The Economist on IT Outsourcing]

[Dave Farber <dave () farber net>]

Delivered-To: dfarber+ () ux13 sp cs cmu edu
Date: Fri, 20 Feb 2004 16:01:02 +0530
From: Suresh Ramasubramanian <suresh () hserus net>
Subject: [Fwd: [Saints] The Economist on IT Outsourcing]
To: Dave Farber <dave () farber net>



-------- Original Message --------
Subject: The Economist on IT Outsourcing
Date: Fri, 20 Feb 2004 05:27:58 -0500
From: Srini Ramakrishnan <sriniram () symonds net>


http://www.economist.com/agenda/displayStory.cfm?story_id=2454530

The great hollowing-out myth
Feb 19th 2004
From The Economist print edition


Outsourcing to other countries has become a hot political issue in America.
Contrary to what John Edwards, John Kerry and George Bush seem to think, it
actually sustains American jobs


EARLIER this month, President George Bush's chief economic adviser, Gregory
Mankiw, once Harvard's youngest tenured professor, attracted a storm of
abuse. He told Congress that if a thing or a service could be produced more
cheaply abroad, then Americans were better off importing it than producing
it at home. As an example, Mr Mankiw uses the case of radiologists in India
analysing the X-rays, sent via the internet, of American patients.

Mr Mankiw's proposition, in essence, is the law of comparative advantage,
first postulated by David Ricardo two centuries ago and demonstrated to
astonishing effect since. Yet the Republican speaker of the House of
Representatives, Dennis Hastert, joined Democrats in their rebuke of Mr
Mankiw for approving of jobs going overseas; another Republican called for
his resignation. The White House gave Mr Mankiw only lukewarm
support-unsurprisingly, since Mr Bush recently signed a bill forbidding the
outsourcing of federal contracts overseas. And the Democratic presidential
contenders? Mr Mankiw had just written their attack ads.

As if to underline the point, this week's Wisconsin primary was dominated by
the subject of jobs, and the failure of the Bush administration to do enough
to protect them from going off to India. In John Edwards, who wants to
rewrite the North American Free-Trade Agreement (NAFTA), the American left
may have found its cuddliest protectionist yet; support for the southerner
surged after he spent much of a debate drawing implicit comparisons between
his own skills as a jobs-defender and those of John Kerry, who has stuck to
free trade only a little more loyally. The Democratic front-runner defends
NAFTA, but rants about "Benedict Arnold" bosses betraying American workers
by moving jobs overseas (presumably to boost returns for fat-cat investors,
like, er, Mr Kerry's family).

As for what might be called the business lobby, this is in disarray. "Tech
jobs are fleeing to India faster than ever," moans the cover of Wired. Watch
"Lou Dobbs Tonight", America's main business show, and every factory-closing
is hailed as proof of America's relentless "hollowing-out" at the hands of
dark forces in China, India and indeed the White House. Strangely, no
mention is made of the fact that a pretty tiny proportion of all jobs lost
actually go overseas.

So what is really happening? Three themes emerge:

.Although America's economy has, overall, lost jobs since the start of the
decade, the vast majority of these job losses are cyclical in nature, not
structural. Now that the economy is recovering after the recession of 2001,
so will the job picture, perhaps dramatically, over the next year.

.Outsourcing (or "offshoring") has been going on for centuries, but still
accounts for a tiny proportion of the jobs constantly being created and
destroyed within America's economy. Even at the best of times, the American
economy has a tremendous rate of "churn"-over 2m jobs a month. In all, the
process creates many more jobs than it destroys: 24m more during the 1990s.
The process allocates resources-money and people-to where they can be most
productive, helped by competition, including from outsourcing, that lowers
prices. In the long run, higher productivity is the only way to create
higher standards of living across an economy.

.Even though service-sector outsourcing is still modest, the growing
globalisation of information-technology (IT) services should indeed have a
big effect on service-sector productivity. During the 1990s, American
factories became much more efficient by using IT; now shops, banks,
hospitals and so on may learn the same lesson. This will have a beneficial
effect that stretches beyond the IT firms. Even though some IT tasks will be
done abroad, many more jobs will be created in America, and higher-paying
ones to boot.

Just you wait

The "jobless recovery" first, then. Despite strong productivity growth and
an accelerating recovery from the recession of 2001 (the economy grew by an
annual 4% in the fourth quarter of last year), jobs are being created at a
feeble rate of 100,000 or so a month. The jeremiahs point out that a net
total of 2.3m jobs have been lost since Mr Bush came to office.

Although this date is often used as the starting-point from which to make a
comparison, it is a silly one. In early 2001 the hangover effects from the
investment boom of the late 1990s were only starting to be felt.
Unemployment, at 4.2%, was unsustainably below the "natural" unemployment
rate, consistent with stable inflation, that most economists put at around
5%. In other words, perhaps two-thirds of those 2.3m jobs were unsustainable
"bubble" ones. Given the scale of job losses-along with the shocks of a
stockmarket bust, corporate-governance scandals and terrorist attacks-it is
a wonder that the recession was so mild. By the same token, a mild recession
is now being followed by a commensurately mild recovery.

This week, the White House retreated from a claim that 2.6m new jobs would
be created this year. But there are reasons to think that job growth will be
more robust. In particular, the remarkably strong productivity growth,
running at twice its long-run average of 2.1%, must slow down eventually. In
the face of rising order books, businesses will have to hire more workers.

This may already be happening in some parts of the country. William Testa,
director of regional research at the Federal Reserve Bank of Chicago, points
out that the downturn began in the mid-west (because of its relative
emphasis on manufacturing, notably business equipment, the mid-west was hit
first by the slump in business investment) and then spread to the coasts.
Now a recovery is spreading in the reverse direction-starting on the coasts
and ending up, alas for Mr Bush, in the key electoral states of the
industrial heartland.

In the absence of an obvious jobs recovery, it is perhaps not surprising
that the myth arose that the American economy was being buffeted by
structural, not cyclical, forces. Yet it nevertheless is a myth-as three
notable economists, William Baumol, Alan Blinder and Edward Wolff, point out
in a recent book.*

Churning, they point out, has being going on in the American jobs market for
years, and "the creation of new jobs always overwhelms the destruction of
old jobs by a huge margin." Between 1980 and 2002, America's population grew
by 23.9%. The number of employed Americans, on the other hand, grew by
37.4%. Today, 138.6m Americans are in work, a near-record, both in absolute
terms and as a proportion of the population (see chart).

Of course some firms wither-Reynolds Tobacco's workforce shrank by
nine-tenths between 1980 and 2002-but others grow: Wal-Mart's by 4,700%.
During the 1990s, about a quarter of all American businesses shed jobs in a
typical three-month period, equivalent to 8m jobs. Yet jobs created greatly
outnumbered these, to the tune of 24m over the decade.

The process leads to incremental shifts that can have profound cumulative
consequences for some sectors of the economy. In 1960 only one in 25 workers
was employed in the business-services and health-care industries. Today, one
in six is. In terms of output, manufacturing has risen, but, thanks to that
productivity spurt, these goods are produced by fewer people-12% of the
workforce, less than half the proportion of three decades ago.

And what of China? Still piffling. Certainly, China competes with some
labour-intensive American industries that have long been in decline, such as
textiles and stuffed toys. In the mid-west, metal-furniture makers and small
tool-and-die foundries face growing competition. Yet most Chinese imports
are of consumer goods, competing with imports from other poor countries,
whereas America's manufactures are chiefly capital goods. Even at their peak
in 2001, the number of all "trade-related" layoffs represented a mere 0.6%
of American unemployment.

As for the Indian threat, "offshoring" is certainly having an effect on some
white-collar jobs that have hitherto been safe from foreign competition. But
how big is it, really? The best-known report, by Forrester Research, a
consultancy, guesses that 3.3m American service-industry jobs will have gone
overseas by 2015-barely noticeable when you think about the 7m-8m lost every
quarter through job-churning. And the bulk of these exports will not be the
high-flying jobs of IT consultants, but the mind-numbing functions of
code-writing.

Meanwhile, there is another side to the ledger. Instead of focusing on jobs
lost to the globalisation of information technology, Catherine Mann of the
Institute for International Economics in Washington looks at globalisation's
power to reduce prices and so help spread new technology, new practices and
job-creating investment through the economy.

She uses the example of cheaper IT hardware, one of the main aspects of
globalisation in the 1990s. Most of the drop in prices for PCs, mainframes
and so on was caused by the relentless advance of technology; but she still
thinks that trade and globalised production-all those Dell Computer
factories in China, for instance-was responsible for 10-30% of the fall in
hardware prices. These lower prices led to higher American productivity
growth and added $230 billion of extra GDP between 1995 and 2002, equivalent
to an extra 0.3 percentage points of growth a year.

These days, software spending is increasing at twice the rate of hardware
spending, as businesses struggle to make their new computers work better.
The manufacturing sector is where such integration has gone furthest. In
many other parts of the American economy, the process has barely
begun-particularly among smaller- and medium-sized businesses. Mr Mankiw's
example of the Indian radiologist shows how the internet could help lower
costs and raise productivity in health care. Who would object to that?

Ms Mann concludes that if IT software sees falls in prices, thanks to
globalisation, similar to those that IT hardware has seen, then the second
wave of productivity gains-notably in the service sector-could be greater
than the first, which was based mainly on manufacturing. Some service
sectors, such as construction and health care, are ripe for gains, because
their efficient use of IT is low.

Will the trend lead to jobs going overseas? You bet, but that is not a
disaster. For a start, America runs a large and growing surplus in services
with the rest of the world. The jobs lost will be low-paying ones, such as
bank tellers and switchboard operators. Trade protection will not save such
jobs: if they do not go overseas, they are still at risk from automation.

By contrast, jobs will be created that demand skills to handle the deeper
incorporation of information technology, and the pay for these jobs will be
high. The demand for computer-support specialists and software engineers, to
take two examples, is expected by the Bureau of Labour Statistics (BLS) to
double between 2000 and 2010. Demand for database administrators is expected
to rise by three-fifths. Among the top score of occupations that the BLS
reckons will see the highest growth, half will need IT skills. As it is,
between 1999 and 2003 (that is, including during the recession) jobs were
created, not lost, in a whole host of white-collar occupations said to be
particularly susceptible to outsourcing.

Yes, individuals will be hurt in the process, and the focus of public policy
should be directed towards providing a safety net for them, as well as
ensuring that Americans have education to match the new jobs being created.
By contrast, regarding globalisation as the enemy, as Mr Edwards does often
and Messrs Kerry and Bush both do by default, is a much greater threat to
America's economic health than any Indian software programmer.



-------------------------------------
You are subscribed as interesting-people () lists elistx com
To manage your subscription, go to
 http://v2.listbox.com/member/?listname=ip

Archives at: http://www.interesting-people.org/archives/interesting-people/