Outsourcing 102

Richard L. Bolin, Director
The Flagstaff Institute
Flagstaff, Arizona, USA1

Outsourcing Components and assembled products from offshore factories has been growing since the 1950s. In the mid-1970s manufacturers and offshore Economic Processing Zones (EPZs) were attacked in the U.S. Congress by trade unions for "stealing American jobs." Outsourcing offshore services such as accounting, programming, and telephone answering by electronic means has grown extremely rapidly and is now under attack. Assurance that outsourcing is here to stay may be found from the manufacturing and EPZ examples. The response to the critics of outsourcing lies in rising U.S. exports.

Far from being a problem, outsourcing is an important way that America can sustain its economic leadership now and in the future. Outsourcing is a process of world economic development in which benefit accrues both to the country outsourcing which achieves lower consumer prices, and to its trading partner which receives new employment. Benefit accrues because the offshore factories and service centers supply the global market as well with the result that all markets are enlarged and world trade grows. Manufacturing of goods is a major force in outsourcing.

American manufacturers do very well in the world market. Detailed statistics show their factories produced $4,208 billion dollars in the year 2000. Of this amount about 80 percent was sold in the U.S. and 20 percent was exported. The figures for overall export sales of High Tech manufactured goods after subtracting the cost of their share of factory labor payrolls show a positive gross margin of $267 billion. The corresponding Medium Tech factory margin over labor costs was $98 billion, and that of Low Tech was $58 billion. Even the No Tech factories had a margin of $4 billion over their factory labor costs. Overall, this experience has added fortyfold to American export progress since 1960 when total manufactured exports reached $20 billion and the world market was opened. Using balance of payments measurements, the U.S. Census Bureau reports substantial growth for exported goods:

Exports, $Billion2042224387502732719682713800 (est)

Exports became important when the product groups exported could compete in world markets because they offered economic efficiencies compared to other places. High Tech products such as aircraft, autos, pharmaceuticals, chemicals, and communications equipment were important. Then came the explosive growth of high tech semiconductors and computers. Employment and Factory Worker Pay are shown in the following tables. To differentiate technology levels we use the percentage of engineers employed in the work force in each of 140 SIC industries depending on National Science Foundation data.2

All US Exports of Manufactures by Technology Level, $Billion
High Tech6384140325
Medium Tech525183162
Low Tech473578138
No Tech[Incl. in Low]1941107
US Manufacturing Employment in 2000, Thousands of Employees
Factory WorkersOtherTotal
High Tech162415513175
Medium Tech18827942676
Low Tech254710003547
No Tech412815715699

*The overall totals of 140 3-digit SIC industries and 21 NAICS manufacturing groups data did not disclose details of approximately 3,340,000 of total manufacturing employment (out of 18,437,000) nor of 2,461,000 factory workers (out of 12,642,000) so as to protect privacy of information under the law.

All US Manufacturing Average Factory Worker Pay
in 2000 by Technology Level

Hourly $

Annual $
US Hourly,
$ Million
US Annual,
$ Billion
High Tech17.2535,8802858
Medium Tech16.1533,5923063
Low Tech15.2731,7623981
No Tech11.9424,83549103
Average All15.1531,512146305
All US Manufacturing Factory Margin by Technology Level of Exports
after deducting Factory Worker Payroll in 2000, $Billion
ExportsPayrollFactory Margin
High Tech32558267
Medium Tech1616398
Low Tech1398158
No Tech1071034

This table reflects only the export share of the factories' outputs. As indicated earlier, exports are about 20 percent of production. The other 80 percent is produced by the same factories and the same workers and covers all the costs of investment in buildings, machinery and equipment, marketing, financial management, etc. The margins shown above are available for all the companies to use. But when a margin gets small, as in the case of No Tech, it may call management's attention to the need to improve its competitiveness.

Learning Tool: A History of Job Flows

Outsourcing From rich countries to poor ones is about the only way the world will develop from now on. It is a proven process with favorable results and relatively little damage. Since about 1925, when New England textile mills abandoned cities such as Lowell, Massachusetts for the low cost southern U.S., outsourcing has continued. At that time the cries of the media about abandonment of the "ivy covered" old brick buildings and displaced workers worried the entire country except the South with its new efficient factories. About seventy years ago the New York City sewing factories followed the textile manufacturers to the South and twenty years later to Puerto Rico3 which started to attract them with exemption from U.S. income taxes for ten years after the first profit was earned in a new plant. In about 1970 the Wall Street Journal lamented that in the South "ivy covered" textile mills were emptying as companies moved to Mexico. The process continues.

Japan deliberately got rid of sewing factories to Southeast Asia by 1981, ahead of their schedule planned in 1969. They couldn't waste their precious labor supply on low value sewing operations. What is going on here? Competition. That's what outsourcing is all about. If a company does not outsource, it will die. And if its country does not find new industries to replace the inefficient ones, it will not attract new investment and better jobs. Everybody has to understand this.

New England has not missed its textile or shoe factories. A few abandoned buildings were used by the up-and-coming plastics industry. In the mid-1940s a few were cleaned up and painted and divided into "incubator" factory real estate by cities and towns to attract new industry. They were very inexpensive and old, but made adequate startup facilities. Then the technology of the universities around Boston filled them to the brim and built many factories on a special circumferential highway (Route 128) within a radius of about ten miles from downtown. Magnificent new buildings using scientists, engineers, and business administrators from universities led huge growth of jobs and investment in the region.

California, not to be outdone, built Silicon Valley in the same way, becoming world-renowned for its significance to the development of computers and information systems. In both cases the result was many more and better jobs in California and Massachusetts. People forgot about the older industries which had to disappear or find their way to offshore labor values.

What was the result in the U.S. market? The disappearance of old ways and old jobs was mitigated by programs to educate workers who lost jobs so they could acquire new abilities and new jobs. Private technical schools sprang up to meet this need. Government supported retraining programs with tax money. The new factories hired many workers, and their local populations expanded. In the end there were many more jobs than there had been before in the manufacturing sector, where jobs pay more for higher skills. Cities expanded to fill newcomers' needs, New supermarkets and retail stores moved in and hired employees where there had been fewer jobs before.

But the major point, never to be forgotten about outsourcing, is the benefit to any country which outsources to others. There are impressive gains in the economy enjoyed by everyone, not just the factory workers. One such benefit occurred with the outsourcing of sewing in America. The outsourced products imported by the U.S. are much less expensive than formerly. The apparel (clothing and shoes) worn in America today costs the American family, in real dollar terms, only 40 percent of what it cost in 1950. That means that 300 million people are now buying for the modern equivalent of forty 1950 cents what in 1950 they had to pay a whole dollar for.

Is it possible that the American public doesn't know that getting all its apparel for a 60 percent discount from 1950 prices is an advantage and a blessing to everybody? Perhaps the media could explain this once a year to all of us as testimony to the excellence of America's industrial and financial progress. I await the first article.

Do you get the picture? That is only part of it. The same overseas factories which supply apparel to the U.S. are selling low cost, high quality apparel to the rest of the world at similar low prices. So everyone benefits. The International Labor Office in Geneva, Switzerland estimated recently that there are now some 40 million workers in the developing world's economic processing zones. That is 40 million people who now buy exports from America that did not exist thirty years ago, and it is these 40 million and the next 40 million who will lose out if advanced nations cannot find ways to increase outsourcing. Also, American companies made investments offshore to operate the factories, and sent engineers and managers offshore to teach methods of manufacturing many products, and the sales people learned about new markets and how to supply them, thus extending America's exports. Finally the supply chain people-airlines, communications companies, railroads, truckers, energy companies and construction companies everywhere- helped reduce costs and gain income from the outsourcing process. And do to this day.

Outsourcing doesn't hurt people. It makes their lives better and is the way the world will continue to develop from now on. Restricting outsourcing will hurt not only a country's neighbor but also the country doing the restricting, its children, and even its children's children. The provision of retraining services, higher education, and compensation for lost jobs due to outsourcing has been part of the scene in America since the textile mills went south. It must continue and improve or we will all lose progress that might have been made.

The top twenty advanced nations and the top thirty-four developing countries (such as Mexico, which purchased $112 billion from the U.S. in 2000) make up the present reliable market for American outsourcing and exports. Another 121 developing countries have their eyes on the process and are slowly beginning to try. The bottom fifty-four Least Developed Countries await their future, having collectively bought only $2 billion of American exports in 2000.

In all of the world population of six billion persons, about one billion are in advanced nations and five billion are in the developing world. It is silly to stop outsourcing to this world. Where else will the export market be? How will we learn? In the last five decades the developing countries have found manufacturing for export to be the fastest way to enrich themselves. As they earn money, they buy exports from advanced nations like America. Think of it this way: until the poor countries can earn more funds, they will be unable to enrich the rich countries as well as themselves. How does that strike you?

1 Richard L. Bolin is Director of The Flagstaff Institute, Flagstaff, Arizona, USA. This article is protected by copyright by The Flagstaff Institute, 2008. It may be quoted in whole or in part provided credit is given. The Flagstaff Institute, P.O. Box 986, Flagstaff, AZ 86002-0986 Tel 928-779-0052 Fax 928-774-8589 URL www.instflag.org

2See "The Influence of Exports to Developing Countries on Manufacturing Employment in the United States" a report to the City of McAllen, Texas, delivered at the Border Trade Alliance Meeting in Washington, October 1992. It can be found at no cost on the Internet at www.wepza.org on page 76 of Journal of The Flagstaff Institute Volume XXVIII Number 1, June 2004 as background for this paper.

3See http://www.wepza.org and click on Editorials to read (in English or Spanish) "What Puerto Rico Faced in Being First to Create EPZs in 1947... and its Huge Success"

Contact Us:
The Flagstaff Institute (Founded 1976)
Director, Richard L. Bolin
P.O. Box 986
Flagstaff, AZ 86002-0986, USA
Tel: (928) 779-0052 Fax: (928) 774-8589
URL: http://www.instflag.org
E-mail: instflag@aol.com

World Economic Processing Zones Association (WEPZA)
(Founded by UNIDO and 29 countries in 1978, privatized in 1985)
3 Bullet Hill Rd, Danbury CT 06811-2906, USA
Tel/Fax: (203) 798-9394
URL: http://www.wepza.org
E-mail: wepza@aol.com