EconSouth (Second Quarter 2004)

Robert A. Eisenbeis is senior vice president and director of research at the Federal Reserve Bank of Atlanta  

Taking the Long
View on Outsourcing


The 2001 recession was mild by historic standards. Real gross domestic product (GDP) was essentially flat over the period as compared with the loss of $110 billion of real GDP during the 1990–91 recession. The subsequent recovery has also been relatively strong, with real growth averaging 3.6 percent since the official end of the recession. This rate is exactly the average rate of growth the U.S. economy experienced over the 1990s.

What has not kept pace during the most recent recovery, however, is job growth. The country has lost approximately 2.4 million manufacturing jobs from the start of the recession. Only recently has the economy begun to recoup those losses. While the pace of job growth has not matched that of previous postrecession periods, it has added about 1.4 million jobs in the past nine months (August–May).

Slower job growth is not only a puzzle but is also an important issue when assessing economic policy. One explanation offered for slower job growth is that firms have increased their use of outsourcing. Not long ago, Gregory Mankiw, chairman of the president’s Council of Economic Advisers, argued that outsourcing was good for the United States. His remarks were greeted by a firestorm of negative reaction from both Democrats and Republicans. More recently, some government entities have enacted requirements intended to stem this loss of jobs to outsourcing. For example, some municipalities now forbid awarding contracts to businesses that rely on outsourcing. At the federal level, discussions about outsourcing include recommendations to provide tax relief to corporations that add new jobs in the United States in lieu of outsourcing. What do we really know about outsourcing, and does Mankiw have a point?

Job migration is an old story
First, we need to understand that the migration of jobs from one part of the country to another or to other parts of the world is not a new phenomenon. Rather, it is part of the “creative destruction” process—a concept introduced many years ago by the great economist Joseph Schumpeter—in which old methods and technologies are destroyed and replaced by new ones.

The explanation behind the creative destruction of job migration and outsourcing lies in the principle of comparative advantage and changes in the relative productivity of labor. The concept of comparative advantage provides the foundation for understanding international trade and the benefits of specialization. And changes in the relative productivity of labor, which depends upon both the quantity and quality of the available capital stock and the skill levels of workers, provide the motivation for job migration.

In the 19th century, New England’s textile industry began migrating to the Southern United States. The capital stock was relatively easy to move, and the South at that time had an abundance of low-cost workers who were willing to do the same jobs as New England textile and garment workers for substantially lower wages. This industry migration clearly hurt not only the New England workers who lost their jobs but also those whose livelihood was providing goods and services to the mill workers. Many towns that depended upon those mills went into secular decline, but New England’s economy did not collapse. In time, the lost jobs were replaced with higher-paying jobs that required the skills and educational levels that the area’s economic base had supported and nurtured during the heyday of textiles. Today, New England is prosperous, and it now has a significant information and services base, including financial services and high-tech industries.

Farewell to farm and factory
Another industry in which productivity and quality of the technology have played important roles in explaining job migration and change is agriculture. At the turn of the 20th century, nearly half the jobs in the United States were in agricultural occupations. By the middle of the century, that number had declined to about 10 percent, and today it is under 2 percent. However, according to the World Bank and the International Monetary Fund, the United States’ share of agriculture value-added as a percentage of global production actually increased over the period compared to the rest of the world.

Similar trends have occurred in manufacturing. The proportion of U.S. employment in manufacturing declined from slightly over 30 percent in 1955 to about 12 percent today. At the same time, the United States’ share of world manufacturing output increased slightly over the period.

The patterns in agriculture and manufacturing suggest that while employment in an industry may decline significantly, it does not necessarily follow that the United States necessarily loses market share or that the value of output produced declines. Of course, the reason behind the patterns in both agriculture and manufacturing has been the tremendous growth in U.S. productivity. Over the latter half of the 1990s productivity gains accelerated, and recent data suggest no change in that trend.

Going abroad
While U.S. jobs have historically moved from one part of the country to the other, more recently jobs have been moving from the United States to overseas. This trend raises the question, What do we really know about outsourcing? Very little hard data on outsourcing are available, and what we do know is largely based on conjecture and forecasts. In fact, some of the research on outsourcing, according to its authors, is being used in ways that either are not true to the nature of the forecasts or fail to recognize that much of the job losses are still in the future and are therefore uncertain.

Although good numbers on the significance of current outsourcing trends are not available, trade data are available, and they provide some indication of how important the phenomenon has become to the economy. When U.S. service jobs are sent abroad through outsourcing, companies are essentially paying other firms to do work that previously had been done in-house. The value of this contracted work shows up in the trade statistics as an import of business services to the United States. In a similar fashion, if a foreign firm outsources its accounting or legal work to a firm in the United States, it appears as an export of business services to the United States.

During the 1990s, the net value of exports increased, and the bulk of this uptick was accounted for by trade and transportation services. When these services are excluded, the data show that net trade in services has steadily increased. In fact, the United States is now exporting about $130 billion in business services—$50 billion more than we are importing. To put these figures in perspective, the country is presently importing about $1.2 trillion in goods on a base of a $12 trillion economy. Overall, then, the United States has clearly benefited from the net trade in business services. However, when compared with either the total size of the U.S. economy or even with total U.S. imports, the services component is still very small.

The long-term perspective
The loss of jobs to other parts of the world is merely part of a longer-term process in which lower-value and lower-productivity jobs migrate to places with lower wages and lower productivity of labor. This process has played out for centuries within the United States and across the rest of the world.

As Federal Reserve Chairman Alan Greenspan properly noted in a speech earlier this year, the loss of jobs to overseas is not a problem that can be blamed on this country or that but rather is a natural feature of a dynamic and evolving economy. While some programming and other jobs that require higher levels of education are also leaving the country, it’s not clear that this development is anything but a temporary trend until wages adjust in a worldwide market.

To address our best interests over the long haul, policymakers should focus on long-term investment in education to ensure that our workforce is highly productive and on providing the means to help workers who lose their jobs make an easier transition to alternative jobs or careers.

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