Offshoring describes the relocation of business processes from one country to another. This includes any business process such as production, manufacturing, or services.
Offshoring can be seen in the context of either production offshoring or services offshoring. After its accession to the WTO, China emerged as a prominent destination for production offshoring. After technical progress in telecommunications improved the possibilities of trade in services, India became a country leading in this domain though many parts of the world are now emerging as offshore destinations.
The economic logic is to reduce costs. If some people can use some of their skills more cheaply than others, then those people have the comparative advantage. The idea is that countries should freely trade the items that cost the least for them to produce.
Frequently used terms
Offshoring is defined as the movement of a business process done at a company in one country to the same or another company in another, different country. Almost always work is moved due to a lower cost of operations in the new location. Offshoring is sometimes contrasted with outsourcing or offshore outsourcing. Outsourcing is the movement of internal business processes to an external company. Companies subcontracting in the same country would be outsourcing, but not offshoring. A company moving an internal business unit from one country to another would be offshoring, but not outsourcing. A company subcontracting a business unit to a different company in another country would be both outsourcing and offshoring.
Related terms include nearshoring, which implies relocation of business processes to (typically) lower cost foreign locations, but in close geographical proximity (e.g. shifting United States-based business processes to Canada/Latin America); inshoring, which means picking services within a country; and bestshoring, picking the "best shore" based on various criteria. Business Process Outsourcing (BPO) refers to outsourcing arrangements when entire business functions (such as IT, Customer Service, etc) are outsourced.
A further term sometimes associated with offshoring is bodyshopping which is the practice of using offshored resources and personnel to do small disaggregated tasks within a business environment, without any broader intention to offshore an entire business function.
Production offshoring of established products involves relocation of physical manufacturing processes to a lower-cost destination. Examples of production offshoring include the manufacture of electronic components in Taiwan, production of apparel, toys, and consumer goods in China, Vietnam etc.
Product design, research and the development process that leads to new products, are relatively difficult to offshore. This is because research and development to improve products and create new reference designs requires a skill set that is harder to obtain in regions with cheap labor. For this reason, in many cases only the manufacturing will be offshored by a company wishing to reduce costs.
However, there is a relationship between offshoring and patent system strength. This is because companies under a strong patent system are not afraid to offshore work due to the fact that their work will remain their property. Conversely, companies in countries with weak patent systems have an increased fear of intellectual property theft from foreign vendors or workers, and, therefore, have less offshoring.
Production offshoring got its big push when the NAFTA made it easier for manufacturers to shift production facilities from the US to Mexico. This trend later shifted to China, which offered cheap prices through very low wage rates, few workers' rights laws, a fixed currency pegged to the US dollar, cheap loans, land, and factories for new companies, few environmental regulations, and huge economies of scale based on cities with populations over a million workers dedicated to producing a single kind of product.
The growth of services offshoring is linked to the availability of large amounts of reliable and affordable communication infrastructure following the telecom and internet expansion of the late 1990s. Coupled with the digitization of many services, it was possible to shift the actual production location of services to low cost countries in a manner theoretically transparent to end-users.
India first benefited from the offshoring trend as it had a large pool of people with the potential to speak English well<ref>Working Through Outsourcing: Software Practice, Industry Organization and Industry Evolution in India Kyle Eischen. eScholarship Repository, 2006. Retrieved 25 November 2006. </ref> and technically proficient manpower. India's offshoring industry took root in low-end IT functions in the early 1990s and has since moved to back-office processes such as call centers and transaction processing. In the late 1990s, India's abundant and cheap software engineering talent combined with massive demand from the Y2K problem helped to move India up the value chain to attract large-scale software development projects for US based customers. Currently, India's engineering talent has made India the offshoring destination of American high-tech firms, lead by HP, IBM, Intel, AMD, Microsoft, Oracle Corporation, and Cisco. Each of these companies has promised or is in the process of investing at least $1 billion in India, to supposedly retain market share in the face of competition and cost-cutting measures of rivals and industry in general, at the expense of investment in the United States.
As a result of the offshoring boom, India has seen double-digit wage growth for much of the 2000s. Consequently, Indian's operations and firms are concerned that they are becoming too expensive in comparison with competition from the other offshoring destinations listed below. They are now attempting to branch out and diversify to other high-end work in addition to software and hardware engineering. These jobs include research and development, equity analysis, tax-return processing, radiological analysis, medical transcription, and more.
The choice of offshoring destination is often made according to cultural concerns. Japanese companies are starting to outsource to China, where large numbers of Japanese speakers can be found — particularly in the city of Dalian, which was Japanese territory for many decades. German companies tend to outsource to Poland and Romania, where proficiency in German is common. French companies outsource to North Africa for similar reasons.
Another country emerging on the scene of offshore software development is Pakistan. Pakistan has been a common source of carpets, garments, and sports goods offshore manufacturing. Funds invested into building educational institutions in Pakistan (when there were not enough jobs to absorb all the graduates from those institutions) are paying off as Pakistan begins to field a modern, highly productive labor force that is the envy of more prosperous but less tech savvy nations elsewhere in the region.<ref>http://www.ecommercetimes.com/story/37750.html</ref>
Once companies are comfortable with services offerings and started realizing the cost savings, many hi-tech product companies started using countries like South Africa, India, China, Mexico, Russia etc. for innovating products.
Many famed Silicon Valley based companies jumped on this bandwagon not only to cut costs but to shorten their product lifecycle and access the talent pool available in these countries. Less Developed countries are usually utilized for this practice.
Transfer of intellectual property
Offshoring is often enabled by the transfer of valuable information to the offshore site. Such information and training enables the remote workers to produce results of comparable value previously produced by internal employees. When such transfer includes protected materials, as confidential documents and trade secrets, protected by non-disclosure agreements, then intellectual property has been transferred or exported. The documentation and valuation of such exports is quite difficult, but should be considered since it comprises items that may be regulated or taxable.
Offshoring has been a controversial issue spurring heated debates among economists, some of which overlap those related to the topic of free trade. It is seen as benefiting both the origin and destination country through free trade, providing jobs to the destination country and lower cost of goods and services to the origin country. This makes both sides see increased GDP. And the total number of jobs increase in both countries since those workers in the origin country that lost their job can move to higher-value jobs in which their country has a comparative advantage.
On the other hand, job losses and wage erosion in developed countries have sparked opposition to offshoring. Experts argue that the quality of any new jobs in developed countries are less than the jobs lost and offer lower pay. Economists against offshoring charge that currency manipulation by governments and their central banks causes the difference in labor cost creating an illusion of comparative advantage. Further, they point out that even more educated highly trained workers with higher-value jobs such as software engineers, accountants, radiologists, and journalists in the developed world have been displaced by highly-educated and cheaper workers from India and China. On May 1 2002, Economist and former Ambassador Ernest H. Preeg testified before the Senate committee on Banking, Housing, and Urban Affairs that China, for instance, pegs its currency to the dollar at a sub-par value in violation of Article IV of the International Monetary Fund Articles of Agreement which state that no nation shall manipulate its currency to gain a market advantage.<ref>Ernest H. Preeg (May 1, 2002). Testimony on Chinese Currency Manipulation Manufacturers Alliance</ref> Traditionally "safe" developed world jobs in R&D and the Science, Technology, Engineering, and Mathematics (STEM) fields are now perceived to be endangered in these countries as higher proportions of workers are trained for these fields in developing nations. Economists such as Paul Craig Roberts claim that those economists who promote offshoring misunderstand the difference between comparative advantage and absolute advantage.
Not surprisingly, many U.S. executives cite the current low U.S. unemployment numbers (4.5%) as proof positive that offshoring has not been deleterious to the U.S. workforce, or to the nation itself. It could be argued that one of the problems in using current unemployment numbers is that the figure does not factor shifts from high wage, high skill jobs to low wage, low skilled jobs. So if an equal number of citizens that once worked in high skilled jobs find a job for unskilled work, the unemployment number will ultimately remain the same.
More importantly, the argument does not contemplate, nor predict effects of continued offshore outsourcing that may occur 10-20 years from now, for example the possible raise of labor costs in emerging countries and a change in their economic orientations, as happened for example in Japan and South Korea in the previous decades.
Falling employment in manufacturing has generated much fear among industrial workers , although total employment has been rising in many countries. The effect of this has been shown to be much higher than that of offshoring or foreign investments, which has nevertheless been accused of being the cause of unemployment , since big offshoring projects are more visible than the slow change from an industrial society to a post-industrial society . Even so, job creation was slow and wage growth low during the 2000-2005 period in the US . Some attribute that to offshoring .
With the offshoring of call-center type applications, debate has also surfaced that this practice does serious damage to the quality of customer service and technical support that customers receive from companies who do it. Call centers have sprung up in South Africa, India, Pakistan, Canada and the Caribbean. Many US companies, most notably Dell and AT&T Wireless, have caught much public ire in the US for their decisions to use Indian and Pakistani labor for customer service and technical support; mostly because of the apparent language barrier that it creates. While India, for example, has a high level of younger skilled workers who are capable of speaking English as one of their native languages, their English skills have caused debate in North America.
Criticisms of outsourcing from much of the American public have been a response to what they view as lackluster customer service and technical support being provided by overseas workers attempting to communicate with Americans who either themselves have strong regional dialects, or are unfamiliar with foreign or non-fluent accents.
Supply chain concerns
Some claim that companies lose control and visibility across their extended supply chain under outsourcing, creating increased risks. A 2005 quantitative survey of 121 electronics industry participants by Industry Directions Inc and the Electronics Supply Chain Association (ESCA) found that 69% of respondents said they had less control over at least 5 of their key supply chain processes since the outsourced model took hold, while 66% of providers felt their aggregate risk with customers was high or very high. 36% of providers responded that they felt an increased risk of uncertainty compared to their uncertainty risk prior to the rise to prominence of the outsourced model. 62% of respondents described as "problematic" at least two core trading partner management practices, which included performance management and simple agreement on results. 40% of all respondents encountered resistance to sharing risk in outsourced partnership agreements, according to the research.
In April of 2005, Indian Citibank workers in Pune employed by Mphasis BFL Group were arrested on charges of defrauding four Citibank account holders living in New York, USA, for the amount of $350,000. Citibank had no prior knowledge of the theft until the customers noticed suspicious transactions in their accounts and notified the bank.
Microsoft has filed a civil suit against Compton Computers and its directors Kamal Vahi and Sandeep Vahi in 2004 for indulging in hard disk loading of pirated or unlicensed Microsoft software onto the computers assembled and sold to the customers. After the hearing in the Delhi High Court on 19th July, 2005, the Indian subsidiary of Microsoft Corporation is awarded $53,000 (Rs 2.36 million) in damages, the highest ever in the country for software piracy.<ref>http://www.zinnov.com/zinnov_whitepapers/zinnov_IP_research.pdf</ref>
In September of 2005, Intel fired 250 workers in India after alleging they falsified their expenses claims. The firings followed an internal audit. The report implied fraudulent employee practices such as "faking bills to claim your allowances like conveyance [and] drivers’ salaries" were endemic not only with the Indian Intel employees, but in Indian business overall. NASSCOM, which is a forum of IT and ITeS companies, has attempted to address these fraud concerns in India by creating the National Skills Registry. That database contains personal and work-related information, enabling employers to verify a staff member's credentials and allowing police to track the background of workers.
Other concerns are the theft of intellectual property given the lax enforcement of intellectual property laws in overseas locations such as China. Domestic companies doing business overseas may have no legal recourse if problems arise. Such problems include domestic companies finding cosmetically near-flawless copies of their goods sold for less than the legitimate goods. These fake goods have even been returned to the legitimate manufacturer for a refund at the legitimate price. Even if IP laws were in place and enforced, tracking down the overseas fake producer is often extremely difficult. In other problems, a foreign government intercepts sensitive trade secrets for use by the foreign government, including use in the foreign military.
While occurring everywhere, political corruption is an endemic problem in the third world. This problem may increase offshore business costs and difficulties through the price of illegal bribes, avoiding the negative consequences of competitors bribing the system, management cost of negotiations with officials, risk of breached contracts, and risk of detection of any illegal activity by outside organizations. Bangladesh, a popular offshoring destination, shares the position of the most corrupt country in the world. Other popular offshoring destinations such as Pakistan, Russia, the Philippines, India, China, and Mexico have decreasing amounts of corruption, in that order. Corruption is decidedly less pronounced in first world countries, partly because officials receive a decent wage and therefore there is less perceived need to engage in such activity.<ref>http://ww1.transparency.org/cpi/2005/cpi2005_infocus.html</ref>
The transfer of knowledge outside a country may create competitors to the original companies themselves. Chinese manufacturers are already selling their goods directly to their overseas customers, without going through their previous domestic intermediaries that originally contracted their services. In the 1990s and 2000s, American automakers increasingly turned to China to create parts for their vehicles. By 2006, China leveraged this know-how and announced that they will begin competition with American automakers in their home market by selling fully Chinese automobiles directly to Americans.
When a company moves the production of goods and services to another country, the investment that companies would otherwise make in the domestic market is transferred to the foreign market. Corporate money spent on factories, training, and taxes, which would otherwise be spent in the market of the company is then spent in the foreign market.
As production increases in the foreign market, qualified and experienced domestic workers leave or are forced out of their jobs, often permanently leaving the industry. At some point, dramatically fewer domestic workers are left who are qualified to perform the work. This makes the domestic market dependent on the foreign market for those goods and services, thereby strategically weakening the "hollowed-out" domestic country. In effect, offshoring creates and strengthens the competitive industries of the foreign country while strategically weakening the domestic country.
Offshoring proponents often say it is necessary to move jobs overseas due to a looming shortage of qualified workers in the domestic market and the booming number of qualified candidates in foreign markets, particularly in China and India. This ignores the many currently unemployed and qualified workers in the domestic market. Further, this perception is enforced by media reports that list incorrect numbers of qualified domestic workers, usually undercounting the number of workers.
A study by Duke University<ref>http://memp.pratt.duke.edu/downloads/duke_outsourcing_2005.pdf</ref> found that 222,335 engineers graduate annually from American universities, far more than the 70,000 often quoted in the media. Further, the Duke study highlights the conflicting numbers coming out of China, India, and the US. China and India, in their official numbers cited by the media, both count the graduates from three year training programs and diploma holders, equivalent to Associate's degrees in the US. The media then compares the China and India numbers to US numbers of four-year Baccalaureate programs. Duke University estimates the total number of engineers with Bachelor's degrees produced annually for the three countries to be 351,537 for China, 112,000 for India, and 137,436 for the US. These figures make the US the per capita leader in producing technology specialists.
Another study by McKinsey and Indian IT body Nasscom<ref>http://news.zdnet.com/2100-9597-5994812.html</ref> reports, "only 25 percent of [Indian] technical graduates and 10 to 15 percent of general college graduates are suitable for employment in the offshore IT and BPO industries respectively". Not only is India graduating engineers in the same numbers as Americans, the vast majority of Indian engineers are not ready to enter the workforce upon graduation.
One solution often offered for domestic workers displaced by offshoring is retraining to new jobs. Some displaced workers are highly educated and possess a graduate qualifications. Retraining to their current level in another field may not be an option due to the years of study and cost of education involved.
Effects of factor of production mobility
According to classical economics, the three factors of production are land, labor, and capital. Offshoring relies heavily on the mobility of two of these factors. That is, how offshoring effects economies depends on how easily capital and labor can be repurposed. Land, as a factor of production, is generally seen to have little or no mobility potential.
The effects of capital mobility on offshoring have been widely discussed. In microeconomics, a corporation must be able to spend working capital to afford the initial costs of offshoring. If the state heavily regulates how a corporation can spend its working capital, it will not be able to offshore its operations. For the same reason the macroeconomy must be free for offshoring to succeed. Generally, those who favor offshoring support capital mobility, and those who oppose offshoring call for greater regulation.
Labor mobility also plays a major role, and it is hotly debated. When computers and the Internet made work electronically portable, the forces of free market resulted in a global mobility of work in the services industry. Most theories that argue offshoring eventually benefits domestic workers assume that those workers will be able to obtain new jobs, even if they have to obtain employment by downpricing themselves back into the labor market (by accepting lower salaries) or by retraining themselves in a new field. Foreign workers benefit from new jobs and higher wages when the work moves to them.
In the developed world moving jobs out of the country began in the 1970s and has steadily continued since then. It was characterized primarily by the transferring of factories from the developed to the developing world. This offshoring and closing of factories has caused a structural change in the developed world from an industrial to a post-industrial service society.
In 1994 NAFTA went into effect. As concerns are widespread about uneven bargaining powers, and risks and benefits, negotiations are often difficult, such that the plan to create a free trade areas (such as Free Trade Area of the Americas) has not yet been successful.
With the development of the Internet, many new categories of work such as call centres, computer programming, reading medical data such as X-rays and MRI's, medical transcription, income tax preparation, and title searching are being offshored.
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- Open Outsourcing
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- Information technology consulting
- Business process outsourcing
- Call center security
- Runaway production
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