Pros and Cons for Outsourcing

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  • Topic: Outsourcing, Offshoring, Offshore outsourcing
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The Pros and Cons of Outsourcing services in the US
By Berend Schoute (1713035), student of the VU university Amsterdam. INTRODUCTION

Hillary Clinton, "I don't know what reality the Bush administration is living in, but it's certainly not the reality I represent, from one end of New York to the other." This response came on the statement of the head of U.S. President George W. Bush's Council of Economic Advisers, Gregory Mankiw. He said: "outsourcing is just a new way of doing international trade," which makes it "a good thing." In the last decade most economists are a proponents of offshoring services outside of the US.

They say that the benefits of outsourcing exceed the

disadvantages. The main discussion is more likely a political one. It shows that a lot of citizens are pursuing protectionism to prevent any problems for American workers. THEORY

Outsourcing occurs when a company fragmentizes a production process and sends this to another outside company. When companies are outsourcing to other countries/continents, it is also known as offshoring. A survey held by Lewin and Peeters (2006) showed that 90 of the 650 companies that are listed on the US Forbes Global 2000 are offshoring major business functions at that time. This outcome says that many major companies are interested in outsourcing jobs. Further outcomes mentioned that overall IT-functions (66% of the survey participants) are mostly shipped elsewhere, followed by Finance/accounting functions (60%). The most attractive destination for offshoring is India, where 60% of the functions of companies participated in the survey is to be offshored to. (Lewin and Peeters,2006)

There are multiple arguments for offshoring jobs to another country. Some of these reasons can be examined by simply looking at the numbers, but most of them are abstract and difficult to catch. We speak of an omitted variable bias when a model that you create misses some important causal variables. The model can give you some positive results, but it isn’t reliable. This problem can occur in every survey, so the investigators need to be careful with the outcomes. The main argument for outsourcing is clearly labor cost reduction. The differences in wages are very large between the developing countries and the US. For example, an IT-specialist is paid $ 60 per hour on average in the US, where India pays this worker only $ 6 per hour. Although these cost benefits trough labor are substantial, extra costs incur when setting up the new offshore location. After taking all costs in account, there still is a cost reduction of 45 to 55 % (Mckinsey Global institute,2003). This cost reduction can cause a higher productivity because the domestic firm can focus on other important operations. Drezner (2003) said: ‘Thanks to outsourcing, U.S. firms save money and become more profitable, benefiting shareholders and increasing returns on investment.

Foreign facilities boost demand for U.S. products, such as computers and telecommunications equipment, necessary for their outsourced function. And U.S. labor can be reallocated to more competitive, better-paying jobs’. This statement is fully supported by most economists. The commodification process allows the spread of the benefits of IT-outsourcing even further, making the growth and the competitive advantage even greater (Drezner, 2003). A simple explanation of the advantage can be given by looking at the Heckscher-Ohlin model. This model simply suggests that countries that are capital abundant will export capital intensive products vice versa. For example it explains the fact that India focuses on labor intensive products because this abundance causes a competitive advantage caused by relatively low wages. In reality it’s off course more difficult, because the underlying assumptions are hardly realistic: 1. factors of production are perfectly mobile and 2. no difference in level of technology across countries. Drezner(2003) explained this by the...
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