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US: Implored to 'Offshore' More


by Paul BlusteinWashington Post
July 2nd, 2004

A report by an influential consulting firm is exhorting U.S. companies to speed up "offshoring" operations to China and India, including high-powered functions such as research and development.

In blunt terms, the report by the Boston Consulting Group warns American firms that they risk extinction if they hesitate in shifting facilities to countries with low costs. That is partly because the potential savings are so vast, but the report also cites a view among U.S. executives that the quality of American workers is deteriorating.

"The largest competitive advantage will lie with those companies that move soonest," the report states. "Companies that wait will be caught in a vicious cycle of uncompetitive costs, lost business, underutilized capacity, and the irreversible destruction of value."

Boston Consulting, which counts among its clients many of the biggest corporations in the United States, admonishes them that they have been too reluctant rather than too eager to outsource production to "LCC's," or low-cost countries.

"Successful companies ask themselves, 'What must I keep at home?' rather than 'What can I shift to LCC's?'" states the report. "Their question is not 'Why outsource to LCC's?' but 'Why not?' "

The report, released in May, has gone almost unnoticed amid generally upbeat news as strong economic growth has begun fueling an increase in jobs, diminishing public debate about offshoring.

But the report's conclusions underline the intensifying pressures on corporate America to shift jobs overseas. Although many economists believe the trend will benefit the U.S. economy overall by improving productivity, and that new job creation will more than compensate for the jobs migrating to China and India, the study suggests that the movement of jobs abroad is likely, if anything, to accelerate strongly in coming years.

Particularly troubling is the report's information about confidential discussions with executives at Boston Consulting's client companies, many of whom conveyed low opinions of their American employees compared with labor available abroad. Not only are factory workers in low-cost countries much cheaper -- well below $1 per hour in China, compared with $15 to $30 per hour in the United States and Europe -- but they quickly achieve quality levels that are "equivalent to or even higher than . . . [the] best plants in the West," according to the report.

"More than 40 percent of the companies we talked with expressed significant concerns about the erosion of skills in the work force," the report states. "They cited machine operators who are unable to handle specialized equipment properly or to make the transition to new work materials. In contrast, LCC's provide large pools of skilled workers who are eager to apply their 'craftsman' talents."

Midlevel engineers in low-cost countries, the report adds, "tend to be more motivated than midlevel engineers in the West." It cites General Electric Co., Motorola Inc., Alcatel and Siemens AG as examples of companies that have set up research and development centers in both India and China "to leverage the substantial pools of engineering talent that are based in the two countries."

Indeed, the report undercuts the view that R&D jobs in Western countries will increase even as low-skill jobs migrate to nations like China and India. Among companies with large operations in low-cost nations, "One of the most intriguing advantages we have come across is faster [and lower-cost] R&D," the report states.

Economists who contend that offshoring benefits the U.S. economy in the long run voiced consternation over the report, which they fear could help revive the political clamor for protectionist measures that erupted last year when the media focused public attention on the loss of high-tech jobs to India. Referring to the authors' "brutal honesty," Catherine L. Mann, a fellow at the Institute for International Economics, said, "Maybe because they're from Boston, they don't know what a hornets nest they've stepped into."

Despite the report's findings, Mann and other economists said it does not alter their fundamental belief that the U.S. economy will grow, and job opportunities expand, even as offshoring continues to disrupt the lives of many American workers and disproportionately affect people at the lower end of the skill scale.

Matthew J. Slaughter, a professor at the Tuck School of Business at Dartmouth, pointed to research he published in March using Commerce Department data to show how offshoring can have a positive impact on U.S. job growth, as part of the "churn" in employment that constantly eliminates jobs but also adds them.

Although U.S. multinationals expanded their overseas payrolls by 2.8 million from 1991 to 2001, in moves that often involved factory closures and layoffs in the United States, they expanded their U.S. employment levels by nearly 5.5 million, according to Slaughter's study. That is partly because as such firms expand the scale of their operations abroad, they need more personnel at home to handle functions such as marketing, logistics, finance and product design. For similar reasons, McKinsey & Co., one of Boston Consulting's main rivals, has estimated that for every $1 invested abroad by U.S. companies, the U.S. economy gains $1.14, which can be plowed into job-creating enterprises.

"In the '90s, we were creating and destroying tens of millions of jobs each year," Slaughter said, "and that context is a little forgotten when people say '3 million jobs will be destroyed over 10 years,' " a widely cited forecast of the number of service jobs that will be moved offshore.

Harold L. Sirkin, one of the chief authors of the Boston Consulting report, agreed that it should not be interpreted as bad news overall for U.S. living standards. "This is the same thing as we had when people were worried about how the Japanese were going to take over the world, or the Mexicans were going to take all the U.S. jobs -- how many times have we heard this refrain?" Sirkin said. "This is an economy that has proven time after time to be incredibly resilient and capable of adjusting."

Offshoring production will mean that American companies lower their costs and raise their productivity, and although some jobs will be lost in the process, pouring the surplus money and workers into new industries means "you'll create jobs you wouldn't have otherwise," he said. Trying to fight the trend, and preserve jobs by making it difficult for firms to lay off workers, "means you become a zero growth economy," with fewer jobs in the long run, he added.

The report provides reason after reason for why U.S. firms should locate operations offshore, and rebuts the arguments for why the trend is likely to slacken.

In contrast to experts who have predicted that rapidly rising wages in China and India will dampen their appeal to corporations, Boston Consulting contends that the Chinese and Indian cost advantage "may actually increase" in coming years. Partly that is because they are starting from such a low level.

"If wages increase at an annual rate of 8 percent in China, while in the United States and Germany they increase at annual rates of 2.5 percent and 2 percent, respectively, in 2009 the average hourly wages will be approximately $1.30 in China, $25.30 in the United States, and $34.50 in Germany," the report said. So in dollar terms, the wage gap will have expanded rather than shrunk.

Moreover, "the growth of wages in China and India will be limited because of the enormous reservoir of underemployed people in these countries," the report says, noting that 800 million Chinese living in the countryside "are expected to exert very strong downward pressure on wages for low-skilled positions over the next few decades. . . . India, for its part, has a pool of 25 million highly educated English-speaking workers, expanding by a million every year."

The report advises that some products should not be moved overseas, such as those where there is a high risk of stealing patents and copyrights. It warns that companies incur high initial costs, including severance payments, when they go abroad -- "in the range of $25,000 to $100,000 per transferred full-time employee." Establishing and managing a supply chain in a foreign country can also entail significant initial outlays.

But those drawbacks typically melt away, according to the report, as companies recognize the other advantages to offshoring, including gaining access to huge and growing markets. China is "a very special entity in this respect," having already become the world's largest market for machine tools, the report says.

"Although [the] risks are real, experience has shown that they can be managed -- and that there may be greater risk in failing to make the move," the report says. "Companies that continue to hesitate do so at their peril."

 





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