The Truth About Outsourcing

There is a growing backlash against outsourcing — sending domestic work to foreign businesses — that erupted in the Senate last week, where anti-outsourcing legislation was adopted on a 70 to 26 vote. Opponents of outsourcing cheered, but investors are becoming aware that these actions threaten profits and stock prices.

There is very little real evidence that outsourcing has caused significant job losses in the United States. All of the data showing job losses in the millions come from consulting firms like McKinsey & Company, Forrester Research and others, which make money by helping companies do outsourcing. It is in their interest to make potential clients think that all their competitors are doing it, so they must, too.

Of course, no one denies that some jobs have been outsourced. But companies often find that the gains don’t match those sold them by the consultants. There are many costs involved with outsourcing that can eat up much of the savings from hiring Indians at one-fifth of what it takes to hire Americans for the same job.

This phenomenon is detailed in a March 3 Wall Street Journal report on ValiCert, a software company based in California that outsourced many operations to India. It quickly found that it required massive and costly effort just to communicate with its Indian workers, due to time differences and the contrasting styles, methods and experiences of American and Indian software programmers. Moreover, the Indians just weren’t as productive. It often took them a week to do projects that formerly could have been completed in two days here.

The story makes clear that ValiCert only ventured into outsourcing because it had no choice. The company was on the brink of bankruptcy. All of its jobs would have been lost if it hadn’t been able to cut development costs. Although some American jobs were lost in the process, the company was able to remain in business, eventually leading to rising employment in the United States in higher-level positions.

Unfortunately, in such cases, people tend to see only the jobs that were lost initially from outsourcing and ignore the jobs that were saved or later gained because of it. General Electric makes this point in its latest proxy statement, in response to criticism from a union pension fund shareholder. Its overseas expansion “has helped keep GE competitive and growing and, in many cases, helped to create and preserve jobs in the United States,” the company argues.

To the extent that GE has outsourced, it is mainly for low-level operations. “Our outsourcing has largely consisted of obtaining commodity products and services from low-cost countries in order to remain competitive,” it states.

The GE statement goes on to note that despite outsourcing, its U.S.-based employment has remained stable. The cost savings have helped finance additional domestic investments in “high-tech, high-value jobs in areas such as healthcare, digital entertainment, energy and water technologies, renewable resources and research and development.”

Another company, Genworth Financial, has warned its shareholders that restrictions on outsourcing could threaten profits. In a January filing with the Securities and Exchange Commission, it said, “The political climate in the United States also could change so that it would not be practical for us to use international operations centers, such as call centers. This could adversely affect our ability to maintain or create low-cost operations outside the U.S.”

This warning proved prescient. On March 4, the Senate adopted a measure that would bar federal contracts to companies that outsource any job previously done by an American. Additionally, it would prevent state and local governments from using federal funds for outsourcing.

While it is unlikely that this amendment will become law and is probably unenforceable even if it does, it sends a bad signal to the rest of the world. U.S. Trade Representative Bob Zoellick has warned that it will endanger relations with India and undermine world trade talks. It would also invite retaliation from other countries and reduce foreign investment in the United States.

But even if the legislation is defeated this time around, undoubtedly it will be back in some other form shortly. Democrats have decided that pandering to the unemployed by railing against outsourcing is their ticket to success on Election Day. Although their proposals wouldn’t do much good — The Washington Post calls them “1 percent solutions” — they get people worked up and put the Bush administration on the defensive.

The administration essentially brought this on itself by backing away from Council of Economic Advisers Chairman Greg Mankiw after he was attacked for defending outsourcing a few weeks ago. Its enemies immediately saw weakness and pounced on its “evident confusion,” as the Financial Times put it. It would have been better for the administration to stand behind Mankiw and make the case for free trade, as Bill Clinton was successfully able to do.