Steven Pearlstein
Steven Pearlstein
Columnist

Outsourcing: What’s the true impact? Counting jobs is only part of the answer.

The battle has been going on since at least the 1880s, when the first New England textile mills began moving production to the Carolinas. Whatever name it goes by — “runaway plants,” “outsourcing,” “global sourcing,” “offshoring”— workers and the public tend to hate it, executives view it as inevitable and economists defend it as part of the painful process by which market economies prosper.

Now, President Obama and his election-year rival, Mitt Romney, have joined the debate. Their focus is Romney’s tenure as head of Bain Capital, which owned controlling stakes in firms that either moved their own work overseas or specialized in helping other companies do so.

Steven Pearlstein is a Pulitzer Prize-winning business and economics columnist at The Washington Post.

Archive

As the Obama campaign sees it, Romney’s involvement undercuts his basic message that his private-sector experience makes him singularly qualified to create more jobs for Americans.

Romney’s retort takes various forms: that the offshore outsourcing didn’t happen on his watch; that it wasn’t Bain-owned companies that did it, just their customers; that outsourcing some jobs was the only way to preserve and create other jobs. The critique, says Romney, is just another example of Obama’s ­anti-business bias.

The debate over outsourcing has been morphing, and today there are growing numbers of people who think that what started as a sensible, globalized extension of sending some work outside a firm to specialized companies may in fact be creating long-term structural unemployment in the United States, hollowing out entire industries.

Rearranging where and how work is done has been going on ever since the first shepherd and farmer decided to trade milk for wheat on a regular basis. Outsourcing is merely an extension of the age-old story of specialization and exchange, whether it is done within a village or country or across national borders.

At the dawn of the industrial era, the general belief was that efficiency demanded giant companies that performed a wide variety of activities to take advantage of the economies of scale and scope. The most modern factory of the day was Henry Ford’s River Rouge plant in Dearborn, Mich., where Ford not only assembled cars but also produced its own steel, fabricated its own parts, generated its own power and created its own advertising.

Since that time, improved technology and production know-how — everything from the telephone and the jet airplane to overnight delivery and just-in-time inventory control — have lowered transportation and coordination costs, making it efficient to move more and more work to outside suppliers and contractors.

Initially, a lot of outsourcing was to other American firms; later it involved moving production to foreign countries. Many companies rushed to spin off all but their most essential “core” activities.

Today, some of the world’s largest companies and biggest employers are the product of this outsourcing trend: Sodexo in food service; IBM in information technology; Wackenhut, now known as G4S, in security services; UPS and FedEx in logistics; Foxconn and Lenovo in computer manufacturing. Instead of the Rouge plant, the new model of industrial organization has become Nike, which outsources the making of all of its shoes, clothing and sporting equipment so it can concentrate on design and marketing, and Apple, which outsources all of its hardware manufacturing.

The impetus for offshoring

Outsourcing has always been controversial, whether its purpose was to get around unions, take advantage of low-cost labor in other regions, or simply tap the greater expertise and efficiencies of large contractors. Whatever the reason, somebody invariably loses a job as somebody else gains one, sometimes overseas, and sometimes at far lower wages. The resentment seems to grow exponentially with geographic distance and the gap between the original wages and the new ones.

While technology and know-how enabled the outsourcing process, the impetus has come from consumers and investors.

In a trend that began in the late 1970s and picked up speed in the 1990s with the opening of trade with China, India and Eastern Europe, competition from foreign imports forced U.S. firms to find cheaper and better ways of doing business.

But equally important was the push from outside shareholders. Back when the business world was dominated by family-owned firms, the owners’ personal ties to workers and neighbors made them reluctant to shift work elsewhere, even if meant giving up a bit of profit. That same sensibility persisted even after entrepreneurial owners began to sell their companies to public shareholders and hire a cadre of professional managers, beginning in the 1920s.

All that began to change, however, in the 1980s, with a wave of corporate takeovers, many of them unwanted and uninvited. Corporate executives came to fear that if they did not run their businesses with the aim of maximizing short-term profits and share prices, their companies would become takeover targets and they would be out of a job. Overnight, outsourcing became a manhood test for corporate executives.

It was into this environment of ruthless focus on “enhancing shareholder value” that the modern private-equity industry was born. Some firms, such as KKR, got their start with hostile and highly leveraged buyouts of large public companies. Others, such as the Carlyle Group, specialized in picking up the divisions cast off by corporations scrambling to demonstrate their corporate focus.

And there was Bain Capital, which mixed a bit of venture capital with corporate turnarounds and investments in family-owned firms that needed more capital, better management and strategic acquisitions to grow to the next level.

While private-equity managers like to boast that they are free to manage the companies they buy without worrying about changes in quarterly profits, the reality is that their “long term” time horizon is limited. Generally, they allow two or three years for recouping their original cash investment and seven years for selling the whole company again at a handsome profit. The standard strategy has been to load up company executives with so much stock and stock options that they don’t hesitate to make difficult decisions such as shedding divisions, closing plants or outsourcing work overseas.

Even its competitors agree that Bain was among the most successful at this game, never more so than during the 1990s when Romney was at the helm.

Bain’s investors and executives tended to do best when their companies grew in sales and profits. Sometimes that also translated into growth in the number of American jobs, but when that happened it was merely a happy byproduct of the core mission: fixing up companies to be sold at the highest possible price. In the entire history of private equity, it is doubtful that anyone’s financial reward was ever based on how many American jobs were created.

The Post recently reported that Bain had invested in a number of companies that specialized in relocating jobs done by American workers to facilities in low-wage countries. The Romney campaign objected to the report after the Obama campaign began selectively using it in ads against Romney.

The data

Over the years, there have been hundreds of studies that purport to prove that global outsourcing has been a net job creator for the United States — that as a result of shifting work overseas, more jobs were created back home than were lost, even though the jobs and the workers may not be the same. Such findings, not coincidentally, are consistent with economic theory, which holds that trade and specialization are win-win propositions, enhancing everyone’s productivity, raising everyone’s incomes and boosting economic growth everywhere.

Many such studies tend to focus on large multinational corporations, for which the data and anecdotes are more readily available. And indeed, during the 1990s, the data seemed to show that for every one job added abroad, companies added almost two new jobs at home.

But for the most recent decade, the same Commerce Department data showed a different story, with U.S.-based multinationals adding 2.4 million jobs overseas even as they cut 2.9 million back home.

“It remains an open-ended question whether, on balance, hiring abroad leads to more or fewer workers back home,” said Matthew Slaughter, a professor at the Tuck School of Business at Dartmouth College who has studied outsourcing for more than a decade.

The answer depends in part on the size and focus of the companies.

At large companies that look to export markets for much of their growth, a shift of work to factories or contractors offshore still creates lots of new jobs in engineering, design, marketing and finance back home. That’s because their export sales are growing so quickly. Indeed, that has been the much-chronicled experience of export powerhouses such as Boeing, Caterpillar, Cisco and Apple.

But the story is likely to be different for small or medium-size firms that are focused largely on the slower-growing U.S. market. For them, offshoring is simply about substituting foreign labor for U.S. labor. From a job perspective, perhaps the best face they can put on the process of shipping work overseas is that, by allowing the company to remain competitive, it helps to save whatever jobs are left in the United States. These are the types of companies that are more likely to be bought or directly controlled by private-equity firms.

The job impact from outsourcing also seems to vary between sectors. As Slaughter notes, even in the most recent decade, the Commerce Department data on multinationals shows that service-sector firms continued to expand employment at home as well as abroad. Unfortunately, those gains were more than offset by the job losses in manufacturing.

What happened to manufacturing?

One theory is that in the early days of offshoring, moving production work overseas did indeed have that salutary effect of creating more than enough offsetting jobs back home in engineering, design, marketing and final assembly.

But in the past few years, a number of respected tech executives, among them former Intel chairman Andy Grove and IBM’s former chief scientist Ralph Gomory, have warned that a tipping point of sorts has been reached. It turns out that designing and developing products requires rather intimate familiarity and close collaboration with the manufacturing process. That was not a problem when there was still some production left in the United States. But now that many categories of high tech have moved virtually all production offshore, companies are finding that they also need to move more and more of engineering and design work overseas as well.

A shifting dynamic

Arie Lewin, director of the Center of International Business Education and Research at Duke University, says we’ve seen a variation of this same dynamic before, with the consumer electronics business in the 1950s and ’60s.

At first, U.S. companies found it cheaper to begin shipping some of the production of radios and televisions to Japan. But in time, Japanese suppliers reverse-engineered the products and figured out how to design and produce their own brands. They then took over the global industry. As a result, an outsourcing strategy that might have been benign or even beneficial in terms of U.S. employment eventually turned negative.

Lewin, whose center does annual surveys with thousands of outsourcing companies and their customers, reports that a different dynamic is taking hold in terms of outsourcing service functions — not just call centers but also billing, software programming and IT services. In that sector, companies are pressuring suppliers to move the work closer, either onshore or near-shore. If it continues, he says, that would bode well for U.S. employment.

For economists, the theoretical argument in favor of offshoring is that, like all other forms of specialization and exchange, it is a win-win proposition for all the countries involved. But the theory is based on a number of assumptions, one of which is that trade is reasonably balanced — that once we started importing more goods and services from the rest of the world, the rest of the world will use that extra income to buy equal amounts of goods and services from us. Years of large and growing trade deficits have now called that assumption into question.

There is a vigorous debate among economists about how many jobs are forgone by running a persistent $500 billion annual trade deficit. There are some purists who would say none, but a lot of studies put the number at a couple of million. To be sure, outsourcing isn’t responsible for all of that number, or even most of it, but there’s little doubt that it is a factor in the longer-term structural unemployment in the United States today.

In thinking about the full economic impact of offshoring, however, this exercise of counting jobs gained and jobs lost in particular companies, or particular industries, only gets you so far.

Few would dispute that, by raising profits, offshoring has been a boon to shareholders in the companies that do it, including investors and executives at private-equity firms. And the bigger benefit has gone to the customers of these firms, businesses as well as consumers, who now enjoy a wider variety of goods at a savings of tens of billions of dollars every year.

Those savings and those extra profits aren’t put under the mattress. Most of it is spent or invested in the United States in ways that are hard to track but have surely created hundreds of thousands of jobs in other companies and other industries. Those who hold those jobs would have no reason to know that they are beneficiaries of the process of outsourcing and globalization. But in a very real sense, they are.

For previous columns bySteven Pearlstein, go to washingtonpost.com/business.

 
Read what others are saying