Exploding the Myths of Offshoring

Far from damaging the economy of the United States, offshoring should enable its companies to direct resources to next-generation technologies and ideas -- if public policy doesn't get in the way.

The McKinsey Quarterly
McKinsey & Co.

July 14, 2004

With the digital revolution and the dramatic fall in international telecommunications costs comes the prospect that white-collar jobs — once insulated from global competition — can be performed offshore, in low-wage nations such as India, where labor can be hired for as little as one-tenth its cost in the United States. Call-center agents, data processors, medical technicians, and software programmers could all find their jobs at risk from the nation's growing trade in services with emerging markets. In fact, offshoring is frequently blamed for the agonizingly slow pace of job growth in the United States, despite a recovering economy.

Even free traders have wavered in their beliefs. Critics warn that millions of people in the United States will become jobless. The response from Congress has been to include in a fiscal 2004 spending bill a provision prohibiting federal agencies from outsourcing some kinds of work to private companies that use workers in foreign countries. Indeed, 23 states are considering similar restrictions; 4 have already passed them. Jobs and trade have become the hot-button issues of the 2004 presidential election race.

The current debate is misplaced, however, because the problem is neither trade itself nor globalization more broadly but rather the question of how the country should allocate the benefits of global trade. Trade in services, like other forms of international trade, benefits the United States as a whole by making the economic pie bigger and raising the standard of living. Outsourcing jobs abroad can help keep companies profitable, thereby preserving other US jobs. The cost savings can be used to lower prices and to offer consumers new and better types of services. By raising productivity, offshoring enables companies to invest more in the next-generation technologies and business ideas that create new jobs. And with the world's most flexible and innovative economy, the United States is uniquely positioned to benefit from the trend. After all, despite a large overall trade deficit, the country has consistently run a surplus in its international trade in services.

A 2003 study by the McKinsey Global Institute (MGI) showed that offshoring creates wealth for the United States as well as for India, the country receiving the jobs. ("Offshoring: Is It a Win-Win Game?" McKinsey Global Institute, August 2003.) For every dollar of corporate spending outsourced to India, the US economy captures more than three-quarters of the benefit and gains as much as $1.14 in return. Far from being a zero-sum game, offshoring creates mutual economic benefit.

True, some US workers will lose their jobs, but this painful reality doesn't weaken the case for free trade. Given the benefits of offshoring, the logical response is to make the US labor force and economy more flexible and able to cope with change.

How the United States Benefits
The offshoring trend prompted us to investigate what happens to a dollar of US corporate spending when a company moves a service job to India. We found that India captures 33 cents, through wages paid to local workers, profits earned by local outsourcing providers and their suppliers, and taxes collected from second- and third-tier suppliers to the outsourcing companies. (Foreign and local outsourcing providers in India enjoy a tax holiday from the government.) The gains to the US economy, however, are larger.

Corporate savings. The cost savings enjoyed by US companies are the most obvious source of value. For every dollar of corporate spending that moves offshore, US companies save 58 cents, and the quality of the services they buy is often higher: wages are lower, so companies can hire better-qualified people and spend more on supervision and training. Offshore workers are often more highly motivated than US workers and perform better, particularly in low-skilled jobs that lack prestige and suffer from high turnover in the United States. One British bank's call-center agents in India not only process 20 percent more transactions than their counterparts in the United Kingdom but also do so 3 percent more accurately.

Outsourcing