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High-tech outsourcing: a benefit-cost framework.

Article Excerpt
I. Introduction and Overview

Some might call it delicious irony; others might say that the chickens have come home to roost; still others say the whole issue is chicken-little. Whatever the characterization, outsourcing or offshoring of domestic US high-technology jobs has become a hotly debated topic. Estimates for this kind of outsourcing are provided mainly by private studies. These have been widely quoted by sources ranging from The New York Times (Porter, 2004), Foreign Affairs (Drezner, 2004), Economist (2004) and The United Nations Conference on Trade and Development (UNCTAD 2003).

A study by McKinsey Global Institute estimates that multinational firms outsourced about $35 billion dollars worth of work in 2002 and that overseas jobs created by this kind of outsourcing would grow 30 to 40% each year through 2008. The Gartner Group says outsourcing is growing 23% per year since 1999 and will reach $300 billion dollars by 2004 while Goldman Sachs places the number at $585 billion by 2005. In India it is predicted that up to 1.1 million people will be employed in information technology-type services by 2008 and, in total, outsourcing could generate some 3.3 million jobs by 2015 with 2.3 million of them in India alone (UNCTAD 2003). The UNCTAD Report groups a series of services under the banner "business process outsourcing" (BPO) and points out that developing countries can take advantage of this outsourcing trend if they provide the necessary information and communications technology infrastructure.

Outsourcing is defined as a firm subcontracting some business function to an outside supplier. Functions outsourced range from simple telemarketing or document processing to the entire management of a particular firm's functional area such as a data center or software testing (Drezner, 2004 and UNCTAD 2003).

Testifying before the House Committee on Small Business, Ronil Hira pointed out that outsourcing can have a negative impact on the United States leadership in technical innovation: technological improvements will be made in other countries since a good deal of technology will be located outside the US (Hira, 2003). The opportunity for innovation in software, data communications and data security will be reduced, the number of young people wanting to pursue careers in science and engineering will shrink because of the downward pressure on job opportunities, wages and working conditions and personal, economic and national security will be at increased risk since more critical data might transferred to other countries. The long-term costs identified by Hira include loss of income and employment of American professionals, loss of payroll and income tax at the national, state and local level, loss of employer contributions to government unemployment insurance and workmen's compensation programs, loss of national, economic and technological competitiveness, further imbalances in international trade. While Hira admitted in this testimony that "reliable statistical information about the current magnitude of global sourcing and its effects on national and international labor markets is sorely lacking" he emphasized the need to take action to counter the outsourcing trend.

Does outsourcing help or hurt the US economy in the short and long-runs? Are domestic (US) workers irreparably harmed through permanent job loss and/or depressed wages or does a competitive equilibration process ensure an optimal economic outcome? Is outsourcing "efficient" or merely a redistribution of resources from one economic sector to another?

This paper will look at this issue from three different perspectives. First, the viewpoint of traditional economic theory will be reviewed. This viewpoint generally abstracts away from institutions and towards generalized incentives which affect behavior. Second, the viewpoint of management theory will be discussed. This stance focuses more intently on institutional issues which economic theory does not. Third, these two perspectives will be brought together within another framework from economic theory, namely that of benefit-cost analysis. The main thrust of the argument is that an evaluation of outsourcing is fundamentally about determining the efficiency question (does the practice really increase the overall size of economic output?) and the equity question (which sectors, i.e. labor and capital, lose and which win, and which countries lose and which countries win?) The paper will conclude with a discussion of next steps with a note that current data on the subject is sparse, even though assertions of fact are plentiful.

II. Outsourcing: An economic theory perspective

What is outsourcing or offshoring in an international context? One definition is the "international fragmentation of the value added chain"(Egger, and Eggery, 2002). Extending this thought, one could say that international outsourcing (this is the term that this paper will use exclusively from this point) is the movement of either entire stages of production, or specific inputs into those stages of production, to multiple geographic locations which cross international boundaries.

This paper is focused...

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