The outsourcing bogeyman is the real threat to the US economy

It seems I managed to confuse some of my readers with my "Why a US ban on offshore outsourcing is the best possible thing for India!" post. I was using sarcasm to make a point, and am not really suggesting that the US ban outsourcing. Any ban on outsourcing would harm both countries overall, but would be especially harmful to the US. Let me make the same point using economic data rather than humor:

Right now the focus is on Business Process Outsourcing (BPO), however, during 1998 to 2002 everyone was convinced that IT outsourcing (ITO) to India would gut the American IT services industry. Let us consider the IT services most directly affected by offshore outsourcing, namely: “computer and data processing services” and “data base and other information services.” According to the “Digital Economy 2003” report published by the U.S. Department of Commerce, US imports of these services rose from $0.3 billion in 1995 to $1.2 billion in 2002 (with a peak of $1.6 billion in 2000). This seems to be clear proof of Ross Perot’s “giant sucking sound” and any number of Lou Dobbs’ tirades. However, in the same time period, US exports of these services rose from $2.4 billion in 1995 to $5.4 billion in 2002 (with a peak of $5.7 billion in 2000). Thus, the U.S. trade surplus in these services expanded from $2.1 billion to $4.2 billion over the same years when the US faced the greatest threat from Indian outsourcing firms due to the Y2K contracts and the Internet boom.

If the US had magically managed to “ban IT offshoring” and other countries had done the same, the US economy would have lost $26.2 billion over these 8 years. How many US jobs do you think that $26.2 billion translates to? I realize data provides cold comfort to people who have lost their jobs due to outsourcing. However, the above analysis highlights how overall global trade creates far more jobs in America than it destroys. If you don’t believe the analysis above, you should at least learn from US history. The following excerpt from the US Department of State website highlights how US protectionism contributed to and exacerbated the Great Depression.

The Smoot-Hawley Tariff Act of June 1930 raised U.S. tariffs to historically high levels. The original intention behind the legislation was to increase the protection afforded domestic farmers against foreign agricultural imports. … But once the tariff schedule revision process got started, it proved impossible to stop. Calls for increased protection flooded in from industrial sector special interest groups and soon a bill meant to provide relief for farmers became a means to raise tariffs in all sectors of the economy. When the dust had settled, Congress had agreed to tariff levels that exceeded the already high rates established by the 1922 Fordney-McCumber Act and represented among the most protectionist tariffs in U.S. history.

The Smoot-Hawley Tariff was more a consequence of the onset of the Great Depression than an initial cause. But while the tariff might not have caused the Depression, it certainly did not make it any better. It provoked a storm of foreign retaliatory measures and came to stand as a symbol of the ‘beggar-thy-neighbor’ policies (policies designed to improve one’s own lot at the expense of that of others) of the 1930s. Such policies contributed to a drastic decline in international trade. For example, U.S. imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932, while U.S. exports to Europe fell from $2,341 million in 1929 to $784 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934.

Thus, between 1929 and 1934, US imports were reduced by just $944 million while exports were reduced by $1,557 million and so the US economy lost hundreds of millions of dollars and more importantly tens of thousands of jobs due to US protectionism. Moreover, today due to the high growth rate of countries like India and China, the rest of the world counts for a significantly greater proportion of global economic growth than they did in the 1930s. As such, US protectionism would probably harm the US even more in the current environment because American companies would be locked out of the rapidly growing Asian economies while Asian and European companies would probably benefit from the vacuum created by the absence of American companies.

Daniel W. Drezner in his thought-provoking article titled “The Outsourcing Bogeyman” (Foreign Affairs, May/June 2004) provides two excellent examples on how US protectionism has already caused US job losses.

Consider the example of candy-cane manufacturers: despite the fact that 90 percent of the world's candy canes are consumed in the United States, manufacturers have sent much of their production south of the border in the past five years. The attraction of moving abroad, however, has little to do with low wages and much to do with protectionism. U.S. quotas on sugar imports have, in recent years, caused the domestic price of sugar to become 350 percent higher than world market prices. As candy makers have relocated production to countries where sugar is cheaper, between 7,500 and 10,000 workers in the Midwest have lost their jobs -- victims not of outsourcing but of the kind of protectionism called for by outsourcing's critics.

A similar story can be told of the steel tariffs that the Bush administration foolishly imposed from March 2002 until December 2003 (when a ruling by the World Trade Organization prompted their cancellation). The tariffs were allegedly meant to protect steelworkers. But in the United States, steel users employ roughly 40 times more people than do steel producers. Thus, according to estimates by the Institute for International Economics, between 45,000 and 75,000 jobs were lost because higher steel prices made U.S. steel-using industries less competitive.

Proponents of American protectionism should keep such recent misadventures in mind while pushing for higher tariffs.

US protectionism impacts more than just the economy. The previously quoted US Department of State article goes on to say: “More generally, Smoot-Hawley did nothing to foster trust and cooperation among nations in either the political or economic realm during a perilous era in international relations.” Does this sound eerily applicable in the current international relations context? George Santayana wrote: 'Those who cannot remember the past are condemned to repeat it.' Unfortunately, the cost of repeating this past mistake could be greater than the anti-globalization brigade can even imagine.