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CIAO DATE: 04/05/07
Offshoring in Perspective
by Diana Farrell
The heated debate over offshoring might suggest that jobs in the world’s major economies are moving en masse to China and India, but the reality is quite different. In fact, only about 4 percent of all jobs lost in the United States over the last few years can be attributed to offshoring and free trade.
Rather than destroying jobs, offshoring is unlocking tremendous long-term economic value around the world. Outsourcing jobs abroad can help keep companies profitable, thereby preserving jobs. It can also generate substantial cost savings, which in turn can be used to lower prices and offer consumers new and better services. By raising productivity, offshoring enables companies to invest more in the next-generation technologies and business ideas that create new jobs.
But not every country is reaping the benefits of offshoring. New research has shown that for every dollar of cost outsourced to India, the United States receives as much as $1.14 in economic gain. In Germany, however, offshoring leads to just €0.80 in value for every euro in cost moved abroad to places like India and Eastern Europe. In short, as their companies globalize operations, Europe’s leading economies are leaving significant value on the table due to lack of flexibility in their labor and product markets.
Globalization today is creating greater job turnover in the developed world than ever before, and there are clearly winners and losers. But protectionism is not the answer. Instead, policymakers should create programs for wage insurance, transferable health benefits, and job retraining to reduce the adjustment costs to those who lose their jobs. In Europe, policymakers will need to adopt wholesale reform of labor and product market regulations that are currently stifling economic growth.
In 2003, the McKinsey Global Institute (MGI) analyzed the economic benefits of offshoring back-office service and IT functions from the United States to India.2 Results showed that, rather than losing out, the United States gained as much as $1.14 in new wealth for every dollar of spending that U.S. companies transfer to India. This value comes from cost savings to businesses, increased exports to India, repatriated earnings from offshore providers in which U.S. companies have invested, and the additional economic output created when U.S. workers are reemployed in other jobs. India, in contrast, receives just 33 cents of new wealth, through wages paid to local workers, profits earned by Indian outsourcing providers and their suppliers, and additional taxes collected by the government.
However, not all rich countries reap as substantial rewards from the practice as the United States. A similar analysis for Germany, Europe’s largest economy and one of the leaders in offshoring, shows that the country benefits much less from offshoring than the United States does. In fact, German businesses lose €0.20 for every euro of spending on service functions moved offshore.3 To understand why, consider how offshoring creates wealth for an economy.
Diana Farrell is Director of the McKinsey Global Institute, the economics think tank of McKinsey & Company.