The Wall Street Journal
January 28, 2004, p. A 16.
'Outsourcing' is Good for America
by Douglas A. Irwin
"The United States will be a Third World country in 20 years." So
intoned Paul Craig Roberts, a former Reagan administration Treasury
official and supply-side economist, at a Brookings Institution briefing
earlier this month. Mr. Roberts makes this prediction because of
white-collar job losses due to the outsourcing of service sector
employment to India and China. As a result, whole classes of high-wage
service sector employees -- from software programmers to radiologists
-- now find themselves in competition with highly skilled workers
abroad who earn a fraction of their U.S. counterparts.
Mr. Roberts also teamed up with Sen. Charles Schumer, a Democrat, to
suggest in the New York Times that "the case for free trade is
undermined by changes in the global economy." The fears they expressed
about the service sector were eerily reminiscent of the early '90s,
when Ross Perot insisted that Nafta would hollow out America and
produce a "great sucking sound" of jobs being siphoned off to low-wage
Mexico. The conservative Mr. Roberts and the liberal Sen. Schumer are
the most politically incongruous team of trade analysts since Patrick
Buchanan and Ralph Nader opposed Nafta a decade ago. Fortunately, just
like their predecessors, their analysis is wrong.
The unlikely bedfellows are right in that the world is changing. The
service sector, which traditionally has been insulated from
international competition, is now ripe for outsourcing on a global
scale. According to McKinsey, about 90% of the value of services output
is now produced within the providing firm, but they expect this share
to drop to 60% in 10 years. High-tech firms such as IBM are now
outsourcing software programming to India, and medical centers are
relying on Indian doctors to process data, to say nothing of the loss
of America's call centers.
What will the service sector look like as a result of these
developments? Some clues come from manufacturing, which already has
been vastly reshaped. Outsourcing has transformed manufacturing from
vertically integrated production structures to highly fragmented ones.
Fifty years ago, Detroit's River Rouge plant sucked in iron and coal at
one end and spat out an automobile at the other. Now, auto firms source
component parts from a vast array of domestic and foreign suppliers.
Has U.S. manufacturing been vaporized in the process? No --
manufacturing production has risen about 40% over the past decade.
Despite lower wages abroad, foreign firms have chosen to produce cars
made by high-wage workers here, including Honda in Ohio, Mercedes-Benz
in Alabama, BMW in South Carolina and Toyota in California. Of course,
the share of the American workforce in manufacturing has fallen
steadily over the postwar period due to vast increases in productivity,
but this is a world-wide phenomenon. Between 1995 and 2002, China,
Japan, Brazil and other countries lost more manufacturing jobs than did
the U.S., according to an Alliance Capital Management study.
The service sector will be reshaped by international developments, too.
But just as low-wage China has not taken all of our manufacturing
capability, low-wage India is not going to take all of our service
sector production. Service producers will become even more specialized
and will have to seek new ways of improving their efficiency and
productivity. (Productivity in the service sector has notoriously
lagged behind that in manufacturing.) As long as the American workforce
retains its high level of skills, and remains flexible as firms
position themselves to improve their productivity, the high- value
portion of the service sector will not evaporate.
Besides, while Messrs. Roberts and Schumer and others focus on the
issue of displaced workers, they have completely ignored the efficiency
benefits of service sector outsourcing.
-- First, consumers will be provided with the services they demand, at
lower prices. As many businesses themselves purchase services, their
lower costs will result in savings that can be passed on to consumers.
If a capable radiologist in India can read x-ray pictures at a quarter
of the cost of doing so domestically, important health- care services
can be delivered at lower cost to everyone, putting a brake on
exploding medical costs.
-- Second, U.S. exporters of goods and services will benefit from the
extra income generated abroad. The outsourcing of services to India
counts in the U.S. balance of payments as an import of services. If we
are going to start importing large amounts of such services, these
imports must be paid for by exports of something. The dollars being
spent by firms to purchase these services will come back to the U.S.
either in the form of demand for U.S. goods (our exports to India) or
foreign investment in the U.S. As McKinsey has noted, "[service]
providers in low-wage countries require U.S. computers,
telecommunications equipment, other hardware and software. In addition,
they also procure legal, financial, and marketing services from the
Indeed, the U.S. is a major exporter of services, accounting for nearly
a fifth of the world's trade in services. Services amount to nearly 30%
of the value of all U.S. exports. Last year, when the U.S. had about a
$550 billion deficit in goods trade, we racked up nearly a $60 billion
surplus in trade in services.
Of course, importing services can create difficulties for some firms
and their workers who are undergoing the process of adjusting to a new
way of doing business. Specialization becomes much more refined across
different economic activities, and can change quickly with shifts in
technology. Messrs. Roberts and Schumer claim that comparative
advantage and the old rules of trade no longer apply in today's world
of mobile factors of production. But it is technology -- not the
movement of labor -- that is creating new opportunities for trade in
services, and this does not undermine the case for free trade and open
To their credit, Messrs. Roberts and Schumer do not advocate what they
call "old fashioned protectionism." Indeed, it appears that
policymakers have few direct options to halt this process of
technological change. Unfortunately, however, several state governments
are considering laws that limit contracting with businesses that
outsource from developing countries. Labor unions, such as the
Communications Workers of America, have been lobbying Congress to
Yet penalizing firms that import foreign-produced services is not an
attractive option. If such imports help high technology and other
service firms become more efficient, then forbidding U.S. companies
from doing that when their foreign rivals are free to do it will only
handicap U.S. firms. As American firms themselves are facing difficult
competitive challenges from foreign producers, this would be like
forcing them to fight with one hand tied behind their back.
Rather than penalizing firms, outsourcing reinforces the importance of
public policies that allow workers to manage their best in a period of
rapid economic change. This includes such things as ensuring the
portability of health and pension benefits in order to reduce the
adverse impact of changing jobs, which must inevitably happen in an
When a hand-wringing friend worried that some misfortunes would ruin
the country, Adam Smith famously replied, "There is a great deal of
ruin in a nation." The U.S. economy will face many challenges in coming
decades, but as long as we do not stifle our dynamic economy that is
the envy of the world, we need not fear that -- as Mr. Roberts predicts
-- the U.S. will become a Third World nation by 2023.
Mr. Irwin is professor of economics at Dartmouth and author of "Free
Trade Under Fire" (Princeton, 2002).