During the presidential campaign of 2004, no economic issue generated more heat or shed less light than the debate over offshore outsourcing. This fact was probably apparent at the time to any economist who followed politics, but it was felt especially acutely by the authors of this paper. We were then working at the Council of Economic Advisers as, respectively, chairman and chief of staff. While the job of the CEA is to focus on the economics of current policy debates, the environment in which that job is performed is highly political, especially in an election year. To some extent, therefore, this paper is a report from inside the eye of a storm.
Our goal is both to describe the heat and then to shed some light. The first part of the paper focuses on the politics, describing the outsourcing debate of 2004. We document how popular concern about outsourcing increased during 2003 and accelerated as the presidential election of 2004 approached. A focal point of the politics was the release of the Economic Report of the President (ERP) in February 2004. The Presidential campaign of Senator John Kerry seized on the issue of outsourcing, lambasting President Bush and his advisers for supposedly favoring it, and putting forward a corporate tax proposal allegedly aimed at removing tax incentives for U.S. firms to move jobs overseas. At about the same time, economist Paul Samuelson made headlines with an article that was widely and wrongly interpreted (including apparently by Samuelson himself) as suggesting a retreat from economists' historical consensus in support of free trade. After the November election, media interest in outsourcing as a topic subsided, although it remained higher than two years earlier.
The second part of this paper surveys the empirical literature on offshore outsourcing, with an emphasis on outsourcing of business services. Work to quantify the impact of increased trade in services on domestic labor markets has lagged behind popular interest, in no small part because existing data sources make it difficult to identify job changes related to trade in business services. Indeed, gaps in the available data make it difficult to say how many jobs are being outsourced and why. The empirical literature is able, however, to conclude that offshore outsourcing is unlikely to have accounted for a meaningful part of the job losses in the recent downturn or contributed much to the slow labor market rebound.
To a large extent, the issue of offshore outsourcing involves the same fundamental questions addressed by economists for more than two centuries concerning the impact of international influences on the domestic economy. To be sure, the world is different, as advances in technology have made it possible to trade a wider range of services. Services offshoring, however, fits comfortably within the intellectual framework of comparative advantage built on the insights of Adam Smith and David Ricardo. This is contrary to the assertions of some non-economists, who see a new paradigm created by improved technology and communications that somehow undermines the case for free trade.
The theoretical literature on offshoring has been mainly positive, focusing on the factors influencing firms’ choice of organizational structure and location of production. There has been little normative analysis on the welfare impact of offshoring. This is perhaps because it is so obvious to economists that outsourcing simply represents a new form of international trade, which as usual creates winners and losers but involves gains to overall productivity and incomes.
Moreover, the empirical evidence, while again still preliminary, suggests that increased employment in the overseas affiliates of U.S. multinationals is actually associated with more employment in the U.S. parent rather than less. These econometric results are buttressed by similar findings in the business literature, where researchers from McKinsey Consulting calculate that overall net U.S. income rises by about 12-14 cents for every dollar of outsourcing (that is, gross income rises by $1.12-1.14).
There are costs to services outsourcing. These costs are familiar from the literature on how trade in goods affects labor markets. In particular, workers with low skills within certain occupations such as data entry and low-end computer programming appear to have been affected by increased trade in services with countries abundant in programmers who can tackle basic tasks. As with other forms of trade, useful policy responses to outsourcing would focus on the transitional costs arising from trade-related dislocation. Policies aimed at preventing trade, including outsourcing, would mean lower standards of living for both Americans and the citizens of developing countries.
On the whole, these findings suggest that there is little new in the outsourcing debate. Some people face dislocation and the potential of losses, but trade is good for the nation as a whole. The appropriate policy response is to help workers adjust rather than to give up the gains from trade in the first place. Policies aimed specifically at outsourcing, including Senator Kerry’s corporate tax proposal, would almost certainly impose net costs on the U.S. economy and involve job losses. This is familiar from an undergraduate course in international trade.
The message from economists that international trade in services is nothing new and likely to be beneficial is enormously frustrating to non-economists, especially politicians. To help bridge this communications gap, we examine the differing ways in which economists and non-economists talk about offshoring, focusing on ways in which economists can communicate more effectively to policymakers and the broader public. These lessons have been learned from experience.
N. Gregory Mankiw is a visiting scholar and Phillip L. Swagel is a resident scholar at AEI.