Offshoring and Its Impact on the Canadian Economy - Coursework Example

Topic: Offshoring and its impact on the Canadian economy Section: Table of Contents Executive Summary 3 2. Introduction – overview 4 3. Concept of offshoring and its historical background 5 4. Offshoring fuels the economy 8 5. Future trends 12 6. Conclusion 14 7. References 15 Executive Summary Offshoring differs from outsourcing as it pertains to location while outsourcing refers to who does the work. US started the trend of offshoring for cost benefits but subsequently other benefits were realized. Contrary to apprehensions, offshoring may temporarily have negative impact across all variables but in the long run there is no negative impact on employment and wages. At the same time there is a positive impact on the GDP. Canada lags behind in offshoring as the firms have a conservative attitude. To survive in the competitive global market, certain policies have to change as offshoring benefits not only the nation’s economy but the world economy as well. Consumers benefit as the prices reduce, reemployment takes place, wages go up, and due to competition firms invest in technology. Both the government and the private sector in Canada have to act fast so that they are not isolated from the world market and continue to have access to the global market. Introduction: brief overview of the purpose of the paper, its contents and findings Corporate restructuring, downsizing and layoffs have led to fundamental changes at the work place on a global basis. Senior executives and corporate leaders around the world agree that offshoring is good for the world economy. These executives also realize that offshoring can deliver more than just labor cost savings (Daga & Kaka, 2006). High technology companies have been contracting out many of their software development projects to overseas software companies, particularly to India. Gradually offshoring is being done in more and more sectors. It is fueled by a combination of quality services at affordable prices both by the service providers and the consumers. The developed countries could venture into offshoring as the developing countries have demonstrated the required skills and upgraded the technology in communications (Sourirajan, 2004). Offshoring emerged in late 1980s and early 1990s initially with tasks related to customer services but now encompasses a broader range of activities including software development, and other activities requiring high skilled human capital. This issue is politically charged as the number of jobs that could be relocated is large. It is expected to have a negative impact on wages and employment. However economists argue that it has long term benefits and would increase the standard of living in OECD countries. In view of these suggestions, this paper will first discuss the concept of offshoring and then analyze the impact that offshoring would have on the Canadian economy as well as the world economy. Despite the apprehensions, offshoring should not be restricted by Canada as it boosts the nation’s economy. This paper consists of five sections. The next section will discuss the concept of offshoring and how it works. The third section will analyze the link between offshoring, productivity and how it impacts Canadian economy. Section would discuss the future trend and how it is likely to affect the global market. Section five would summarize the findings and provide a response to the hypothesis. Concept of offshoring, its historical background and how it works The term ‘offshoring’ refers to relocation of jobs and production to a foreign country (Garner) while Olsen (2006) looks at it as contracting out business activities to foreign providers. Both differentiate between ‘offshoring’ and ‘outsourcing’. Outsourcing refers to relocation of jobs and services irrespective of the providers location whereas offshoring refers to relocation to other foreign countries where the provider may or may not be affiliated with the parent firm. Scott, Ticoll and Murti (2005) of PriceWaterHouseCoopers, clarify that offshoring refers to the location of the work while outsourcing refers to who does the work. A company may offshore without outsourcing if the jobs are relocated to its captive unit or its own office in another country. The trend towards offshoring is likely to continue due to interplay between three factors – technological advances, economic and competitive pressures to reduce costs and improve productivity and institutional development in favor of trade liberalization. Economists refer to offshoring as specialization of labor (Le Goff, 2005) while some observers call it a new form of international trade. The emerging economies are now able to perform complex tasks including design and development. This implies that offshoring and globalization go hand in hand. In order to participate in offshoring, developing countries are responding by adopting policies to encourage economic development (Longobardo, 2005). Offshoring therefore creates a need for trade agreements and policies opening the door for development. Types of services associated with offshoring are those that are capable of being performed at a distance and the final product can be delivered using the advanced technology in communications. These include software programming and designs, call center operations, payroll and accounting operations, medical transcriptions, paralegal services and software research and testing (GAO, 2005). As far as the service sector is concerned, lower productions costs in foreign countries is the major reason for offshoring (Garner, 2004). The developing countries have very cheap labor available. Managers rank cost controlling as the most important reason for offshoring. Countries like India and China have abundance of cheap unskilled labor, hence based on the comparative advantage theory of international trade, labor-intensive production in these countries results in cost savings. Of late the human capital in these countries has acquired skill and hence has become competitive. Besides, due to advanced technology, information and communications has become easier and cheaper as well (Garner). Because of this, just as manufacturing could be outsourced, services can be outsourced as well. Advanced technology has led to vertical specialization in service production by lowering costs. As economy has become digitized, it has become possible to conduct business in entirely new ways. Deregulation and liberalization in the developed countries have caused the developing countries to adopt new technologies at a faster rate. Offshoring began as a means of providing access to large numbers of low cost ICT professionals to customers in higher cost regions. Offshoring is a business strategy and in the extremely competitive environment decisions are based on production, distribution and productivity. If a firm can offshore some of its processes, it can focus on the core areas where it has comparative advantage or engage in new business. Firms would not like to offshore core competitive areas as the risks of security and control exists (Scott, Ticol & Murti). The agency theory suggests that when conflicting goals and interest between the firms and the employees pose a problem, activities can be outsourced to an external provider. The control or output can be controlled through a contract. According to the transaction cost theory, offshoring can be done as long as the costs of related asset specific investments, contractual incompleteness and search efforts are lower than the expected cost advantage. To remain competitive, western countries are moving large number of their manufacturing and services to countries where wages are lower, like India and China. After the North American Free Trade Agreement (NAFTA) many companies have taken advantage of this trend (Le Goff, 2005). Canada too benefited by the U.S. companies relocating various production processes like film production and call centers. While America started IT offshoring, India is the major recipient of this offshored IT work. Indian companies are now opening facilities in China where the wage rates are lower than in India and where a huge local market is emerging (Balatchandirane, 2007). While the US can produce vast quantities of human capital but this does not suffice. India has an educated workforce while the US math and science educational system is slowing down. US firms have always turned to Indian firms in times of crises like Y2K fixes. Besides, companies like to have presence in the countries where they would like to sell their products. US companies even exploit the time difference between India and the West to work on software round the clock. The vast number of studies available on offshoring denotes the significant increase in the degree of internationalization. It boosts the world economy as large amount of high-quality jobs created in less developed countries helps them build a strong economic base, increased domestic consumption and therefore foster imports from developed nations. It also boosts the living conditions in OECD countries as increased productivity and lower costs lead to lower product prices and drive up real wages. It may also provide reemployment for those who lost the jobs due to offshoring. Offshoring boosts the economy Canada lags behind in the use of offshore knowledge resources (Scott, Ticol & Murti). Sixty-eight percent of the ICT firms use offshore employees but this is applicable only to the big Canadian firms. This helps them to improve their own costs, innovation capacity and time to market. A telecommunications manufacturer carries out the designing and identification in North America and then job off the detail work to specialized R&D centers in low cost economies. As of now the non-ICT firms have been slow to offshore but they are now beginning to take note of the benefits of offshoring in Canada. They have been slow to act because of low adoption of information technologies and innovation business practices. This threatens Canada’s competitiveness, its standard of living, and its ability to sustain social programs in an increasingly competitive global environment. Its growth momentum is much lower than several countries that are behind it and hence there are apprehensions that Canada may slip still further down. The Canadian businessmen are confused about the implications of offshoring on their business, on the national economy and its workforce. There is official measure of the jobs moved offshore and hence it is difficult to measure its impact. International organizations like the ORCD and the World Trade Organization observe that the governments have failed to track the offshoring phenomenon with vigor. Olsen (2006) states that there us little empirical evidence on the economic impact of offshoring. There have been debates about Canadian businesses moving jobs offshore and a report by PriceWaterHouseCoopers suggests that Canadas 2.4 million knowledge workers and 3.3 million manufacturing workers are particularly vulnerable to global job competition. Moving jobs to cheaper locations would improve productivity. Another analyst states that Canadian companies fall behind in the ability to capitalize on low cost sources of ICT related global knowledge work. According to the Organization for Economic Co-operation and Development (OECD) Canada fell from sixth to 13th place in business export rankings from 1995 to 2002 (IEEE, 2005). The investment in offshoring is small in Canada. Most offshore projects employ fewer than 100 people. A study by IDC Canada found that only 15% of the large firms are currently considering offshoring whereas almost half of American respondents in the same survey would consider procuring offshore services. The survey demonstrated that costs, quality of service and access to human capital was the top consideration in making the decision to offshore, security concerns ranked second. Over 70% of the Canadian respondents are taking steps to minimize the movements of jobs outside of Canada. While Canadian firms do outsourcing within Canada they lag behind their counterparts like USA and UK. They believe they have a responsibility to create employment where they do business. They project a loyalist attitude. Furthermore, they also contend that firms consider offshoring a bad investment as many did not get the desired outcome. They do not want to get on the wrong side of the Department of Finance by offshoring jobs. The Canadian industries that are ripest for offshoring are highly regulated and do not face competitive pressures. Nevertheless, the Canadian companies and the Canadian economy need to be globally competitive if they want to continue distributing social benefits. The value related reasons are borne out of misconception, note Scott et al. any strategy needs to be competitive and they have to continually renew the agility of Canada’s knowledge-based workforce. Various research studies by MIT and McKinsey have proved that investments in IT combined with effective business practices, leads to productivity growth. This leads to increased market share, lower prices, higher incomes, improvements in the standards of living. This further enables social investments in infrastructure, health and education. As far as Canada is concerned, its investment in IT per worker has been on the decline since 1990. While U.S. invested US$3137 per worker on ICT, Canadian firms invested only US$1332. There are other factors that affect productivity apart from ICT but the companies that are able to effectively utilize their ICT, they outperform their competitors. Trifler (2005) states that the paradox in offshoring is that it presents both threats and opportunities. Canadian firms are still unaware that China has risen as the world’s manufacturer and has become the fourth manufacturing power in the world (Le Goff, 2005). China ranks first in the world in the production of items like telecommunication devices, household appliances, textiles, and the pharmaceutical and chemical industry to name a few. Despite this, Trifler says, Canada remains ignorant of the offshoring possibilities and benefits that exist. The benefits outweigh the costs as consumers get a lower price and the producers can expand into foreign markets. The Canadian policy makers have to awaken to the fact that the unskilled workers in Canada will bear the brunt of the Chinese offshoring onslaught. India is now exporting high value-added services and is known as the world’s office (Le Goff, 2005). India is the most profitable country in which to operate service delivery operations. India has an abundance of flexible and economically competitive labor. India has also made massive investments in leading technology sectors like nuclear and aerospace. Under the circumstances, Canada can insulate itself from the global competitive pressures that come from low cost offshoring, which will definitely protect the firm and the workers in the short run. In 1989 also high tariffs had insulated Canada and retarded growth (Trifler). Foreign countries may even deny Canada market access if it insulates itself. Alternatively, domestic framework could promote competitiveness which could lead to enhanced investments and productivity. Workers have to adjust to a new level of global competition. Economists argue that offshoring becomes necessary for companies to survive. It has a positive effect on employment. It enables a company to maintain its profitable position, increases a firm’s market share and position, increased employment, and can even lead to innovation and enhanced production (Le Goff). A McKinsey study reveals that for each dollar spent offshore, American or other companies save $0.58 primarily in wages. Exports too increase for the western economies. When low skilled jobs are offshored, the labor can be utilized for high skilled jobs at better pay scale which increases the standard of living. It is interesting to note that offshoring of jobs often underplays the jobs that are inshored. These are jobs that are moved into U.S. based affiliates of foreign multinationals. The number of such jobs more than doubled between 1987 and 2002 (Martin, 2005). These US subsidiaries employ high skilled workers and pay higher wages. Canada’s offshoring at the moment is dominated by offshoring with the United States. The offshore rates from India and Hong Kong are rising at a compound annual rate of 20% (Trifler). This indicates that service offshoring to low cost countries will become a substantial issue in the near future. Nevertheless, China and India are still a long way away from being the world’s innovation giants and Canada still has time to take corrective and preventive measures. Future trends According to a Forrester Report, US will export 3.3 million US jobs by 2010 and most will be in the IT software development sector (Sourirajan, 2004). By 2015, Forrester predicts, roughly 3.3 million service jobs will have moved offshore, including 1.7 million "back office" jobs such as payroll processing and accounting, and 473,000 jobs in the information technology industry (Otterman). This according to economists is a very low figure as the United States employs some 130 million non-farm workers. Despite the recent economic downturn, according to a McKinsey Analysis, the U. S. economy created an average of 3.5 million new jobs in the private sector per year. According to a study by Komiyama et al., (2003), initially offshoring may have negative impact across all variables in the short run but between 2007 and 2016 the impact on employment, exports to the rest of the world, on migration and labor force will be negative. At the same time, the impact will be positive on GRP, output, real disposable personal income and wage rates. As such the policies should enable ameliorating social effects in the initial years but should not discourage offshoring. Firms should involve in training and retraining and constantly be in search of new sectors. The government should boost expenditure on R&D. Balatchandirane (2007) reports that the workforce in India has grown from 284,000 in 1999-2000 to an estimated 813,500 in 2003-04. based on the demand and supply for the IT sector NASSCOM estimates that the supply of IT professionals will outstrip demand by 2008. The business leaders, the government institutions, the politicians and academicians alike must categorically state that Canada has no choice but to offshore activities that can best be performed elsewhere. Investments have to be strategically planned. Offshoring is not just about cost savings. Firms must have the ability to free up domestic resources for higher priority tasks, access to global markets, access to new ideas, and become the source of innovation. Government has to take initiative to reduce costs, improve performance and customer service and build Canadian based knowledge industries. If Canada continues to ignore offshoring, Indian and Chinese exports will devastate Canada. They will export high-tech goods and services leaving the Canadian workers shattered. Offshoring of activities is set to increase and will no longer be restricted to textiles or the informatics. Developed countries have already started offshoring even research facilities (Le Goff). Low cost would no more be the sole determinant of offshoring jobs and processes. The mobility of high skilled labor and development of scientific and technical expertise will lead to harmonization of social conditions of production round the world. Conclusion Canada is a rich and successful economy but to sustain in the competitive global market place, policies have to be reconsidered. Offshoring has raised the stakes in the global game. It is important at this juncture that Canada reframes the domestic productivity enhancing policies. Framing domestic policies that encourage the government and the private firms to invest in human capital and technology would enable Canadian firms to be part of the global market and compete globally. Canada must consider education the key factor supporting its competitiveness. It has to invest in educating and training its workforce. This will help workers become more flexible and enable Canada to maintain its economic capacity to attract investment. US has a every educated workforce but still offshores jobs to India. Canada lags behind in education and hence it is extremely important to make this the key factor in development. Offshoring may have negative impact in the short run but in the long run there is no negative impact on employment or wages while there is positive impact on the GDP. Canada needs to seriously reconsider and eliminate the veil against offshoring if it wants to have access to global markets and if it does not want to be insulated by the global market. References: Balatchandirane, G., (2007), IT Offshoring and India: Some Implications, Institute of Developing Economies, 05 April 2007 Daga, D., & Kaka, N. F., (2006), Taking offshoring beyond labor cost savings, The McKinsey Quarterly, 04 April 2007 GAO (2005), Offshoring of services, An overview of the Issues, United States Government Accountability Office, Report to Congressional Committees, 04 April 2007 Garner, C. A., (2004), Offshoring in the service sector: Economic Impact and Policy Issues, 03 April 2007 IEEE (2005), "Hi-Tech Outsourcing & Offshoring", 04 April 2007 Le Goff, P., (2005), Canada and Offshoring, Library of Parliament. 04 April 2007 Komiyama, N., Kumar, R., Libertun, N., Venkatesh, H., & Vidican, G., (2003), Socioeconomic Impact Analysis of Offshoring of Jobs on the Suffolk County, 05 April 2007 Longobardo, A., (2005), The Increasing Amount of Offshoring: Thailand’s Chance to Take Control of the Global Runway, 03 April 2007 Martin, P., (2005), Globalization, Offshoring, And American Trade Politics: Prospects For Canada-Us Trade, 03 April 2007 Otterman, S., (2004), TRADE: Outsourcing Jobs, Council on Foreign Relations, 04 April 2007 Olsen, K. B., (2006), Productivity Impacts of Offshoring and Outsourcing: A Review, OECD Directorate for Science, Technology and Industry (STI), 04 April 2007 Scott, R., Ticol, D., & Murti, M., (2006), A Fine Balance, The Buying and Selling of Canada, PriceWaterHouseCoopers, 04 April 2007 Sourirajan, S., (2004), GLOBALIZATION and OFFSHORE OUTSOURCING A Tale of Two Realities, 04 April 2007 Trefler, D., (2005), Policy Responses to the New Offshoring: Think Globally, Invest Locally, 04 April 2007 Read More