Offshoring and Public Policy -- a Conundrum

Big news from IBM. Multiple sources are reporting that IBM will lay off about 5,000 positions in the United States, while expanding hiring overseas (Reuters story). Also did an interview with the WSJ, but they story is behind a subscription wall.

This story illustrates several of the challenges facing firms and policymakers as they grapple with the Services Shift.

First, the advantage that developing countries have in services for medium skilled positions is much larger than the advantage they enjoy in manufacturing. This is primarily because services are so labor intensive. If you save 60% on labor, but labor is only 20% of your cost base (as in auto parts) that gives you a 10-12% advantage. If labor is 75% of your cost base, a 60% savings gets you a 45% advantage.

Second, unlike with manufacturing, it is very difficult to match jobs lost in the US to jobs gained elsewhere. If Delphi closes a plant in Michigan and opens on in Mexico, you have about the same number of people doing the same tasks. It's easy to say "these jobs replaced those jobs." With services, however, it's rarely so simple. Say IBM hires lots of SAP and networking specialists in India in 2007-08. These people service many markets, including the US. Now in the midst of the financial crisis, they lay off systems engineers and COBOL programmers in the US. Is it really accurate to say "the SAP people replaced the COBOL programmers."?

The positions are not matched up in either time or function. So is one really replacing the other?

I'm sure the anti-trade, nativist zealots would respond that "there is a US programmer 'willing' to do the job," but that's a far cry from saying that person is qualified. Is it reasonable to ask IBM to spend tens of thousands of dollars retraining an expensive and under qualified US worker? Does this make sense even if the person will be serving global markets (including India)? Does it make sense if doing so will cause IBM to become uncompetitive with rivals who do not follow a policy of giving preference to US workers?

Third, services offshoring is much more disruptive than trade in manufactured goods. Why? Because the advantage that developing countries have is much larger in services (see above). Also, many more people are affected by globalization of services. Manufacturing accounts for approximately 15% of US employment. Services for about 70%. Tens of millions of people who thought they were safe from global competition are finding out that they are not. They want the government to do "something," but no one is exactly clear on what.

Fourth, what can the government do? Actually, very little. As mentioned above, it is very difficult to identify which jobs are displacing which other jobs. Foreign workers account for 71% of IBM's global workforce. Foreign sales account for just over 2/3 of IBM's sales. So, the workforce and sales distribution are roughly in alignment.

But say your congressman wanted to do "something." What would this be? It is unlikely that Congress is willing to cut IBM off from the Internet or satellite communication? Does anyone think congress can micromanage IBM's (or any other firm's) global resource allocation. Beyond making a fuss, there is little that policymakers can do without crippling the very firms that prop up their home economies.

Bottom line, Congress is impotent.

There are really two issues at play here.

1. In the long run, does the globalization of services raise of lower living standards in the rich countries? Almost everyone agrees that it is disruptive and inconvenient in the short run. I believe that the long run benefits outweigh the short run costs (as do most economists, the McKinsey Global Institute, and many others). But intelligent people can disagree on this.

2. What policies can the government put in place to slow of stop services offshoring? Even if you believe offshoring harms the United States, the onus is on the opponents to suggest a policy that would be effective. I can't think of one. Sputtering and whining won't cut it. Most policies (such as the Grassley-Sanders fiasco on H-1B visas) cause more harm than good.
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So, it's a tough problem. Everyone wants to focus on question #1. But without addressing question #2, it's just whining. Still waiting for an answer on that.