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Limits to outsourcing?

April 21, 2004

Recently a bill was introduced in the Washington state legislature that seeks call centres to identify themselves. Agents who make or receive a call would need to identify their company and geographical location.

It is hoped that, if passed, the bill would apply to all companies registered to do business in Washington state.

While ostensibly the bill seeks to make call centres more responsive to customers, it is being seen as another attack on the off-shoring process. Indians fear that it would hit telemarketing and credit card operations based in call centres in India.

Anti-offshoring sentiment in the United States has created fears among many Indians. How valid are these fears? Will such legislation and other obstructions to outsourcing emerging in the US, have a significant impact on export of services from India?

Let us look back in history. Many decades ago, technological improvements dramatically reduced the cost of cargo transported by ship and air.

Suddenly, the work that had traditionally been done in the US could be done cheaper in Asia. The result was a phenomenal growth in intra-firm trade.

Companies started relocating manufacturing to where it was cheaper. Countries such as Mexico, Hong Kong, Singapore, Taiwan and South Korea became manufacturing and assembling hubs.

Not surprisingly, there were protests in the US when this was happening. Relocation of jobs is clearly unkind to those who lose their jobs. While workers in East Asia were gaining, the American labour force stood to lose.

However, those who thought that consumers would prefer the 'Made in the US' label were disappointed as cheaper products from Korea saw a very sharp growth in sales. Shoes made by Reebok in the Philippines continued to sell. Wal-Mart succeeded by outsourcing to China.

The shift of manufacturing to cheaper countries could not be stopped by protests. The growth of companies that used these venues could not be contained by legislation. The logic of competition was infallible. Companies that cut costs, succeeded.

A similar drama is being enacted afresh today. This time through a different technological impetus. The driver here is the progress in telecom. High bandwidth is now available virtually across the globe at extremely low prices. It is now possible to think of "global production chains" for services as well.

As a consequence, production of services is also being sliced up into pieces, and each piece is placed at the best production venue available globally.

Companies such as General Electric, which have taken advantage of the incredible progress in telecommunications to relocate jobs have benefited by being able to cut costs and prices.

Consumers in Western countries have benefited from cheaper goods. Today they are benefiting from cheaper services. Cheaper healthcare makes it more affordable.

A company that outsources tests and diagnosis to India will be able to offer better services for the same costs. Time lags will come down. Companies that are unable to cut costs, will, at the end of the day, lose out.

Even if this does not happen immediately, sooner or later, a company whose products are more expensive or quality is poorer, gets priced out.

A company that can do more R&D because its labs are located in India where R&D costs less than half as much as that in the US will, in the long run, be more innovative. Its CEOs will be able to place bigger bets. Innovations in products, designs, processes will benefit not only American consumers but the whole world.

Knowledge spillovers have enormous benefits. There is no doubt that, as in manufacturing, the infallible logic of competition will push companies to outsource.

Even if politicians are able to put obstructions to outsourcing for some time, it is unlikely that they will be able to do so in the long run.

This is because of the demographic changes taking place across the globe. Lower fertility rates in countries of Europe and Japan will result in a very high dependency ratio. The ratio of the old non-working population to the young working population will be very high.

It will be difficult for the workers of those countries to produce enough goods and services needed by the old. At the same time, with growth in incomes, the demand for goods and services will be even higher.

The problem will be two-fold. On the one hand, incomes will be higher. On the other, the number of workers available to produce goods and services will be lower. At higher levels on income the demand for products will be greater for which supply will be inadequate. Some of the gap will, undoubtedly be met by productivity increase.

However, it is reckoned that demand will significantly outstrip supply. So, for example, there will not be enough European nurses and doctors to care for the retired population in Europe. How will the greater demand for health care be met?

Among the options faced by these countries will be to have a policy of much higher immigration of the young working force from poor countries and/or to have much greater trade.

To the extent that goods can be traded, trade is far more politically and socially acceptable to most nations than immigration. Its impact on ethnically homogenous communities is negligible, while immigration poses bigger problems. Trade will be the easier solution.

Further, the moves by politicians to reduce outsourcing are, in general, limited. While there are attempts to prevent government departments from outsourcing jobs to India, there are no significant moves that would prevent companies from splitting up global production chains.

This is not surprising. It is Fortune 500 companies that are the biggest beneficiaries from the process. Smaller companies have less opportunities to outsource. It is the large ones who are in the best position to break up their global operations further.

Given their importance in America's polity and economy, it is not likely that it would be easy to take measures that directly harm them.

In the short run, there may be ups and downs in the outsourcing to India, but in the long run there are huge gains to be made from service exports. Indeed, potential gains for India can be greater than the gains China is making by becoming a manufacturing centre.

The reason for this is that GDP and employment in services in developed countries is far greater than in manufacturing. Further, the income elasticity of services is higher. So, over the years as incomes in rich countries grow, the demand for services from India will grow at an even faster rate.

Instead of worrying about protectionist noises in the US, India needs to focus on becoming a good source of well educated workers, providing good infrastructure and a conducive environment in the years to come.

The author is at NCAER. These are her personal views.

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