Weighing Outsourcing's Impact

There's been a lot of commotion about outsourcing, from election rhetoric to the recent news that CEOs' pay soared at companies that do outsourcing. Fools on our discussion boards have also jumped into the fray, such as Wax's anti-outsourcing message on the Foolish Collective board and Rich Smith's recent argument that overall, outsourcing is good for America. Both sides make good points, but the overall benefit to America seems unclear.

Rich's argument is that Americans who lose their jobs suffer, but lower prices for goods benefits consumers and creates jobs by increasing the demand for goods. The flaw in this reasoning is that not all jobs are created equal. High-paying knowledge and manufacturing jobs are easily outsourced, while the lower-paying service jobs are the ones that must remain at home.

As long as Cisco's (Nasdaq: CSCO) engineers, Morgan Stanley's (NYSE: MWD) analysts, and Omnicon's (Nasdaq: OMC) graphic artists are happy to flip burgers at McDonald's (NYSE: MCD), deliver packages at FedEx (NYSE: FDX), or stock the aisles at Wal-Mart (NYSE: WMT), then there is no problem. Even the newly created accounting, customer service, and Web-design jobs at Amazon (Nasdaq: AMZN) or animation jobs at Pixar (Nasdaq: PIXR) that Rich describes are likely to be created offshore in an efficient global economy.

What we need is a way of determining whether the gain is worth the pain. Suppose the net benefit to America is the degree to which the average employee's purchasing power increases. The benefit really depends on four factors: the proportion of consumer expenses spent on potentially outsourced goods, the decrease in prices due to outsourcing, the proportion of American jobs that can be outsourced economically, and the wages of jobs that can be outsourced relative to the jobs that cannot.

Take a case where consumers spend half their income on potentially outsourced goods. My calculations show that if a third of jobs are outsourced and the incomes of displaced workers fall by a third, but consumers receive an average price decrease of 25%, then America breaks even. If the price decrease is less or the incomes fall more, then, overall, America suffers. (Though in any case, shareholders benefit.) Perhaps America will benefit initially as companies focus outsourcing on the areas with the greatest price decreases, but will do poorly when corporations run out of low-hanging fruit.

In the long term, American workers will be competing with labor elsewhere, pressuring American wages. Though prices should fall, it's unclear whether these benefits will compensate Americans for lower wages. On the other hand, India and China will benefit from both higher wages and falling prices. Consequently, outsourcing will likely narrow America's standard of living lead over other countries.

Fool contributor Richard Gibbons recognizes the irony of a Canadian resident writing an article on America's outsourcing. He does not own shares of any of the companies in this report.