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...components. Policymakers should respond the phenomenon by enhancing both Canadian competitiveness and workers' ability to adjust.
U.S. job losses in recent years have fueled anxiety in that country about global outsourcing--the practice of acquiring component parts or service functions from abroad. During the election campaign, Democratic presidential nominee John Kerry criticized" Benedict Arnold CEOs who send American jobs overseas", and his running mate John Edwards vigorously blamed global outsourcing for job losses. Lou Dobbs, who hosts a CNN show, "Exporting America", maintains a constant harangue against U.S. companies that send jobs to India and China. At the same time, at least 13 federal and over 100 state proposals aim to restrict the scope for global outsourcing.
Cheaper long distance costs and the ability to digitize production enable call center services, medical diagnostics, and software development to now be provided from anywhere in the world. As a result, some commentators express growing concern that global outsourcing will lead to large numbers of permanent job losses for skilled, well-paid service workers.
In Canada, critics are far less vocal, though some observers argue that there is genuine reason for concern. In 2004, the National Post published a series of columns called "Exporting Jobs", while a headline on a column in the Toronto Star read: "Outsourcing: Our Next Challenge". (1) Meanwhile PricewaterhouseCoopers warned in a study that Canada could lose 75,000 information technology service jobs to global outsourcing by 2010.
This Commentary attempts to put what is largely an anecdotal discussion in perspective by examining the limited available evidence on Canada and global outsourcing. The paper is a beginning, rather than an exhaustive study of all data, trends and issues, and focuses on services instead of manufactures, to respond to the recent debate.
The paper contends that Canada should not share concerns expressed by some in the U.S. about global outsourcing. Currently, Canada appears to be a prime destination for companies that outsource some of their service functions globally. Canada's employment record over the past few years does not suggest cause for concern, and global services outsourcing activity is likely much more limited than public commentaries suggest. Indeed, most services still have to be provided locally. If the trend accelerates and Canadian companies increasingly send business segments to be produced by their foreign affiliates or other firms abroad, gains are likely to flow across the economy in terms of lower component prices for companies, lower final prices for consumers, and higher living standards, both in Canada and in developing countries.
Acquiring a service function from abroad is no different in principle from trade that takes place across the street. The results--short-term dislocation for some and overall long-term net benefits--are likely to be the same. Nor are the characteristics and consequences of trading a service function to another country different than trading manufactured components, say auto parts, internationally. In both cases, multinationals and other companies have reorganized production along global supply chains, so that each element is produced where it can be done most efficiently. Just as large reductions in transport costs and tariff barriers in recent decades have created situations where manufactured parts are often more efficiently traded across national borders, declines in telecommunications costs and the ability to digitize service functions now enable companies to outsource call centre and IT services across borders.
There is much we do not yet know about current and future global services outsourcing developments. Though the data have limitations, some priorities are clear. Rather than restrict global outsourcing, the public and private sectors should invest in education and skills development, enhancing workers' ability to adjust and Canada's capacity to compete for service functions. To further attract outsourced activity, policymakers should take measures to improve domestic competitiveness and further liberalize trade in services. And Canada must attempt to forestall U.S. measures that restrict outsourcing abroad.
The Facts About Outsourcing
There is no commonly agreed definition of the terms outsourcing and offshoring. They tend to be used interchangeably and often mean different things to different people. (2) For simplicity and to address the trend of public and political concern, in this paper I use the term global outsourcing to refer to acquiring globally business functions and component parts that go into the production of final goods and services. In-sourcing refers to the provision of those components.
Rather than being a radical new development as recent attention suggests, global services outsourcing is a form of trade (3). The traditional conception of trade consists of cross-border exchanges of final products. But trade also takes place within countries, and increasingly in intermediate products, as well as final goods. Companies have been fragmenting production within national borders for many years, locating component production wherever it can be performed most efficiently--whether across the street or across the country.
With further advances in IT, reductions in trade barriers, and declines in transportation costs, companies developed global supply chains and began to acquire intermediate components internationally--either within the same firm through an affiliate, or from an independent company--from wherever they could be produced most efficiently. Feenstra (1998) discusses the rapid growth in global outsourcing and trade in intermediate components for manufactures in recent decades.
The global fragmentation--or the globalization--of service production is the next phase in this evolution. Declining transportation costs expanded the range of component parts that it made sense to trade across national borders. Similarly, declines in global telecommunications costs and technological advances that make digitization possible enable many business segments that could formerly only be produced locally or traded through the movement of individuals to be produced anywhere.
Though most service functions--such as restaurants, hotels and retail--must still be produced where they are consumed, in future, national borders will be much less important in determining where to locate service functions. Software development, telemarketing, data entry, and medical transcription, for example, may now be handled globally as part of the provision of a company's larger goods or services packages. As technology improves, companies will be able to import smaller and smaller business segments from wherever in the world they can be produced most efficiently.
Some economists define outsourcing as buying a business segment or component from an independent subcontractor (see, for example, Antras and Helpman 2004). Concerned workers, however, do not distinguish between components that are purchased at arm's length from the company and those that are traded between a parent company and its foreign affiliate. Since the economic results from intra-company trade are likely to be the same as those from arm's length transactions, global services outsourcing in this paper refers to trading business segments both within multinationals across borders and between companies--multinationals and others--and independent subcontractors abroad.
It is important also to note that, though a U.S. company could set up an affiliate abroad through foreign direct investment (FDI) and that affiliate's activity could include in-sourcing back to its parent, global outsourcing of service functions, though related, is distinct from FDI.
The Economic Consequences of Outsourcing
Importing goods and services and their component parts from where they can be produced most efficiently is likely to improve overall economic welfare. Multinationals and other companies orient along global supply chains where they break down production into smaller pieces, producing each individual segment wherever it is most cost-efficient.
Because all countries have a comparative advantage--even if not all have absolute advantages--in the production of some goods and services, according to theory a trading country will specialize in those industries that, at world prices, it is relatively better at producing. Specialization results in more final output with lower-cost components. This increases productivity, reduces prices, and raises living standards. These gains from trade apply to trade in final products and components, trade within companies and at arm's length, as well as to exchanges within a country and between countries. As well, when companies outsource globally, they can shift their domestic operations towards more productive and higher-value activities.
The economic upshot of global service outsourcing is very similar to that from global trade in component parts--such as car or airplane parts--used to manufacture final goods. Both result in short-term economic dislocation for some and long-term net economic benefits across the economy. The results of global service outsourcing are also similar to those of other structural changes that dynamic economies have experienced over recent decades, such as advances in technology. Both are driven by competitive pressures to reduce costs (Brainard and Litan 2004) and both increase productivity, real income and growth.
Work by Catherine Mann (2003) shows that global outsourcing can increase gross domestic product (GDP). By her calculations, outsourcing information technology production...
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More articles from C.D. Howe Institute Commentary
Recent C.D. Howe Institute Publications.(Bibliography), November 01, 2004
How Canada Wins from Global Services Outsourcing: C.D. Howe Institute ..., November 01, 2004
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