Why We Can All Stop Worrying About Offshoring and Outsourcing

The old math no longer applies when it comes to where multinationals choose to open shop.

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China Daily/Reuters

Labor markets have for the past quarter century been at the center of the globalization disputes under the "off-shoring and out-sourcing" rubric. How many jobs were lost at home to cheap labor abroad? What were conditions for those overseas workers? But the rapidly changing nature of the global economy has changed much, though not all, of that "off-shoring/out-sourcing" debate. Today, cheap labor is only one of many factors leading global companies to choose where to do business in diverse nations across the world. Major economic changes like the internal growth of emerging markets have scrambled debates about the global economy, posed challenges for international business, stimulated contradictory public policies and confused the general public.

It was often cheap labor in emerging markets that, more than two decades ago, led companies in developed markets to move company jobs away from the home country either to company owned facilities (off-shoring) or to third parties (out-sourcing) in developing markets. The broad idea was that less expensive manufacturing or inexpensive white collar workers would create goods and services in developing nations that would serve world markets. China, especially, would be the global product-manufacturing center; India, via the web, would be the global service provider.

The well known debate ensued between free-trade (more competition, cheaper goods in U.S., growth in developing markets) and fair trade (only wealthy benefit, hollowing out of U.S. middle class, exploitive labor standards overseas). The debate heated up in political years (including 2012), when "outsourcing" became an especially a dirty word. But, in addition to dramatic economic growth in emerging markets, four recent trends have significantly modified this old off-shoring and out-sourcing schematic.

First, labor costs for many businesses may no longer be the critical or even primary factor in global location decisions. Wages are rising in many emerging markets due, in part, to increased demand, new labor laws, and greater worker voice. Wages are declining in developed markets like the U.S. where depressed economic conditions for workers have led to lower wage and benefit packages, especially for lower entry level workers, and often through negotiations with organized labor. New technology, such as robotics, and higher productivity have also lowered the price of labor as a percentage of total product or service costs. When labor cost differences are not as dramatic or important, other costs like materials, energy, transportation, currency, capital, government imposed costs (tariffs, regulation) -- which were always important -- may have as great (or greater) impact on the location as cheap workers.

Second, companies are retaining but modifying their global supply chains by selectively reversing the long-term trend of outsourcing. They are "making" important parts of the products or services rather than "buying" from third parties, as described recently by U.S. business people and journalists, Companies are recognizing that closely interrelating, even co-locating, research and development, design and marketing, manufacturing and assembly close to the markets served can lead to much faster response to market shifts and to much faster innovation. The old practice of designing at home and then manufacturing abroad can slow the pace of innovation and product change to a crawl. So companies are making complex trade-offs between "making" and "buying" -- and between the need to develop technology at connected global R&D centers and the need to apply it in a variety of local settings in a variety of ways.

Similarly, companies which were enamored of outsourcing key service functions like information technology to nations like India are discovering that these, too, are key to fast-paced innovation and should be "made" not "bought" -- bringing them back in-house, with corporate units integrated across the world under global/local management. The "de-verticalizing" outsourcing process - when a company sent many of its functions between raw materials and the finished product to third parties - is now being partially reversed with "re-verticalization." But, even with changes, global supply chains, even if owned more by the company and less by third parties, will remain critical.

Even when labor is a still a significant portion of the cost of a product (e.g. textiles, toys, some electronics), there is a growing movement among major, developed world companies, as I have detailed elsewhere, to engage in responsible off-shoring and out-sourcing by adopting labor and quality standards which aim to create decent wages, working conditions and environmental protections as well as more rigorous quality checks. The apparel industry has an off-shoring/out-sourcing code of conduct monitored by a third party, the Fair Labor Association (FLA), a practice now followed by Apple, but not the electronics industry as a whole.

But it must be emphasized: there are still great problems in supply chains for low cost products (as demonstrated by last year's deadly factory fire in Bangladesh) and there is a great deal yet to do. Most brand-name, iconic multi-nationals, however, do understand that labor and quality standards are needed -- both in their own overseas facilities for their own employees and in their supply chains -- which will either increase costs or ameliorate some of the worst practices. And, at least for these major companies, this is another factor which may means that decisions about location and employment are not made purely on the cheapest possible labor.

Presented by

Ben W. Heineman Jr.

Ben Heineman Jr. is is a senior fellow at the Belfer Center for Science and International Affairs, in Harvard's Kennedy School of Government, and at the Harvard Law School's Program on Corporate Governance. He is the author of High Performance With High Integrity.

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