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Updated May 2006

Frequently asked questions (FAQ) about offshoring

Why are people worried about white-collar offshoring?
There is little disagreement about why white-collar offshoring became a hot political topic. The U.S. economy experienced an acute job creation crisis between 2001 and 2004: between March to March in these years private-sector jobs declined by 2.6 million, including 560,000 jobs lost after the official recession ended in November 2001.

Additionally, workers in many sectors of the economy that have been relatively insulated from past labor market weakness felt an economic pinch this time around. Computer programmers, for example, saw their rates of unemployment surge over the national average in 2001 and 2002 after being well below it for the previous two decades.

While the manufacturing sector lost 15% of its jobs from March 2001 to March 2004, the software-producing industries lost an even-higher 16% share of their jobs. Moreover, jobs in software occupations within the manufacturing sector shrank even faster than overall manufacturing jobs. Between 2000 and 2002, total manufacturing jobs fell by 12%, while software jobs within manufacturing dropped by 19%, affecting workers who were told for the past 20 years that they had precisely the skills needed to thrive in the global economy.

These labor market developments, combined with an avalanche of media reports of U.S. firms sending technical work overseas, undermined the job security traditionally expected by white-collar workers with advanced technical skills. As both the broader labor market and the labor market for computer professionals recovered (albeit slowly), offshoring became a less pressing political issue. This issue guide argues against any complacency regarding offshoring's impact on American workers in coming years (and decades): offshoring's impact will not show up in poor employment performance, but in slower wage growth than would otherwise prevail.

How does offshoring fit in with larger trends in white-collar work?
First, a point of clarification: white-collar offshoring did not cause the jobless recovery and it doesn't explain why employment growth in this recovery is so far below trend averages. These developments are caused by a combination of relatively slow output growth and relatively strong growth in measured productivity. The widespread diffusion of information technology accounted for much of the measured gain in productivity, but increased offshoring may have contributed to other factors that might be boosting the productivity measures: increased intensity of work, longer salaried work hours that have escaped measurement, and overstatement of gains in net U.S. output due to understatement of the value of imports.

Despite not being a prime suspect in explaining the slack U.S. job market, offshoring remains, rightly, a source of anxiety for American workers. The labor market for college-educated workers, especially for those in occupations and industries newly considered vulnerable to offshoring, took a large hit in the early 2000s and remains notably weak. Furthermore, corporate threats of offshoring may well cause a pronounced deceleration of wage growth even if it contributes to accelerating productivity over the coming years.

A good proxy for labor market demand for a particular group of workers is the share of that population employed. Figure 1 shows the trend in employment rates of all college graduates over 25 and young college graduates age 25-35. In both cases, employment rates have fallen more steeply over the past few years than in any other period dating back to 1979. By this measure, demand for highly educated workers faltered in the recession of 2001 and has yet to recover.

This is even the case for young college graduates, who presumably have the most up-to-date skill set. In fact, as the figure shows, college graduates age 25-35 have employment rates that exceed those of overall college grads by about eight percentage points. As the top line in the figure reveals, their employment rates tumbled even further than those of all college grads during the early 2000s, and, despite a recent spike upwards, remain below the average that prevailed all through the 1990s.

Figure 2 shows the real hourly wages of young college graduates age 25-35. Note that, after rising about 10% through the mid-1980s, young college grads' wages were flat for the next 10 years, before rising sharply in the tight labor market of the latter 1990s. However, the persistently weak labor market since 2001 took the momentum out of this trend, reversing course in 2002 and 2003, and even three years after the recession in 2004.

The lack of demand for these workers grows directly out of weak job creation in fields that disproportionately employ them. A salient example is the software and computer services sector, where many young college graduates found employment over the last decade. This sector is particularly relevant to the offshoring debate and its net job losses were particularly steep in the last recession. Even today, employment remains well beneath its pre-recession peak, even as software investment has fully recovered (see Figure 3).

These labor market data point to weak demand for the existing stock of U.S. college graduates and underscore the fact that there is good reason for American workers to be anxious about the demand for white-collar work in general and the effects of white-collar offshoring in particular. The occupations and industries frequently pointed to as being newly vulnerable to offshoring have, indeed, recovered slowly after a deep labor market slump, and these include some of the most highly paid occupations and industries in the American economy (see Figure 4). Furthermore, the effects of offshoring on the wages of white-collar occupations are probably already at work and could have profound implications for the future living standards of American workers.

It is often (correctly) pointed out that offshoring potentially provides access to good, middle-class jobs that would not otherwise be available in India and other developing countries. Expanding the middle class in developing nations is an important goal, and the U.S. reaps great benefits in the long run from prosperity abroad. But the challenge to the U.S. economy is to make sure that the benefits from offshoring also accrue to U.S. workers. While offshoring has had a significant effect on only select segments of the U.S. labor market so far, over the long run an increase in the global supply of highly educated workers could depress the living standards of American workers who historically have been insulated from the economic pressures of globalization.

Of course, this does not mean that U.S. wages cannot rise in the face of offshoring. In a dynamic economy, there are many influences on U.S. wages: productivity growth in the United States; changes in the terms of trade between the United States and the rest of the world; and, (importantly but often overlooked) changes in the way national income is distributed between labor compensation and corporate profits. If the U.S. economy can regain the tight labor market that characterized the late 1990s, wages will almost certainly rise briskly again. In the absence of a tight labor market, current trends in offshoring and the continued integration of economies with large labor pools into the global economy will likely depress American wage growth.

Doesn't the United States run a trade surplus in services?
Many defenders of white-collar offshoring have pointed to the fact that the United States runs a trade surplus in services, that is, it exports more services than it imports. In 2004, the United States ran a $53 billion trade surplus in services, well beneath the peak of $90 billion in 1999.

However, much of this service trade surplus is in items related to tourism and transport (for example, air fares), and is not the "competitive" service trade that most people have in mind when they talk about America's comparative advantage (for example, architects or software engineers). This more competitive service trade is best captured in the statistics on "business, professional, and technical services".

A quick look at these numbers shows that the United States runs relatively modest surpluses in these industries that are most relevant to the debate over offshoring (see Figure 5). The professional, technical, and business services category (which includes accounting, computer programming, and research and development) ran a measured surplus of $18 billion in 2004. This surplus is below the 1999 peak of $19.2 billion, and it is stagnant at best when measured as a share of GDP.

We believe that the official numbers on trade in services from the Commerce Department's Bureau of Economic Analysis (BEA) are almost certainly missing substantial amounts of service imports. Because of this, their data almost surely understate the degree to which offshoring and imports of white-collar work are affecting the U.S. economy. One anecdotal piece of evidence supporting this supposition is the large gap between what the BEA claims the level and trends of U.S. imports in computers services categories from India are and what the Indian software industry association, the National Association of Software and Services Companies (NASSCOM), reports on these data. The BEA levels are smaller by orders of magnitude (reporting imports of $159 million in 2002, compared to NASSCOM's report of $4.7 billion), and actually show an increase of only $26 million (or less than 20%) between 2000 and 2002 in the amount of software and computer service imports from India between 2000 to 2002. The NASSCOM data show an increase of over $3.7 billion, or, over 400%, relative to the 2000 levels.

While we're not arguing that the NASSCOM numbers are correct, they are much more in line with the anecdotal and qualitative evidence on offshoring from India that has appeared in the business press. In short, there seems ample reason to believe that service imports are being undercounted.

Won't offshoring fade as an issue once the economy recovers?
While offshoring's contribution to current cyclical employment troubles has been modest to date, its impact on the U.S. economy will become more pronounced over time. Historically, the U.S. labor market has provided ample opportunities for highly educated workers to find gainful employment. Note, for example, that over the past 30 years, the share of college graduates in the U.S. workforce has doubled, yet their unemployment rates remain far below the national average.

In fact, policy makers have argued that high levels of education provide U.S. workers with some insulation against the dislocations and income pressures caused by globalization. Thus, in the debate about the impact of trade in manufacturing goods, more education and training has always been put forth as the policy solution for those domestic, non-college-educated workers in competition with similar workers from countries with far lower earnings than in the United States.

The United States' comparative advantage, it was argued, was in its relatively large number of educated workers. However, some less-developed countries have been sharply increasing their own supply of educated workers, meaning that offshoring has the potential to vastly increase the global supply of educated labor, eroding the comparative advantage of the United States in this area.

However, the NASSCOM report cited earlier provides evidence that the supply of such workers in India is rapidly increasing. India is adding about 2.5 million college graduates to its workforce each year. For a sense of comparison, the United States adds about 1.2 million per year. While the U.S. number is still larger when measured as a share of the national workforce, the implication of offshoring and global integration is that it is the global, not national, labor market that may largely influence wage rates in years to come. ¹ Of these Indian graduates, 250,000 earned engineering degrees and the 2003 entering class for Indian engineers is reported to be 375,000, a large jump that suggests the Indian population is responding to expectations of the global market's forthcoming demand in this field.

This supply shock has the potential to significantly depress the earnings of educated workers here, who enjoy a very substantial wage advantage over workers with similar education in less-developed economies. Anecdotal reports reveal that the pay gap between educated workers here and those in offshoring target countries could be as high as 10 to 1. The BLS reports that a programmer in Silicon Valley—an area particularly vulnerable to offshoring of tech jobs—earns about $78,000 annually, including benefits; the comparable job in India pays around $8,000. ² Other comparisons reveal similar differentials. ³

What is driving white-collar offshoring?
The information technology (IT) revolution has made location much less important for work that involves inputs and outputs that can be transmitted digitally. The full impact of the offshoring phenomenon will be felt in the years to come, as a significant proportion of the jobs in America today could be done outside the country, and those jobs can be done much more cheaply abroad. In little more than a decade, governments of nations constituting more than half the world's population (China, India, Eastern Europe) have decided to join the world market system. Those countries have large and rapidly growing pools of talented and educated people with much lower incomes than people with similar skills in the United States.

Most discussions of white-collar offshoring fail to properly identify just how much the IT revolution has opened up opportunities to import white-collar work. Perhaps only a minority of U.S. jobs today must be done on site, and many of those are blue-collar jobs: construction, care of children and the sick, mail and package delivery, security, hotel and restaurant attendants, etc. A large share of white-collar work now done in the United States could potentially be done offshore. With today's technologies, it's now possible to put online—and therefore potentially offshore—many jobs in industries such as financial services, retail and wholesale, business and professional services, even government and higher education, not to mention the white-collar portions of manufacturing, construction, and health care.

Substantial legal, technological, and economic barriers have impeded importation of white-collar work in the past. As a result, U.S. employers have not been able to tap the large pools of talented, educated, underemployed, and low-cost white-collar workers abroad. Until recently, importation of white-collar work has often been impeded by the cost of establishing sufficient bandwidth, compatible software connections or video hookups, and a secure relationship. With the costs of overcoming those three barriers falling rapidly, many employers will be attracted by the opportunity to replace American employees with much lower-cost foreign employees.

How much will the U.S. economy gain from white-collar offshoring?
Recent anxieties over the economic impacts of white-collar offshoring have spurred a counter-offensive from economists and policy makers arguing that more of this trade is better for the United States. ⁴

Two recent studies—one by the Institute of International Economics (IIE) and one by the McKinsey Global Institute (MGI)—have tried to quantify the benefits to the United States from white-collar offshoring. Both have received much media attention for their assertion that such trade entails enormous benefits for the U.S. economy. The studies' claims are, in the end, not very convincing as to the magnitude of the gains from trade, as they both exaggerate the benefits and ignore large potential costs from offshoring. For a detailed look at some of the most widely-quoted of these studies, see Bivens (2005).

Who benefits from offshoring?
Economists who advocate expanded trade are voluble in pointing out the benefits of trade, but they are taciturn about the distribution of these gains. Occasionally, even trade advocates will come clean on the skewed distribution of the benefits of trade, pointing out that trade leads to both winners (those who end up with more income) and losers (those who end up with less). The second edition of the textbook International Economics: Theory and Policy, by Paul Krugman and Maurice Obtsfeld, sums it up best: "Thus trade has a powerful effect on income distribution...owners of a country's abundant factor gain from trade, but owners of a country's scarce factor lose" (p. 78).

What is usually left completely out of discussions about trade is the size of the winning and losing groups. Because proponents of expanded trade predict that the benefits of trade are greater than the losses, they tacitly suggest trade helps more people than it hurts in the U.S. Such is not the case. As the Krugman and Obtsfeld textbook quote above states—that trade harms "owners of a country's scarce factor of production"—expanding global trade has hurt, in practice, those U.S. workers without a four-year college degree. In other words, trade expansion has hurt 70% of the American workforce ⁵ over the last three decades.

On the other hand, college-educated workers, especially those working in occupations insulated from trade, saw gains due to trade in the 1980s and 1990s. These workers, however, may now see shrinking gains from trade, or even outright losses, as white-collar offshoring starts to pressure their part of the labor market.

The consistently big winners from trade (especially offshoring) are capital-owners—those who derive a significant portion of their income from profits. Profit rates rose in the 1990s relative to previous decades, and they recovered well before wage income did in the latest recovery. In fact, the current recovery is the most profit-biased on record in terms of income growth that is accruing to corporate profits as opposed to labor income.

It has been suggested that white-collar offshoring has the potential to shrink the gap between white-collar and blue-collar wages. This gap has grown enormously since around 1980; shrinking it is a worthy goal. The optimal way to reduce inequality would be to increase blue-collar wages, not to suppress white-collar ones. Unless white-collar offshoring has the potential to reduce the prices of goods consumed in large part by blue-collar labor, however, it seems unlikely that it will lead to real wage gains for blue-collar workers.

Businesses are offshoring U.S. work to obtain lower costs. Unless those businesses compete away their gains from cheaper imports and pass them along to blue-collar workers and consumers, white-collar offshoring will not lead to a net increase in the real wages of blue-collar workers (relative to what would have prevailed absent this offshoring).

Isn't offshoring compensated for by "inshoring"?
Recently, a number of economic observers have suggested that "inshoring" has created as many jobs as offshoring has displaced. Inshoring apparently refers to the phenomenon by which foreign companies increase their investments and employment in the United States. The evidence used to assert the benefits of inshoring, however, has so far proven to be weak. The vast majority of employment associated with new investments by foreign companies has taken the form of acquisitions of ongoing U.S. companies (such as Daimler's takeover of Chrysler), not the creation of new jobs. For more on the scale of "insourced" jobs, see the EPI Economic Snapshot, "Insourcing" is not creating jobs in the U.S. economy.

How is offshoring distinguished from outsourcing?
Outsourcing is a term that refers to the practice of one company hiring another to perform tasks that used to be done in-house. Say that a company that produces automobiles has a cafeteria in one of its plants. If the automaker decides to replace its own payroll employees who run the cafeteria with a catering firm, then it has outsourced the running of the cafeteria. Or, if the automaker used to make its own tires, but now buys them from another company that specializes in tire production, it has outsourced the tire-producing portion of their business. The term outsourcing, however, does not necessarily indicate nationality—functions can be outsourced to either domestic or foreign workers.

As international trade grows in importance to the U.S. economy, more and more outsourcing is provided by foreign workers. To take an earlier example, the U.S. automaker may decide to replace its own tire-production line with tires imported from abroad. This is sometimes referred to as international outsourcing.

As used in this issue guide, offshoring refers to substituting foreign workers for U.S. labor. When a company finds replacements for current U.S. employees outside the country, it may hire its own employees abroad (offshoring) or it may outsource the work to another company operating abroad.

Take the familiar example of a U.S. company that decides to replace U.S.-based computer programmers with programmers in India. If this programming work is performed for sale in the U.S. market, it is classified as a service import. The firm is substituting a service import for U.S. employees.

International trade in goods is easy to conceptualize. Tangible goods are produced in one nation, shipped over international borders, and sold in others. Service trade is a bit harder to imagine. Services in general have been defined as something you pay for but cannot drop on your foot.

But the general principle of service trade is the same as goods trade: work performed in one nation and sold to residents of another. In the example above, the computer programming performed in India should be classified as a service import (to the United States) and a service export (from India). Work performed in one nation to serve customers in another is classified as an import by the nation receiving the service, regardless of whether it passes physically through a seaport or virtually through fiber optic cables.

There is, however, one aspect of offshoring (substituting foreign for U.S. workers) that could occur without a corresponding increase in service imports to the United States. This is when foreign labor is substituted for U.S. exports abroad.

Say, for example, that a U.S. financial services firm does the accounting work for a German firm. This service should show up as a service export from the United States to Germany. Then, the U.S. firm decides to open up a subsidiary in Germany and begins doing the accounting work from this German-based subsidiary. Its workers in the United States are laid off, and accountants in Germany are hired. There is no increase in service imports into the United States; this offshoring shows up as a decline in U.S. service exports.

For the past couple of decades, the manufacturing sector has been most affected by international outsourcing and offshoring. This is because most trade occurs in manufactured goods (about 85% of imports and 70% of exports are manufactured goods). Furthermore, the impact of manufactured goods trade on labor markets has been magnified by the huge deficit in this kind of trade: the United States imports almost $500 billion more than it exports in manufacturing.

Notes:

1. See The IT Industry in India report by the National Association of Software and Service Companies (NASSCOM), 2004.

2. These figures were report in the San Francisco Chronicle, March 7, pg. A1: "Offshoring's Giant Target: The Bay Area."

3. See the statement by the AFL-CIO executive council regarding offshoring, provided in the "Offshoring resources on the Web" section of this Issue Guide.

4. For these references, see the "Further resources on outsourcing" section at the end of this Issue Guide.

5. This group is scarce in the United States by global, not national standards, meaning that the proportion of unskilled workers in the United States is much lower than their proportion in the global economy.

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