One of the sensitive economic issues likely to be raised in the 2008 presidential campaign is the emotionally charged debate over "offshoring," the practice of outsourcing work to overseas companies, or transferring work within a multinational company to an overseas location. Most people acknowledge that the cost savings from offshoring can reduce consumer prices and improve corporate profitability. But there is controversy over the impact of offshoring on U.S. employment and wages. So it is well worth closely examining the trend in one of the most heavily affected parts of the economy: the technology sector.
Forces Behind Offshoring in the Technology Sector
To refer to the "technology sector" as a monolithic entity is to gloss over important differences between sub-sectors such as IT infrastructure, business processes, and research and development (R&D). Most people understand the difference between a call center operator answering questions on how to fix your computer and a software engineer writing code. But these various sub-sectors do share some common traits that are key to understanding the forces behind offshoring:
Technological Advances: Today's telecommunications networks allow digital content to be shipped easier and faster than physical products, and they allow workers in remote locations -- including low-wage, developing countries -- to compete in global services markets.1
Economic Pressures: Americans who perform services that can be easily outsourced typically make two or three times more than their offshore competitors.2 It is true that the wage differential between U.S. and foreign workers is closing: In India, for example, salaries in the software industry have been rising by 10 percent to 15 percent in recent years.3 But until this salary growth eliminates the cost advantages of overseas outsourcing vendors, there will continue to be pressure on U.S. companies to achieve savings through offshoring -- especially when their competitors can access the same potential savings.
Limitations to Offshoring: "Core" vs. "Context"
The large discrepancies in cost and the ease with which information can now be shared across the globe make some observers wonder why all technology jobs haven't moved offshore. The answer lies in the distinctions among the sub-sectors within the technology sector, and in the ways call center operators are different from software engineers.
Business consultant Geoffrey Moore argues that certain parts of a company's business are "core" operations that give the company its competitive advantage.4 He says workers involved in those operations will always be kept in-house, regardless of labor costs. But Moore distinguishes core operations from what he calls "context" work -- activities that may be crucial to a company's success (such as helpful call center services), but don't necessarily distinguish the company from its competitors. For the technology sector, such context activities typically include implementation and support work -- occupations that are easier to offshore, and ones in which physical proximity to the customer is less important.
Studies have shown that core workers are more productive and therefore more valuable when they don't have to focus on context work.5 Yet what constitutes a core function may vary from company to company. Indeed, activities like web development may be context operations for most U.S. companies and simultaneously core for U.S. companies specializing in it. A core function typically requires skills and focus not easily found when offshoring: creativity, analytical problem solving, strategic thinking, and an awareness of business issues as well as technical ones. In the technology sector, the types of workers with these skill sets are focused on activities such as product development, systems design, sales, and marketing.
In addition to the skills needed for core work, there are often geographical proximity requirements. Time zone differences across continents can affect a company's ability to respond quickly to issues and can negatively impact overall communication, especially when staying close to the customer is important.
Lastly, factors such as infrastructure and quality of life also play an important role in determining the location of work. "Infrastructure" can mean anything from an effective transportation network and stable utilities, to close access to top universities and attractive living conditions. These are all ingredients giving places like Silicon Valley sizeable leads over most places in the developing world when it comes to high-skilled, high-value-added core work.
Focusing on core work in the United States -- while offshoring context work -- can create mutually beneficial growth opportunities in both U.S. and overseas markets. A good example of that trend is in the fast-growing market for "green" technologies, where it is common practice to use offshore vendors for context work. To secure critical early-stage funding, start-up green-tech companies typically must show venture capitalists that their business plans call for using offshore companies to reduce costs and allow U.S.-based employees to focus on the high value-added core work of building new businesses.6 Without overseas companies in the equation offering to do context work cost-effectively, these new companies might not be able to get off the ground -- which would be a missed opportunity to create new, high-skilled jobs.
Net Impact
There is no doubt that some American technology workers have lost their jobs or had their wages depressed as a result of offshoring. The question is what overall effect does the supply of lower-cost overseas technology workers have on employment and economic growth in the U.S. technology sector.
From 2002 to 2005, the three years following the dot-com bust, overall employment in the U.S. computer sector grew a modest 6.5 percent. But this number masks changes in the composition of computer-related employment. Relatively low-paying occupations like database administrators saw employment numbers shrink by 2.7 percent over those three years, while relatively high-paying occupations like software engineers experienced an amazing 27 percent increase in overall employment.7
Meanwhile, computer and information services imports including such things as tech support from overseas call centers and software development were only 3 percent of total service imports in the United States in the most recent year for which data is available, 2005. And 2005 was the first year in which the United States ran a deficit in the trade of computer and information services -- a modest $730 million deficit compared to the overall services surplus of $79 billion.8
What Can We Do
Companies may be able to serve their own interests and their workers' interests at the same time. Moore points out that it is both cruel and counter-productive for companies to simply lay off context workers. A better alternative is to reassign employees no longer doing outsourced tasks to work on the next generation of products or services.9 In this "resource recycling" model, companies are constantly shifting resources -- including yesterday's context workers -- into supporting positions focused on deploying and optimizing tomorrow's core operations. The important thing is to keep workers in similar roles but in different areas of the company, and not expect call center operators to become engineers.
There has also been much debate over what role the government can play in helping U.S. workers compete effectively for the jobs of tomorrow. Previous studies by the Progressive Policy Institute have addressed these issues. Ideas include public investment in science and research, R&D tax credits, improving math and science education, aggressively opening foreign markets, and providing better support for those who are negatively affected by offshoring and foreign trade.10
More Than Just Technical Skills
Improving math and science education is probably the solution that is mentioned most frequently when discussing offshoring and global competition. But one of the lessons learned from the technology sector is that education must also include non-technical skills, like thinking creatively and understanding an industry's business needs. Being able to conceive the next big idea can be more important than being the one who can build it.
1. Thomas Friedman's recent book The World Is Flat: A Brief History Of The Twenty-First Century (2005) lists several political, business, and technological developments over the past decade which have helped to fuel offshoring. The technological developments include the advent of the web browser, work-flow software, open-source software, search engines, and several innovations that he groups to together as the steroids of the digital world (fiber optics, wireless networks, broadband connections, Voice Over IP, etc.)
2. Estimates based on author's interviews with Silicon Valley IT managers and outsource companies that specialize in software development. Linda Tucci also writes in SearchCIO.com that the salaries of Western software engineers can be five times their Indian counterparts ("Offshoring in India to Flourish, Despite Wage Hikes," August 9, 2006).
3. Sengupta, Somini, "Skills Gap Threatens Technology Boom in India," The New York Times, October 17, 2006, p. 1A.
4. Moore, Geoffrey, Dealing With Darwin: How Great Companies Innovate At Every Phase Of Their Evolution (2005).
5. A Global Insight study sponsored by the Information Technology Association of America in October 2005 ("The Comprehensive Impact of Offshore Software and IT Services Outsourcing on the U.S. Economy and IT Industry") found employment gains due to lower inflation and higher labor productivity. They estimate that the increased economic activity that results from offshoring creates more than twice as many jobs than are displaced, although not necessarily in the same sector or for the same workers.
6. In the first three quarters of 2006, venture capitalists invested $435 million in U.S.-based green technology start-up companies, according to Dow Jones VentureOne and Ernst & Young Venture Capital Report, 3Q' 2006. While this still represents less than 5 percent of the $19 billion in venture capital investments in the United States, green technologies are the fastest growing segment with a 215 percent annual growth rate.
7. U.S. Department of Labor, Bureau of Labor Statistics, Occupational Employment Statistics, Occupational Employment and Wage Estimates.
8. U.S. Department of Commerce, Bureau of Economic Analysis, International Economic Accounts, U.S. International Services: Cross-Border Trade 1986-2005.
9. Moore, op. cit.
10. Gresser, Edward and Paul Weinstein Jr. and Will Marshall, "Raising Our Game: A National Competition Strategy," Progressive Policy Institute, June 2006.
