Wednesday, September 24, 2014
Two Narratives to Understand Off-shoring
There are two contrasting narratives in our readings on off-shoring (or reshoring or next-shoring or any of its derivatives). The first is a story of domestic jobs being exported to chase after labor arbitrage opportunities in developing countries, especially in industries that might take advantage of economies of scale or the commoditization of goods. The second is a story of growing consumer markets in developing countries, wherein increased local demand obliges offshore investment, both to reduce transportation costs, strengthen the supply chain, and most importantly, to respond to local demand parameters. These narratives paint starkly contrasting pictures of off-shoring: a zero-sum game vs. a coordination game; profit-seeking vs. basic market responsiveness; the selling of US jobs abroad vs. the creation of global employment opportunities. Of course, either characterization is a reduction of a complex situation that comprises a broad array of corporate rationales for embracing off-shoring.
A recent study published by the Institute for Research on Labor and Employment (IRLE) found a number of surprising results with respect to off-shoring. Probably the most significant finding was that the majority of international sourcing is to high cost locations, like Canada, and only secondarily to low cost locations. Additionally, there is a positive relationship between domestic outsourcing and international off-shoring of core business functions. The implication being that outsourcing core business functions domestically may be a precursor to international off-shoring. In all, the IRLE study carves out a much finer distinction between the two stories outlined above, albeit with 2010 data and a small (~300 company) data set. The classical portrayal of off-shoring as a technique to drive down labor costs in the manufacturing sector may be wrong, especially if off-shoring firms are paying as much or more than they would in the US.
An article in Forbes magazine supports the above assertions. While noting that growth in manufacturing as a percentage of US GDP has fallen from 94% to 45% over the last 40 years, it points out that minimum wage may not buy the minimum skill needed to competently perform a job in the US. This would provide ample rationale for off-shoring to other developed countries with higher labor costs, but commensurately higher worker skill. It also notes (albeit briefly), that emerging economies grew by 5% on average, while the US grew by just 2%, further vindicating the choice second narrative, that off-shoring is an attempt to capture foreign market share at a minimum cost and with better responsiveness to local conditions.
Both of the above articles seem to point towards a complex and multifaceted picture of off-shoring. While companies do continue to off-shore parts of their operations, especially in commoditized products, their reasons may have little to do with labor arbitrage. Although we should not expect to see off-shoring disappear any time in the near future, we may also see a resurgence of reshoring, as corporations focus on supply chain agility over economies of scale in both home and foreign markets. This will mean shorter, more resilient supply chains, better responsiveness to local market conditions, and concurrent foreign and domestic output growth.
What will be the biggest factors in determining rates of off-shoring and reshoring over the next decade?
Will improved manufacturing technology drive production towards local sourcing? Or will improved transportation infrastructure drive down the price of shipping, leading to more off-shoring?
Is there an ethical obligation for corporations to contribute to the countries in which they originate? If off-shoring, even for labor arbitrage, improves employment opportunities locally, what is the aggregate harm?
 Strategic Sourcing (2013). Margaret Pierson and Willy Shih.
 Next-shoring: A CEO’s Guide. (2014) Katy George, Sree Ramaswamy, and Lou Rassey. McKinsey Quarterly.
 Clair Brown, Timothy Sturgeon, and Connor Cole. (2014). “The 2010 National Organizations
Survey: Examining the Relationships Between Job Quality and the Domestic and International
Sourcing of Business Functions by United States Organizations”. IRLE Working Paper No. 156-13.
 Innocence Abroad (2014). The Economist.
 Reshoring or Offshoring: U.S. Manufacturing Forecast 2015-2016 (2014). Bill Conerly. Forbes Magazine. <http://www.forbes.com/sites/billconerly/2014/09/02/reshoring-or-offshoring-u-s-manufacturing-forecast-2015-2016/>