Term Paper: Outsourcing &amp International Trade Economics

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Outsourcing & International Trade

ECONOMICS: INTERNATIONAL TRADE & the EFFECT of OUTSOURCING

In the past few years the United States economy has emerged as a growing economy, dramatically and irreversibly impacting the global market. One of the most significant impacts of this growing economy lies in the area of outsourcing to foreign countries. The United States government and large corporations view outsourcing as a method of enabling International Trade to prosper and allowing industries to grow. This economy has an international impact in regard to the recent trend in outsourcing and off-shoring; many domestic headquartered companies are now turning to outsourcing manufacturing and production to drive down costs.

As a result, these manufacturing positions are lost in the United States, but are creating more jobs in India, China and the Philippines. Although a majority of the literature regarding outsourcing is critical, concluding that it results in domestic job loss, there is a high amount of evidence to the contrary. According to the Business Council of New York State (2004), foreign outsourcing creates more jobs and higher real wages for American workers, and assists domestic companies in becoming more productive and competitive. This paper will discuss international trade, outsourcing, and the effects of outsourcing on domestic jobs. It will address the evidence proving that outsourcing actually helps to create domestic jobs, and will provide case study analysis regarding outsourcing in India.

A review of the literature regarding outsourcing indicates that it emerged in the early 2000s, but was not publicized until the mid-2000's by the media reports. The media has been criticized as being responsible for the majority of the negativity associated with outsourcing as a result of their publications and broadcasts highlighting job losses attributable to outsourcing. This is because outsourcing first emerged as a trend in the manufacturing sector, where formerly high-paying jobs moved offshore to countries where vast amounts of labor were available at much lower costs. Outsourcing has been described as holding down the prices consumers pay for goods. According to Manci (2005), price drives demand as opposed to quality or brand recognition -- the group of producers or region capable of producing a product for the least cost will dominate the marketplace. This is a benefit since companies will always have to compete with each other, the company selling the same goods at the cheaper price will sell more. As a result, other companies will also have to sell their competing goods at similar low prices. When this occurs, the customer saves money because companies competing with each other will have to maintain low prices for their goods.

Reasons for Outsourcing

Outsourcing is commonly defined as the practice of subcontracting manufacturing work to outside and especially foreign or nonunion companies. Belenkiy (2004) discusses the origins of outsourcing as beginning with the troubled manufacturing sector. He states that manufacturing has seen a decline in workforce as more and more labor intensive intermediate goods of production are being imported from countries that can produce those goods more cheaply. According to Belenkiy (2004), outsourcing activity is a kind of vertical foreign direct investment for the U.S. firm that splits the manufacturing of the final good across different countries. The use of foreign suppliers allows for a reduction in the complexity and in the average cost of producing a final good, without sacrificing proximity to the initial market and overall productivity (Belenkiy, 2004). He discusses that manufacturing jobs in the U.S. declined on their own at first, and were not a direct result of outsourcing. Belenkiy (2004) illustrates this point with statistics from Michigan. Michigan formerly was the nation's capital of manufacturing; however, between 1970 and 2003 manufacturing employment declined from a 33% share to a 16% share of the job market. In the Michigan area, from 1994 to 2003, approximately 7000 manufacturing jobs disappeared. However, only 21% of those job losses were tied to international trade (Belenkiy, 2004).

As a result of this decline in the manufacturing sector, outsourcing brought some mixed trends in employment patterns in manufacturing industries. For example, advances in technology increased production costs and in order to remain competitive, manufacturers had to emphasize education and training. International trade forces firms to seek to increase the skill levels of their employees, hence increasing productivity over time (Belenkiy, 2004). Domestic manufacturing investment grew in the 1990s and the U.S. was the largest recipient of foreign investment. From 2002 to 2004, manufacturing investment by U.S. manufactures in China and Mexico was only 3% of $140 billion in investment by U.S. manufactures. While many opponents of outsourcing argue that it destroys domestic jobs and decreases wages through manufacturers' access to cheaper goods overall, Belenkiy's (2004) research finds that outsourcing actually increases domestic wages. Belenkiy (2004) states that opponents of outsourcing misjudge the real cause of the decline in jobs and the decrease in wages in the manufacturing sector. According to Belenkiy (2004), there is evidence to suggest that this decline is mostly attributable to an increase in the productivity of workers and to the widespread replacement of workers by highly productive machinery. Finally, he states that while it is true that manufacturing jobs are being lost, the loss is not primarily due to outsourcing activity.

Actual Rate of Job Loss Attributable to Outsourcing

Other research indicates that job loses due to outsourcing are actually very small in comparison to the usual rate of job loss. According to research conducted by Baily & Farrell (2004), losses of 30,000 jobs per month are very small compared to the two million or more job changes that occur routinely in a single month in the United States. In another study of related research, the Bureau of Labor Statistics (BLS) examined their unemployment insurance applications to identify firms that had layoffs involving more than 50 workers out of work for more than 30 days. The firms were then asked whether the layoff involved moving workers to a different geographical location within the company, whether the layoff involved moving work that was previously performed in-house to a different company, and the destination for any relocation (the state if domestic or the country if overseas). For the out-of-country relocations, the BLS research concluded that layoffs within a company or to a different company actually accounted for only 1.6% of job separations in mass layoffs over the first six quarters. Even more interesting, the BLS research concluded that outsourcing jobs only accounted for 3.3% of separations in mass layoffs. Thus, it appears that when compared to the normal rate of job loss, outsourcing does not account for more than 5% of the total numbers of domestic job loss. In other words, the majority of the research concludes that the vast majority of job losses do not involve the foreign relocation of work at all.

Positive Domestic Effects of Outsourcing review of the literature indicates that there are several positive effects of outsourcing, including the creation of additional domestic jobs. New York State can expect more than 18,000 new jobs by 2008 as a result of information- technology job growth outside the United States, according to a new study commissioned by the Information Technology Association of America (ITAA) (the Business Council of New York State, 2004). In addition, it is estimated that 18,239 new it jobs will be created over the next four years as a result of it outsourcing. The Business Council of New York State (2004), reports that the U.S. can expect 317,000 new net jobs by 2008, it found. The study also found that only 2.8% of U.S. It jobs losses over the past four years could be attributed to overseas outsourcing (the Business Council of New York State, 2004). Even though foreign outsourcing does cause some to lose their jobs, new economic activity spurred by offshore outsourcing created nearly 100,000 jobs nationwide in 2005. Further studies conclude that outsourcing will also boost the average real wage of U.S. workers by making businesses more productive. Since companies are able to provide outsourced labor at lower prices, more goods are sold at cheaper process, and the company grows, allowing it to pay its domestic workers higher salaries.

McKinsey (2003) concludes that outsourcing creates additional net value for the U.S. economy that did not exist before. For example, when $1 of labor cost is outsourced from the U.S., the total value created globally is $1.45 to $1.47; out of this, the receiving country such as India, captures just 33 cents (McKinsey, 2003). Thus, the remaining $1.12 to $1.14 is captured by the U.S. In terms of new revenues (the receiving country buys goods and services from the U.S.), repatriated earnings, and redeployed labor (Flatworld Solutions, Pvt. Ltd., 2007). In analyzing the McKinsey research, Flatworld Solutions Pvt. Ltd. (2007) states that outsourcing delivers tangible and significant benefits in the following ways: 1) reduced capital costs, 2) increased efficiency, 3) reduced labor costs, 4) quicker project starts, 5) focus on your core business, 6) level playing field, and 7) reduced risk. The benefits of offshore it outsourcing added $33.6… [END OF PREVIEW]

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