Corruption is an endemic problem in the third world. This problem increases offshore business costs through the price of illegal bribes, management cost of negotiations with officials, risk of breached contracts, and risk of detection of illegal activity. Under US law, companies face severe penalties if caught bribing foreign officials. Transparency International tracks this problem in their Corruption Perceptions Index. Bangladesh, a popular offshoring destination, shares the position of the most corrupt country in the world. Other popular offshoring destinations such as Pakistan, Russia, the Philippines, India, China, and Mexico have decreasing amounts of corruption, in that order. Corruption is decidedly less pronounced in first world countries.
Competitive Concerns
The transfer of knowledge outside the country inevitably creates competitors to the original companies themselves. Chinese manufacturers are already selling their goods directly to their overseas customers, without going through their previous domestic intermediaries that originally contracted their services. In the 1990's and 2000's, American automakers increasingly turned to China to create parts for their vehicles. By 2006, China leveraged this know-how and announced that they will begin competition with American automakers in their home market by selling fully Chinese automobiles directly to Americans.
Further, when a company moves the production of goods and services overseas, the investment that companies would otherwise make in the domestic market is transferred to the foreign market. Corporate money spent on factories, training, and taxes, which would otherwise be spent in the domestic market, is then spent in the foreign market. There is then a decrease in the property values, wages, and tax receipts in the domestic market. The reduced tax receipts directly translate to reduced funding for domestic schools, increasing the long-term disadvantage of diminished educational opportunities in addition to fewer job prospects to workers' children.
As production increases in the foreign market, qualified and experienced domestic workers leave or are forced out of their jobs, often permanently leaving the industry. At some point, dramatically fewer domestic workers are left who are qualified to perform the work. This makes the domestic market dependent on the foreign market for those goods and services, thereby strategically weakening the "hollowed-out" domestic country. In effect, offshoring creates and strengthens the competitive industries of the foreign country while strategically weakening the domestic country.
Educational Concerns
Offshoring proponents often say it is necessary to move jobs overseas due to a looming shortage of qualified workers in the domestic market and the booming number of qualified candidates in foreign markets, particularly in China and India. This ignores the many currently unemployed and qualified workers in the domestic market. On top of that, a recent study by Duke University found that 225,925 engineers graduate annually from American universities, far more than the 70,000 often quoted in the media.
Further, the Duke study found that both China and India inflate their numbers. Both of these countries count the graduates from three year training programs and diploma holders in addition to four-year graduates. In the past, these numbers have been compared against US numbers that only included four-year graduates.
The Chinese government reports that it graduates 644,106 engineers yearly. However, China does not mention whether that number includes only graduates from four-year degree programs and does not provide the means for independent verification. Duke University estimates the actual number of Chinese engineering graduates at 300,000. India produces 215,000 engineers a year, far less than the 350,000 figure often quoted in the press. These figures make the US the per capita leader in producing techology specialists.
Further, another study by McKinsey and Indian IT body Nasscom reports, "only 25 percent of [Indian] technical graduates and 10 to 15 percent of general college graduates are suitable for employment in the offshore IT and BPO industries respectively". So, not only is India graduating engineers in the same numbers as Americans, the vast majority Indian engineers are not ready to enter the workforce upon graduation.
Retraining Concerns
One solution often offered for domestic workers displaced by offshoring is retraining to new jobs. However, some displaced workers are highly educated and possess a bachelor's and master's degree. Retraining to their current level in another field may not be an option due to the years of study and cost of education involved. There is also little incentive to go through this re-education given that the jobs in their new field could also be outsourced in the future. These workers may never recover if their jobs are sent overseas.
Effects of Factor of Production Mobility
According to classical economics, the three factors of production are land, labor, and capital. Offshoring relies heavily on the mobility of two of these factors. That is, how offshoring effects economies depends on how easily capital and labor can be repurposed. Land, as a factor of production, is generally seen to have little or no mobility potential.
The effects of capital mobility on offshoring have been widely discussed. In microeconomics, a corporation must be able to spend working capital to afford the initial costs of offshoring. If the state heavily regulates how a corporation can spend its working capital, it will not be able to offshore its operations. For the same reason the macroeconomy must be free for offshoring to succeed. Generally, those who favor offshoring support capital mobility, and those who oppose offshoring call for greater regulation.
Labor mobility also plays a major role, and it is hotly debated. When computers and the internet made work electronically portable, the forces of free market resulted in a global mobility of work in the services industry. Most theories that argue offshoring eventually benefits domestic workers assume that those workers will be able to obtain new jobs, even if they have to obtain employment by downpricing themselves back into the labor market (by accepting lower salaries) or by retraining themselves in a new field. Foreign workers benefit from new jobs and higher wages when the work moves to them.
History
In the United States, moving jobs out of the country began in the 1970s and continued throughout the eighties. It was characterized primarily by the closing of factories, frequently with the corporations opening new factories in Mexico. Many of these new factories were called Maquiladoras. This offshoring and closing of factories has caused a structural change in the US from an industrial to a post-industrial service society.
In 1994 NAFTA went into effect. As concerns are widespread about uneven bargaining powers, and risks and benefits, negotiations are often difficult, such that the plan to create a Free Trade Area of the Americas has not yet been successful.
With the development of the internet, many new categories of work such as call centres, computer programming, reading medical data such as X-rays and MRI's, medical transcription, income tax preparation, and title searching can be offshored.
External links
- [1] TechUnite - IT Workers Group
- [2] Offshoring Digest - Covering Offshore Outsourcing
- [3] GoneWithTheWorld - Criticism article and blogs on offshoring and globalization
- [4] Offshore Outsourcing Blog - Brings together article and news about offshore outsourcing
- [5] Offshoring Forum - forum for all Offshoring and Outsourcing discussions
- [6] Making offshore outsourcing sustainable - EU funded project run by UNI Europa
- [7] Outsourcing Weblog - Best Practices and Industry News
- [8] Informed Choices - Website devoted to detailing and commenting on offshoring and outsourcing, particularly from the UK.
- [9] - SurviveOutsourcing.com is the blog of an American IT professional. SurviveOutsourcing covers events in the offshore outsourcing world and provides a perspective on how to position your career in a changing economy.
Criticism
- [10] Onshore Alternatives - Voice against Offshoring
- [11] Stop Offshoring Blog
- [12] Polar Opinions at Offshoring Wiki
News
- [13] Offshore Outsource Savings Can Be Elusive, Survey Shows
- [14] Don't be afraid of offshoring - by Diana Farrell
Research
- [15] Analyst Views report summarizing views of various research firms on offshoring.
- [16] McKinsey document on offshoring in Germany.
- [17] McKinsey document of offshoring in the United States.
- [18] Report from the BCS on offshoring and outsourcing with regard to IT.
- [19] Report by McKinsey and Nasscom regarding skills and quality of Indian workforce.
- [20] Report by Duke University finding the US engineering students undercounted while Chinese and Indian engineering students overcounted.de:Offshoring
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