Offshoring of Services: An Overview of the Issues
Released: 2005-11-28T00:00:00

Letter

Background

Defining Offshoring

Offshoring generally refers to a company’s purchases from abroad (imports) of goods or services that were previously produced domestically. A company may offshore services either by purchasing services from another company based overseas or by obtaining services in- house through an affiliate located overseas. For example, a U.S.-based company might stop producing parts of its accounting and payroll services in-house and instead outsource them to a foreign-based company. A U.S.- based multinational company might also offshore by moving parts of its accounting and payroll services from its domestic operations to its foreign affiliate, thus keeping the services in-house. Importing services that had previously been acquired domestically or relocating services to foreign affiliates both can result in the displacement of U.S. service production and employment, though as we discuss later, will likely have other economic effects, such as on consumer prices and productivity.

However, other business activities that do not directly result in the displacement of U.S. workers are sometimes included in broader definitions of offshoring. Offshoring could include other business activities that may result in foregone job creation domestically but would not result in job losses. For example, a U.S.-based company might expand its accounting and payroll services through a foreign company or affiliate, but do so without affecting its U.S. workforce.

Broader definitions of offshoring sometimes include the movement of production offshore. This definition of offshoring focuses on U.S. companies’ investing in overseas affiliates. Offshoring defined in this way could but would not necessarily result in the displacement of U.S. service production or employment. For example, a U.S.-based company investing in its overseas affiliate to produce accounting and payroll services to sell to other companies abroad might do so without affecting its production and employment levels in the U.S.

Types of Services Associated with Offshoring

Types of services associated with offshoring tend to be those that are capable of being performed at a distance and whose product can be delivered through relatively new forms of advanced telecommunications. Examples of these business functions include software programming and design, call center operations, accounting and payroll operations, medical records transcription, paralegal services, and software research and testing.

More than three-quarters of U.S. private-sector employees are in service- providing industries; however, not all services jobs are likely to be at risk from offshoring. Many services jobs, such as child care providers and hairdressers, require face-to-face contact with customers. Other jobs, such as transportation workers, construction workers, and auto mechanics, require hands-on contact with physical equipment. In addition, some work, such as marketing and creative design, may be done more efficiently and productively in close proximity to customers and other workers.

U.S. Trade and Foreign Direct Investment

While government data on trade and foreign direct investment offer limited insight into the extent of offshoring, the data provide some evidence that services imports are growing. Trade data from the Department of Commerce’s Bureau of Economic Analysis (BEA) show that imports of services associated with offshoring are growing. For example, U.S. imports of business, professional, and technical services grew from $20.8 billion in 1997 to $40.7 billion in 2004—an increase of about 10% per year. It is important to note that these import data show that U.S. entities have been purchasing these services offshore, but the data do not indicate whether these entities had previously been purchasing these services from domestic U.S. sources.

The U.S., Canada, and the United Kingdom are among the world’s leading exporters of services. According to World Trade Organization data, the U.S. was the world’s largest exporter of commercial services in 2004. BEA data show that in 2004 Canada and the United Kingdom accounted for 42 percent of the U.S.’s imports of unaffiliated business, professional, and technical (BPT) services, or BPT services traded between firms that are separate entities from each other.

The U.S. currently exports more services than it imports and therefore maintains a trade surplus in services overall. In 2004, this surplus was nearly $48 billion, according to BEA data. However, since 1997, the trade surplus in services has generally been shrinking. At the same time, the overall trade deficit has generally been expanding (see fig. 1), though imported services comprise a small share (about 17 percent) of total U.S. imports of goods and services.

BEA data on direct investment abroad capture U.S. multinational companies’ establishment of affiliates abroad, including establishment of affiliates to produce services. The data suggest that most services produced abroad by U.S. majority-owned foreign affiliates are sold to foreign markets rather than to the U.S. In addition, the data show that U.S. direct investment abroad tends to be concentrated in other developed countries, rather than in developing countries frequently associated with services offshoring. For example, according to BEA data, 61 percent of U.S. direct investment abroad in 2004 took place in the European Union, Canada, and Japan. In the same year, U.S. direct investment in developing countries that are frequently cited as suppliers of offshore services (e.g., India, the Philippines, Malaysia, and China) was relatively small—about 1 percent or less of total U.S. direct investments in each case. In addition, BEA data from 2003 show that over nine-tenths of services sold by U.S.- majority-owned nonbank foreign affiliates are sold to foreign markets rather than to the U.S.

BEA data also show that the U.S. receives large amounts of direct investment by other countries. In 2004, the U.S. received nearly $96 billion in foreign direct investment. The countries that are the largest recipients of U.S. foreign direct investment abroad are also the largest foreign direct investors in the U.S., with the European Union, Japan, and Canada accounting for 82 percent of foreign direct investment in the U.S. Foreign firms investing in the U.S. employ U.S. workers. U.S. affiliates of foreign multinational corporations employed 5.3 million U.S. workers in 2003, accounting for 5 percent of total U.S. employment in private industries.

Enabling Factors and Incentives for Offshoring

Firms have been offshoring long before the recent trend in services offshoring. In previous decades, U.S. manufacturing companies were motivated to offshore because of the low costs and availability of skilled labor, production and supply networks in some developing countries, and reductions in cost of transporting goods. At the same time, U.S. companies divided their production processes into discrete pieces, which allowed them to offshore some of the components. As a result, some businesses offshored total production, and others offshored parts of the production process. Firms generally retained higher-end, higher-skilled services functions in the U.S., such as management, finance, marketing, and research and development.

Offshoring has recently expanded into services due to three key factors. First, technological advances, such as advances in telecommunications and the emergence of the Internet, have enabled workers in different locations in the world to communicate and be connected electronically and has also facilitated the digitization and standardization of activities needed to complete business processes. These changes in turn have allowed business processes to be divided into smaller components, some of which could be done in different locations. For example, standardized software has made it possible for firms to outsource financial or human resources activities to a separate overseas company that performs them for many clients, rather than handling the functions internally. Thus, in many cases, the offshoring of services constitutes an outgrowth of outsourcing business functions. Second, countries such as India, China, Russia, and much of Eastern Europe have increasingly opened their borders to the global economy. Third, other countries have highly educated populations with the technical skills for performing services and technology-related work.

According to several business studies, a primary reason that organizations engage in offshoring is to reduce costs. The cost savings from offshoring are primarily the result of differences between the U.S. and developing countries in the unit cost of labor, the worker compensation (wages and benefits) that must be paid to produce one unit of goods or services. Unit labor costs are lower for certain services in developing countries primarily because workers’ wages in those countries are lower than in the U.S. However, unit labor costs also depend upon the productivity levels of workers. Although labor costs in a developing country may be lower than in the U.S., it may still be possible for the unit cost of labor to be lower in the U.S. than the other country if U.S. workers’ productivity is much higher, meaning than the U.S. worker can produce many more or higher quality products within a certain time frame than a worker in the other country. Differences in unit labor costs can also result from differences in costs of employee benefits, such as health care and pension benefits. In addition, cost savings can be affected by currency exchange rates, countries’ tax policies, and government-provided incentives such as tax rebates.

Aside from cost savings, firms may have other incentives to offshore. Access to a workforce in different time zones across the globe may enable companies to conduct work around the clock and consequently meet worldwide customer needs. Establishing a presence in foreign countries can provide companies access to overseas markets. In addition, offshoring non-core services can enable companies to focus their resources on their core functions. By outsourcing non-core functions to overseas firms that specialize in them, businesses may also experience improvements in the quality of these functions.

Although firms may have many incentives to offshore, they may also face disincentives to offshore. Offshoring has several costs associated with it, including costs to start up an offshore operation and to manage and train an offshore workforce. In addition, some experts have noted that wages of workers in developing countries are rising more rapidly than U.S. wages, therefore shrinking the cost savings of offshoring over time. Furthermore, offshoring carries potential risks, such as possible political instability in overseas locations, less reliable civil infrastructure, exchange rate volatility, less developed legal and regulatory systems, and risks to intellectual property.

Legislation Enacted in Response to Trade-Related Concerns

In the last few decades, the Congress has enacted various pieces of legislation related to trade and increasing global interdependence, primarily due to concerns about their effects on the manufacturing sector. (See fig. 2.) This legislation sought to expand U.S. exports; establish fair trading practices; assist workers, firms, and communities adversely affected by trade; and improve U.S. competitiveness through support for education and research and development. For example, trade acts of 1962, 1974, and 1979 sought to expand U.S. exports by establishing mechanisms for negotiating and entering into trade agreements. The trade acts also established remedies for industries hurt by import competition through unfair trade practices. The Trade Act of 1974, as amended, established a trade adjustment assistance program to provide financial assistance and retraining to workers involved in the manufacturing of articles who lost their jobs due to foreign competition. In addition, the act also established a program that enabled manufacturing firms and communities hurt by trade to receive technical assistance and financial support to develop new strategies to improve their competitiveness. Congress enacted various other legislation to enhance the competitiveness of the U.S. economy by improving education and supporting research and development. Among others, these included the Stevenson-Wydler Technology Innovation Act of 1980, which authorized the creation of various technology centers. With regard to services specifically, the Trade and Tariff Act of 1984 required the Commerce Department to establish a program on international trade in services and to issue a report every 2 years. In addition, the Omnibus Trade and Competitiveness Act of 1988 directs the Secretary of Commerce to conduct a benchmark survey of services transactions.

Aside from these laws, other legislation enacted by the Congress may address some concerns raised by trade and globalization. For example, under the Workforce Investment Act of 1998 (WIA), the Department of Labor oversees an employment and training system operated by states and localities to assist displaced workers in obtaining new jobs, which could include workers who become displaced due to trade-related reasons.

WIA funds may also be used to provide training for employed workers to upgrade their skills.

While Traditional Economic Theory Predicts That Offshoring Will Benefit the Overall Economy, Concerns Have Been Raised about Four Areas of Potential Impact

Traditional economic theory predicts that expansion of international trade, including offshoring, will have beneficial effects on the U.S. economy, but a number of concerns have also been raised about the potential economic and social impacts of offshoring. We have identified four areas of concern about the potential impacts of offshoring: potential impacts on the average U.S. standard of living, including average wages; employment and job displacement among American workers; the distribution of income; and national security and consumer privacy. Economists and other policy analysts have expressed in literature and in interviews with us a range of views about the likely impacts of offshoring on each of these areas. This diversity of views reflects several factors: the fact that services offshoring is a relatively recent development in international trade whose impact is not yet fully known; the limitations of currently available data about the extent of offshoring and its impacts; and different theoretical expectations about the likely impact of expanded trade in services on the U.S. economy. The issues identified in this section may not be exhaustive; others may raise concerns about offshoring that are not discussed in this report. Figure 3 summarizes experts’ different views about the four areas of potential impact for the U.S. that we identify.

Potential Impacts on the Average U.S. Standard of Living

Traditional economic theory on international trade predicts that offshoring is likely to be beneficial for the average U.S. standard of living in the long run; however, some economists have argued that offshoring could harm U.S. living standards. Economists who contend that offshoring will increase average U.S. living standards expect that it will do so through raising productivity (and thereby increasing national income), increasing average wages for American workers, and providing consumers with lower prices and access to a broader range of goods and services. In addition, they expect that U.S. companies will respond to the challenges of international competition by developing new areas of specialization in the global economy. Economists who argue that offshoring may lower U.S. average living standards focus on the possibility that offshoring may contribute to a decline in the strength of some U.S. industries and may threaten U.S. leadership in innovation and technological development. Some economists also focus on the possibility that offshoring may lead to downward pressure on U.S. wages even if it has positive effects on the U.S. economy overall. Underlying these disagreements are different predictions about what areas will emerge as new sources of comparative advantage in the global economy, as well as different assessments about whether offshoring is contributing to downward pressure on U.S. wages.

Traditional Economic Theory Predicts that Offshoring Will Benefit Average U.S. Living Standards in the Long Run

Effects on Productivity: Offshoring of services represents an expansion of trade into sectors of the economy that in the past were relatively untraded; as such, many economists we interviewed or who have published literature on offshoring expect offshoring to increase productivity in these sectors. Offshoring is expected to lead to productivity increases through several mechanisms. First, increased competition could lead to pressures for greater efficiency, causing least productive firms to exit the market so that firms that remain in the market are increasingly focused on managing for greatest productivity. Second, offshoring—like domestic outsourcing—could enable U.S. firms to specialize in the core functions in which they add the greatest value, while moving lower-value job functions out of the country. As U.S. firms reallocate resources toward higher-value activities, moving lower-value activities overseas, the U.S. economy overall could see productivity gains. Third, offshoring could enhance productivity by promoting reductions in the costs of technology and other inputs that improve the efficiency of business processes. For example, some economists have argued that offshoring of IT services will reduce the cost of these services, making IT-enabled products and services more affordable and leading to increased diffusion of productivity-enhancing technology throughout many industries. For instance, the lower cost of offshored health-record transcription services might encourage more health care providers to keep digitized medical records, improving the efficiency and productivity of the health care industry.

Because the acceleration in services offshoring is a relatively recent phenomenon, empirical evidence about its effects on the productivity of the U.S. economy remains preliminary. However, the effects of offshoring in manufacturing have been observed over many years and can shed some light on the potential impact of services offshoring on U.S. productivity. A number of research studies suggest that offshore outsourcing contributed to productivity improvements in U.S. manufacturing. Catherine Mann, among others, has argued that offshoring in the production of computer hardware—along with domestic innovation—kept prices of new hardware low and thereby played a role in the deepening of IT investment throughout the U.S. during the 1980s and 1990s. Since the mid-1990s, the U.S. has experienced a period of unusually rapid productivity growth, which many attribute to accelerating investment in IT and the rapid diffusion of new applications and uses that occurred in the 1980s and 1990s.

New Areas of Comparative Advantage: Traditional economic theory also predicts that increased trade—including offshoring—will increase economic growth, and therefore average living standards in the long run, by driving the economy to develop new innovative and high-value areas of comparative advantage—that is, to specialize in the creation of high-value goods and services that are produced most efficiently in the U.S. Although increased competition due to offshoring and other trade may lead to contraction of production and employment within some U.S. industries, trade is also expected to reallocate the resources of the U.S. economy to sectors that are comparatively more efficient, such that U.S. companies are expected to eventually develop new areas of comparative advantage in the global economy that will lead to continued economic growth. Some economists contend that advantages that the U.S. has over less developed countries, such as a relatively high-skilled workforce, abundance of capital, and well-developed financial markets and investment opportunities will enable the U.S. economy to specialize in higher-value work. In particular, they expect that offshoring will contribute to the reduction or elimination of certain lower-skilled occupations in the U.S., but lead to the creation of new jobs in occupations that require higher levels of skill, shifting U.S. production and the distribution of employment to fields with higher returns.

Some empirical studies suggest that the U.S. economy has historically developed new high-value areas of comparative advantage as trade has increased. The process of the U.S. developing higher-value areas of comparative advantage as lower-value work is moved offshore has been observed over many years in some manufacturing industries. For example, in the semiconductor industry, assembly work that was originally conducted in the U.S. began to be moved offshore in the 1960s. Although this offshoring did lead to job losses in the U.S., economists Clair Brown and Greg Linden assert in their research that this movement also kept the U.S. semiconductor industry competitive and permitted the U.S. industry to specialize in higher-value work within the industry. According to Brown and Linden, as chip assembly moved offshore, U.S. firms specialized in higher-value fabrication work, and when fabrication work began to move offshore, U.S. firms specialized in design. Offshoring of services has not been occurring long enough to observe the relationship between offshoring and the emergence of new areas of specialization; however, economists J. Bradford Jensen and Lori Kletzer have argued that recent data demonstrates that workers in industries and occupations that are more likely to be affected by international trade tend to have higher wages and higher skills than workers in “non-tradable” service sector jobs, which is consistent with the hypothesis that offshoring and globalization is leading the U.S. economy to specialize in higher-value work. Historical trends also suggest that openness to trade has increased the economy’s aggregate output in the past. The U.S. economy has grown as trade has expanded, and internationally, there is some evidence that countries that are more open to trade typically experience faster growth than those that are more closed.

Effects on Wages: Some economists also argue that offshoring could increase average living standards by contributing to growth in average real wages for U.S. workers, corresponding to offshoring’s effects on productivity. Economic theory predicts that average real wages should typically rise with average productivity rates, as workers are compensated for producing more per hour of work. Wages are expected to move with productivity growth in the long run if the share of national income that accrues to workers versus the share that accrues to firms’ profits and other income remains fairly constant. Historically, wage growth in the U.S. has broadly tracked productivity growth, although changes in wages and productivity may have diverged for periods of time (see fig. 4). During the post-World War II period, the share of national income spent on total compensation—wages and benefits—rose throughout the 1950s, 1960s, and 1970s, and has been fairly constant since 1980, averaging about 66 percent of national income, with the remainder accruing to corporate profits, proprietor’s income, rental income, and net interest. Since 1970, an increasing amount of total labor compensation has been spent on benefits rather than wages and salaries. In recent years—since the end of the 2001 recession—wages have not moved up with productivity growth, and total labor compensation as a share of national income has declined somewhat, from 66 percent in 2001 to 64 percent in 2004. During this time, wages and salaries as a share of national income declined from 55 percent in 2001 to 52 percent in 2004. Some economists have argued that this divergence of compensation growth from productivity growth is problematic and runs counter to assertions that increased productivity gains from offshoring will necessarily raise average living standards; however, this fluctuation is considered by other economists to fall within recent norms.

Effects on Prices and Availability of Consumer Goods and Services: Traditional economic theory also predicts that offshoring will improve average U.S. living standards by lowering consumer prices and providing consumers access to a wider range of goods and services than would otherwise be available. Many economists expect that competition will lead companies to pass the cost savings from offshoring onto consumers in the form of lower prices. However, economic theory also predicts that the extent to which cost savings are passed onto consumers depends on how competitive the market is for particular goods and services. While firms in highly competitive markets are likely to pass most of the cost savings from offshoring through to the purchasers of the service, in less competitive markets, economic theory predicts that firms may retain some or all of the cost savings.

Some Economists Have Argued That Offshoring Could Negatively Impact U.S. Living Standards

Although the most commonly cited economic trade theories predict that offshoring will likely have positive effects on the average U.S. living standard, some trade models generate scenarios under which the U.S. could lose either its absolute or relative position in the global economy, and some economists have argued that services offshoring is better described by these latter types of economic models. Models in which the U.S. could face potential losses from increased trade such as offshoring reflect the possibility that as our trading partners become more productive in creating goods and services that the U.S. specializes in, the economic position of the U.S. could be undermined. For example, Ralph Gomory and William Baumol have described scenarios in which a trading partner experiences productivity improvements in an important U.S. export industry, resulting in declines in U.S. national income because U.S. firms lose their position as the most competitive producers in the industry. The impact on the U.S. workforce, in this model, is particularly detrimental if the industry in which the U.S. is challenged is highly profitable and pays high wages, such as industries in which the U.S. has long held technological superiority or an industry that is difficult to enter. Other economists have developed different models in which productivity changes abroad lead to losses in the absolute or relative position of the U.S. in the global economy. The negative results of increased trade in these models are not specific to offshoring—they could result from other forms of trade too, but they are sometimes cited when concerns about offshoring are raised because services offshoring raises the specter of the movement of high-value work from the U.S. to foreign trading partners.

Some have raised concerns that offshoring poses risks to U.S. leadership in innovation, particularly in high-value areas such as technology fields and research and development, raising the possibility that the global economic position of the U.S. could be eroded over time. Economists and other offshoring observers have suggested a range of mechanisms through which offshoring could have a negative impact on U.S. innovation. Some argue that innovation results from solving technical problems during manufacturing, design, and research and development. To the extent that this work is conducted overseas, offshoring could promote faster technological diffusion to foreign firms, which may over time lead to foreign competitors coming to dominate an industry in which the U.S. was once the technological leader. Some contend that offshoring portions of the research and development infrastructure could threaten U.S. technological leadership by disrupting important innovation networks in the U.S., such as the IT cluster in Silicon Valley in California, or the biotechnology cluster in Cambridge, Massachusetts, and promoting the emergence of such networks abroad. In addition, some express concern that offshoring routine or entry-level work in some technical industries could hurt the U.S.’s ability to maintain an innovative workforce by closing off career prospects for some U.S. workers and discouraging U.S. students from entering those fields.

Another concern raised by some economists is that offshoring could reduce average living standards for American workers by slowing the growth of average wages. These economists raise the concern that even if offshoring promotes economic growth and productivity, it could decrease labor’s share of national income by subjecting American workers to direct competition with foreign workers, leading to slower growth or even a decline in average wages. As we previously noted, recent statistics show a dip in the share of national income accruing to total worker compensation in recent years, and some economists believe that offshoring may be contributing to this trend.

Finally, some question whether firms will use the cost savings from offshoring in ways that lead immediately to the productivity improvements and consumer price reductions predicted by trade theory. Under certain market conditions, an individual firm could retain supernormal profits (profits above the usual for their particular industry and product) for a period of time, distributing these gains to shareholders or their remaining employees, rather than passing on cost savings to consumers in the form of price reductions or investing their cost savings in productivity- enhancing reorganization or new technology. Although economic theory predicts that under many market conditions competitive forces will constrain the ability of firms to earn supernormal profits on an ongoing basis, the assumption that individual firms face perfectly competitive market conditions may not necessarily be accurate. Thus, some offshoring experts stress the importance of examining firm-level decisions to determine whether, how, and how quickly offshoring leads to price reductions and the reorganization of firms and industries toward specialization in higher-productivity activity.

Underlying the debate about the effects of offshoring on the average U.S. standard of living are different perspectives on the following questions: What new areas of comparative advantage will the U.S. economy develop to compensate for declines, if any, in areas threatened by offshoring?

How will offshoring affect average U.S. wages? Will the possible benefits of productivity gains offset the possible downward pressure exerted by increased exposure of U.S. workers to global competition?

Potential Impacts on Employment and Job Displacement

Many economists agree that offshoring is not likely to affect aggregate U.S. employment in the long run, but acknowledge that in the short run, workers will lose their jobs when employers relocate production abroad. At the same time, some economists have commented that offshoring may cause structural changes in the labor market because increased trade alters the mix of goods and services produced in the U.S. These structural changes could generate permanent changes in the types of work conducted by the U.S. labor force and could also possibly have longer- term effects on the U.S. unemployment rate. There is disagreement about the expected direction of any structural changes in the labor market due to offshoring, the expected magnitude of job displacement due to offshoring, and the implications of this displacement for those workers who are directly affected by it. Underlying these disagreements are different estimates about the projected extent of job losses due to offshoring, which types of jobs will be offshored, which areas of the economy will generate growth in job opportunites, and the re-employment experiences of workers whose jobs are offshored.

Many Economists Expect Offshoring to Have Little Effect on Long-Run Aggregate Employment, but Expect It to Have Effects on the Structure of Employment

Economic theory predicts that expansions in trade, including offshoring, typically should not affect the overall employment level (net employment) in the U.S. in the long run. Some economists argue that the U.S. labor market is generally expected to adjust quickly to changes in economic conditions because new jobs will be created as jobs are lost, and as a result, those who lose their jobs due to economic changes such as offshoring are expected to readily find new work. Given a flexible labor market, these economists theorize that the primary determinant of fluctuations in the employment rate is aggregate demand in the overall economy, observed in the business cycle.

Historically, the U.S. economy has rarely experienced unemployment rates higher than 10 percent of the labor force, with the exception of unique periods such as the Great Depression. According to Bureau of Labor Statistics (BLS) data, since 1947, the civilian employment rate has increased gradually from around 59 percent in the 1940s and 1950s, to an average of 66 percent over the past 20 years. During this period, the unemployment rate has generally fluctuated between about 4 percent to 8 percent, averaging 5.6 percent per year, even though the U.S. labor force has grown by, on average, 1.4 million people per year. Furthermore, the U.S. employment rate has not been correlated with trade or imports. While traded goods and services have increased from about 4 percent of the gross domestic product (GDP) to about 14 percent of GDP over the past 60 years, employment rates have steadily increased. Even shocks to the percentage of the economy that is open to trade, such as the passage of major trade agreements, have not been correlated with significant changes in employment rates. Some have argued that while balanced trade may not affect employment levels, large and continued trade deficits put American jobs at risk. Historically, however, although employment in certain sectors of the economy is sensitive to trade balances, there has been no evidence of a correlation between trade deficits and overall employment.

Although there is dispute over the number of jobs likely to be lost due to offshoring in years to come, even the larger estimates generally represent a small enough fraction of the total number of jobs destroyed and created in the U.S. that many believe the U.S. labor market is likely to be able to absorb the change. For example, some private sector studies estimate that between 100,000 to 500,000 information technology jobs will be displaced over the next few years, and potentially several million jobs across all occupations could shift outside the U.S. over the next decade. Several economists have pointed out that even the larger job loss estimates represent a relatively small percentage of the total number of jobs destroyed and created annually in the U.S. According to BLS statistics, since the end of the last recession in the fourth quarter of 2001, the U.S. has shed an average of 7.64 million jobs per quarter, while creating an average of 7.77 million jobs per quarter. Viewed in this context, some note that estimates of the number of jobs that could be lost due to offshoring do not appear to be as large of a shock to the economy. Moreover, some maintain that job losses due to offshoring should also be viewed in the context of the two-way flow of trade. Jobs are created as a result of U.S. firms exporting goods and services to other countries and foreign firms locating their production in the U.S. through direct foreign investment.

Although some economists argue that trade, including offshoring, is unlikely to affect long-term employment rates, others have noted that increases in offshoring and globalization could lead to changes in the structure of employment, which could lead to changes in the number of jobs available in different occupations and industries and could also potentially increase unemployment. Structural changes to employment involve the permanent reallocation of workers and resources throughout the economy. Offshoring could contribute to structural changes in employment by changing employers’ demand for different skill-sets and occupations within certain industries. For example, offshoring could lead to substantial reductions in low-skilled IT-based services work while generating increases in high-skilled work such as IT systems management. It may take a long time for the economy to replace jobs lost to structural changes with new jobs because workers must switch industries, locations, or skills in order to find re-employment and because employers must create new jobs. Although the workforce should eventually adjust to the structural changes in the economy, a significant structural change could potentially lead to an increase in unemployment in the meantime.

Regardless of the impact of offshoring on aggregate employment and the unemployment rate, many economists acknowledge that offshoring and increased trade could produce structural changes that could generate permanent shifts within the U.S. labor market. Some economists believe these structural changes will lead to the U.S. workforce gaining better jobs overall, as U.S. businesses respond to offshoring and globalization by creating jobs in new areas of specialization that capitalize on the relatively highly skilled workforce and abundance of capital of the U.S. economy. For example, some note that while the U.S. has lost significant numbers of computer programming jobs, potentially due to offshoring, the U.S. economy at the same time has experienced an increase in the number of more sophisticated computer-related occupations, such as computer software engineers. Other economists suggest that structural changes could lead to lower-quality jobs if the U.S. develops comparative advantage in areas that primarily produce low-skilled jobs.

Research has been done on the extent to which job gains and losses in recent years have resulted from structural changes in the economy; however, this research does not indicate whether the structural changes were due to offshoring. For example, in their study of the recent U.S. labor market, Erica Groshen and Simon Potter found evidence of structural change following the end of the 2001 recession, although they did not investigate whether offshoring was a cause of the structural change.

There is Widespread Recognition That Offshoring Will Cause Some Job Displacement but Considerable Disagreement about the Expected Magnitude of This Problem

Although many economists believe that aggregate employment will not be significantly affected by offshoring, there is widespread recognition that offshoring may nevertheless displace at least some workers from their jobs, leading to adjustment costs incurred by these workers and their families as they seek re-employment. In other words, although net job loss due to offshoring may be minimal, with losses in some industries and occupations offset by employment growth in other areas, gross job losses due to offshoring could be significant.

Limited data make it difficult to draw conclusions about the current extent of job loss due to offshoring. The data limitations have led to conflicting claims, with some arguing that offshoring is a minor phenomenon and others arguing that it is being underestimated. For example, some cite data from the Mass Layoff Statistics (MLS) program produced by the Bureau of Labor Statistics, which showed that about 16,000 manufacturing and services job separations—less than 3 percent of the nonseasonal mass layoffs that took place in 2004—resulted from “movement of work” to locations outside the U.S. However, the MLS undercounts total job separations due to offshoring because it is designed to capture only mass layoffs, not total layoffs. In contrast, others cite privately collected data that suggests that the extent of offshoring is much greater. For example, some have cited data collected by Kate Bronfenbrenner and Stephanie Luce, who attempted to measure the extent of offshoring with data collection from media reports and other sources. Extrapolating from a three month period, they estimate that as many as 406,000 manufacturing and services jobs were shifted from the U.S. to other countries in 2004.

Although there is considerable uncertainty about the number of jobs that have been lost due to offshoring, a number of economists expect that offshoring is likely to expand in the future, both in absolute numbers and in types of work. For example, Cynthia Kroll has estimated that nearly 15 million people, or 12 percent of the employed labor force, are in white- collar occupations at risk to offshoring, though she notes that not all jobs in these occupations are likely to be offshored. Private sector studies have also attempted to create forecasts of the effects of offshoring on employment in “at-risk” occupations; some of these studies project that between 100,000 and 500,000 IT jobs will be displaced within the next few years, and potentially several million jobs across all occupations will shift outside the U.S. over the next decade. However, these studies face challenges in estimating the effects of offshoring because they are often based on federal statistics that currently provide limited information on the level and effects of offshoring.

Some economists have expressed concerns about the potential size of the dislocation costs for workers who lose their jobs due to offshoring, based in part on the experiences of manufacturing workers whose jobs were lost due to trade; others argue that the costs of displacement might not be as large for services workers as they have been for manufacturing workers. Dislocation costs that workers could potentially experience include lost income during their period of unemployment and a lifetime of reduced wages if they cannot find a job that pays as much as the job they lost. Dislocation costs could be higher if job losses are concentrated in geographic areas because it may be difficult for the regional economy to absorb so many job seekers quickly and the local real estate market could be impacted. Research on workers dislocated from jobs in manufacturing industries that faced import competition suggests that workers who lose their jobs due to trade-related employment changes tend to be less likely to find reemployment and to face larger income declines after job displacement than workers displaced from industries that are less trade- sensitive. However, some have raised questions about whether these results are applicable to trade-impacted services workers, who tend to have more desirable labor market characteristics than manufacturing workers. Research by J. Bradford Jensen and Lori Kletzer suggests that in recent years, services workers displaced from “tradable jobs”—jobs in industries and occupations likely to be affected by trade—had labor market advantages over those displaced from “non-tradable” service sector jobs and from manufacturing jobs, such as more education and higher predisplacement earnings. Re-employment rates were slightly higher for displaced service sector workers in tradable jobs, compared to those in non-tradable jobs, and were significantly higher than the reemployment rates for displaced manufacturing workers. Earnings losses were significant for displaced services workers in tradable jobs, however. Of those re-employed, 55 percent experienced a decrease in earnings, with the average re-employed worker experiencing a 30 percent decline in earnings after reemployment. These large losses reflect the fact that displaced services workers in tradable jobs tended to have had relatively high wages prior to displacement.

Underlying the debate about the effects of offshoring on employment and job displacement are different perspectives on the following questions: Will offshoring contribute to structural changes in U.S. employment, and how will these changes affect aggregate employment levels and the type of occupations available to U.S. workers?

How many workers will be displaced due to offshoring?

What are the reemployment experiences of workers dislocated due to offshoring?

Potential Impacts on the Distribution of Income

Some economists have expressed concern that offshoring could accelerate income inequality in the U.S.; however, others argue that changes in the income distribution are driven primarily by factors unrelated to offshoring, and still others point out that offshoring could potentially decrease income inequality. Those who think offshoring might accelerate income inequality believe it could do so by lowering the wages of some lower-wage and middle-class jobs, while potentially increasing the wages of smaller numbers of highly compensated positions. Those who disagree argue that offshoring is unlikely to have significant effects on wages and the U.S. income distribution because changes in demand for different skills are driven more by technological developments than by the changing international division of labor. Those who argue that offshoring could reduce income inequality note that this could occur if offshoring generates wage pressure on high-wage jobs, such as engineering, without significantly affecting the wages of low-wage jobs. Offshoring could also reduce income inequality if it reduces the cost of services that are consumed by primarily lower- and middle-income Americans. Underlying these disagreements are debates about whether, in the long run, offshoring will change the demand for U.S. workers with different skill levels, which sectors of the income distribution are most likely to be affected by this changing demand, and whether offshoring leads to reductions in the cost of services that primarily benefit lower- and middle-income Americans.

Some Economists Expect That Offshoring Could Affect the Distribution of Wage Income among U.S. Workers

Because offshoring is expected to have effects on the structure of employment within the national economy, it is expected to affect the distribution of income in the U.S.; however, experts hold differing views about the direction of these effects. Some contend that offshoring will increase income inequality and note several possible ways that it could do so. First, offshoring could increase income inequality if it primarily led to job losses or wage reductions among relatively low-income workers but had less of an effect on the jobs or wages of middle- and higher-income workers. Some offshoring observers argue that offshoring in the service sector has thus far primarily affected lower-wage jobs, such as call-center work and office support functions, rather than middle- or higher-income jobs. Second, some economists and policy analysts have expressed concern that offshoring could reduce wages at the middle of the income distribution and lead to a “hollowing out” of the middle class if it is primarily middle-income jobs that are moved offshore or experience wage declines. For example, some economists and other policy analysts have noted that sophisticated and well-paid job functions, such as computer programming and radiology analysis, are increasingly susceptible to offshoring. In addition, some contend that offshoring will lead to increased inequality by contributing to income growth among those at the high-end of the income distribution. For example, an increase in corporate profits resulting from offshoring may promote growth in high-wage managerial positions and income accruing to business owners.

However, some economists contend that offshoring could also reduce income inequality if it leads to job losses or reduced wages among higher- wage occupations, such as engineering, without significantly affecting the jobs and wages of low-wage workers. In addition, some argue that offshoring could reduce inequality if it led to a decline in the wages, and consequently fees charged, by highly compensated workers who provide services to lower- and middle-income households. For example, if offshoring puts downward pressure on the wages of accountants, the resulting decrease in the cost of accounting services represents an increase in real wages for lower- and middle-income households who use these services, reducing inequality.

Trade theory can provide a rationale for those who have noted that offshoring could lead to increasing income inequality. One of the most commonly cited models, the Heckscher-Ohlin model, predicts that when the U.S. initiates or expands trade with a country that has a dissimilar workforce, such as a developing country, this trade is likely to have a negative effect on the distribution of wage income within the U.S. workforce. For example, when trade expands between the U.S., a country with a large pool of highly-skilled and educated workers, and a developing country with a large pool of less skilled and educated workers, this model generally predicts that the U.S. will specialize in those goods and services that are best produced by more skilled and educated workers, while the developing country will specialize in those goods and services best produced by less skilled and less educated workers. The implication of this international specialization for U.S. workers is that demand for skilled workers in the U.S. will grow, while demand for less skilled workers in the U.S. will shrink. As a result, wages for more skilled and educated U.S. workers will increase relative to the wages of less skilled and educated U.S. workers, thus increasing income inequality. However, to the extent that services offshoring involves the movement of higher-skilled work to developing countries, more complex versions of this model generate different predictions about income inequality in the U.S.—income inequality could decline if the demand for higher-skilled workers declines relative to the demand for lower-skilled workers.

Although many economists agree that international trade, including offshoring, could have some impact on the distribution of income, some argue that these factors are not among the more important determinants of the U.S. income distribution. These economists argue that other factors are much more significant determinants of the changing U.S. income distribution. In particular, technological change is viewed by some economists as the primary determinant of the growing wage gap between more and less skilled workers. Many economists claim that as technological advances have occurred, particularly in computers and IT, requirements for technological skills for workers across a range of occupations have increased, requirements that often translate into increased demand for more educated workers. At the same time, technological advances have permitted some routine work to be automated, decreasing demand for less-skilled workers. Numerous studies have examined whether trade or technological change explained a larger share of the growing wage gap between more and less educated workers during the 1980s and 1990s, with the majority concluding that technological change was a more important determinant than trade. On balance, these studies conclude that trade has made a small contribution to the increase in income inequality. Estimates suggest that trade explains between 10 and 20 percent of the increase in income inequality, with the majority of the increase attributable to other factors such as technological change that favors higher-skilled workers. However, the impact of services offshoring on income inequality has not been examined to the same extent that manufacturing trade has.

Underlying the debate about the effects of offshoring on U.S. income distribution are different perspectives on the following questions: What are the characteristics (occupation, skill level, and wages) of jobs that are moving offshore?

What are the characteristics of jobs that are being created?

Will offshoring reduce the cost of goods and services that are important consumption items for middle and lower income households?

Potential Impacts on Security

Experts express varying degrees of concern that offshoring could pose security risks, including increased risks to national security, critical infrastructure, and personal privacy. Underlying these disagreements are unresolved questions about the extent to which offshore operations pose additional risks than outsourcing services domestically and the extent to which U.S. laws and standards apply and are enforceable for work conducted offshore.

Some Concerns Have Been Raised That Offshoring May Pose Increased Risks to National Security and Critical Infrastructure, Though Some Experts Contend That Offshoring May Not Pose Additional Major Risks

Some security and offshoring experts, including the Department of Defense (DOD), have raised concerns that offshoring could pose increased risks to national security and critical infrastructure, but others believe that offshoring will not. National security concerns relate to government programs and systems involved in national defense, particularly military and intelligence operations. Critical infrastructure concerns relate to systems and structures owned by either government or private entities that are essential to the country, such as utilities, transportation, and communications networks.

One concern raised by security experts is that offshoring the development of software used in defense systems could pose additional security risks, specifically, that foreign workers with hostile intentions could obtain critical information or introduce malicious code into software products that could interfere with defense or infrastructure systems. There are currently few explicit restrictions on the type of services work that can be sent offshore. DOD’s Defense Security Service has analyzed this issue and identified concerns with the potential exploitation of software developed in foreign research facilities and software companies for projects related to classified or sensitive programs. We have reviewed DOD’s management of software developed overseas for defense weapons systems as well. Our report noted that multiple requirements and guidance acknowledge the inherent risks associated with foreign access to classified or export-controlled information and technology and are intended to protect U.S. national security by managing such access. However, we found that DOD does not require program managers of major weapons systems to identify or manage the potential security risks from foreign suppliers. For instance, DOD guidance for program managers to review computer code from foreign sources not directly controlled by DOD or its contractors is not mandatory. In addition, DOD programs cannot always fully identify all foreign-developed software in their systems.

Private-sector groups and government officials have raised similar concerns about the added security risks posed by offshoring to U.S. non- military critical infrastructure, such as nuclear power plants, the electric power grid, transportation, or communications networks. For example, some have noted that sensitive but unclassified information, such as the plans of important U.S. utilities or transport networks, could be sent to foreign locations where it could be released improperly or made available to hostile foreign nationals. Other concerns relate to the offshoring of software development and maintenance. Software security experts in the public sector—including DOD and the Central Intelligence Agency—have expressed concern that organizations and individuals with hostile intentions, such as terrorist organizations and foreign government economic and information warfare units, could gain direct access to software code by infiltrating or otherwise influencing contractor and subcontractor staff, and then use this code to perpetrate attacks on U.S. infrastructure systems or conduct industrial or other forms of espionage. Security experts also note that critical infrastructure systems rely extensively on commercial off the shelf (COTS) software programs that are developed in locations around the world. These programs include exploitable vulnerabilities and potentially even malicious code that can allow indirect access to infrastructure systems to cause the systems to perform in unintended ways. Thus, some experts believe that ongoing use of COTS software modules, whether developed offshore or not, as well as offshoring of software-related services could increase the risk of unauthorized access to critical infrastructure code in comparison to in- house development and maintenance of proprietary programs and code.

Security experts also express concerns about longer-term effects of offshoring. For instance, some note that continued offshoring of certain products might make the U.S. dependent on foreign operations for critical civilian or military products, and therefore vulnerable if relations between the U.S. and those countries become hostile. Another concern is the ability to control access to certain civilian technologies with military uses when work on these technologies takes place in foreign locations. Some fear that offshoring certain high-tech work may lead to the transfer of information and technology that could be used by foreign entities to match or counter current U.S. technical and military superiority. The U.S. can control exports of such dual-use technologies by requiring firms to obtain an export license from the Department of Commerce before they can be worked on in foreign locations or by foreign nationals. We have reviewed some aspects of this export licensing program and found key challenges to Commerce’s primary mechanism for ensuring compliance with export licenses.

Some representatives of business groups contend that offshoring may not pose major increased security concerns for a variety of reasons. Some believe that protections currently in place are adequate to manage the added risks posed by offshoring. Currently, the Department of Defense has mandatory procedures to safeguard classified information that is released to U.S. government contractors, and firms that offshore certain work related to military technologies are required to obtain export licenses from either the State or Commerce departments. In addition, some argue that foreign workers in offshore locations do not necessarily pose added security risks, relative to U.S. workers in domestic outsourced operations, because domestic workers could also improperly handle information. Some foreign affairs experts also argue that offshoring could have positive effects on national security. They contend that increased international trade may reduce the threat of international tensions because countries with integrated economies have a stake in one another’s well-being.

Concerns Have Been Raised about the Impact of Offshoring on Personal Privacy

Experts express varying degrees of concern about the impact offshoring may have on personal privacy when medical and financial records become accessible in overseas locations. Privacy advocates, academics, and offshoring researchers have noted concerns with the possibility that personal information sent to foreign locations could be improperly released, leading to identity theft, diversion of funds, and breaches of confidentiality. However, others note that the Gramm-Leach-Bliley Act, which covers the privacy of financial information, limits disclosure of personal information and requires financial institutions to protect the security and confidentiality of their customers’ personal information through written agreements when information is sent to a third-party service provider. The privacy of medical information is covered under the Health Insurance Portability and Accountability Act Privacy Rule, which requires certain entities that hold medical records to receive satisfactory written assurance that any of their business associates will handle information appropriately. We are currently conducting work that examines offshoring of protected health information and related privacy issues.

Underlying the debate about the effects of offshoring on security are difference perspectives on the following questions: To what extent does offshoring pose added security risks?

Do existing laws, regulations, and controls provide adequate protection from the added risks posed by offshoring that do exist?

A Wide Range of Policies Have Been Proposed to Address Concerns about Offshoring’s Potential Impacts

Offshoring observers have proposed a broad range of policies in response to offshoring, representing a variety of different ideas about how public policies could address the concerns raised by offshoring. We have categorized these proposals into four types on the basis of concerns they seek to address: (1) improving U.S. global competitiveness, (2) addressing effects on the U.S. workforce, (3) addressing security concerns, and (4) reducing the extent of offshoring. Some analysts have proposed policies in more than one of these areas. On the other hand, it is also possible to take the position that services offshoring does not warrant any changes in government policies. While we indicate the rationales that have been presented for the various policy proposals, we do not evaluate the merits and drawbacks of these proposals. Relevant factors to consider in evaluating proposals would include the magnitude of the problems that policy proposals seek to address, likely effectiveness of the proposals, potential negative consequences, financial costs to government, and feasibility of administration.

Proposals to Improve the Competitiveness of the US Economy

Proponents of policies that seek to improve U.S. global competitiveness view offshoring as one aspect of much broader economic and trade issues and maintain that the debate should be focused on issues broader than the offshoring of work by companies headquartered in the U.S. They contend that the appropriate focus should be on the broader public policy issue of how the U.S. can continue to compete and attract high-paying jobs in a time of rapidly increasing trade and open global markets that allow multinational firms to hire labor from around the world. These proponents have articulated proposals that seek to help the U.S. economy develop new areas of specialization in response to increased foreign competition by fostering the types of industries and businesses that can succeed in a global economy and promote the creation of high-value jobs. In addition, some regard these proposals as important for promoting U.S. economic growth, regardless of the offshoring debate. Many of these proposals have been articulated as broad policy objectives, such as “fostering innovation” or “improving education” rather than as specific policy mechanisms to achieve these objectives. Suggestions for how to improve U.S. global competitiveness include proposals to promote innovation and creative industries, improve human capital and the skill level of the U.S. workforce, reduce the costs of doing business in the U.S., and establish trade practices that promote U.S. exports.

Promoting Innovation

Many economists and policy analysts have predicted that for the U.S. economy to successfully adjust to offshoring, it will need to develop and produce new, innovative goods and services that require and reward higher levels of skill, and they believe that government actions can help to bring about this development. In addition, they point out that private companies can lack the incentives and time horizons to invest sufficiently in basic research—research undertaken without specific desired applications but that can lead to innovations. Some have also noted that federal funding for basic research has recently declined as a percentage of GDP and that foreign governments are increasing their research spending to improve their own economies’ innovative capacity. Policies that have been proposed to promote innovation include: Increasing government support for basic research and development projects.

Making permanent the current research and development tax credit to encourage companies to increase their own spending. Currently, the tax system allows businesses to obtain a tax credit for certain spending on research and development, but this credit requires regular reauthorization, rather than being a permanent feature of the tax code.

Increasing government spending on particular forms of infrastructure and technology that can support innovation, such as broadband Internet connections.

Improving Workforce Skills

Many who emphasize the broad goal of improving U.S. competitiveness also support upgrading the nation’s workforce skills and human capital by improving education, increasing opportunities for worker training, and reforming immigration policy. They contend that for the economy to move into higher-end, innovative products to replace job functions that have been offshored, more American workers will need to develop the knowledge and skills to perform complex, nonroutine work. In particular, they emphasize the importance of education programs in the science, technology, engineering, and mathematics fields. In addition, some have noted that workers will increasingly need to upgrade their skills continually throughout their careers in order to adjust to rapid changes in the modern economy. As a result, many policies proposed in response to offshoring seek to increase the skill level of current and future generations of U.S. workers, including the following proposals: Improving K-12 education, with special attention on increasing achievement in math and science fields. Proponents of these policies argue that U.S. students demonstrate poor achievement in these subjects relative to students in other nations, bringing into question whether the U.S. will have an adequate supply of scientists and engineers to sustain a globally competitive and innovative economy.

Expanding and improving lifelong learning through increased federal support of worker training and advanced adult education programs. One specific proposal is instituting “human capital tax credits” that could be offered either to businesses that spend money on worker training programs or to individuals who spend money on their own education. Such tax credits could partially offset the costs to business of training workers who may not stay with a company for long and the costs to workers of learning skills that may not guarantee long-term employment.

Encouraging immigration of high-skilled workers. Proponents of these policies note that a large and growing segment of U.S. scientists and engineers are foreign-born. Specific proposals to increase the number of highly educated immigrants in the U.S. include raising the number of temporary work visas that allow high-skilled workers to enter the country and expediting the issuance of green cards for foreign graduates of U.S. universities.

Reducing Business Costs

Other proposals to improve competitiveness focus on ways to reduce the costs of doing business in the U.S. relative to other countries. Proponents of these policies note that cost reduction is a leading motive for businesses to offshore service-sector work and that higher costs can affect the ability of U.S. firms to compete against foreign firms in the global economy. Proposals to reduce business costs in the U.S. include: Reducing federal taxes and regulatory requirements on businesses.

Proponents of these policies argue that complex and high taxes and extensive regulations raise costs for companies to do business in the U.S. These proposals assume that taxes in foreign countries would remain unchanged, so that a decline in U.S. taxes would reduce the cost of doing business in the U.S. relative to the cost of doing business overseas, thus increasing incentives for companies to keep work in the U.S.

Reducing costs to businesses of providing health care to employees.

Proponents of these policies argue that high health care costs drive up the total cost of labor compensation for employers, although it is possible that increases in U.S. health care costs could be partially or fully offset by decreases in other components of labor compensation. Various approaches have been proposed to decrease health care costs, such as use of improved technology in the management of patient care, establishing association health plans that would allow small businesses greater leverage in negotiations with health insurance providers, and establishing a universal healthcare system.

Enhancing U.S. Exports

Another type of policy response to offshoring and increasing global interdependence focuses on expanding the market for U.S. exports. Proponents of these policies contend that several factors may be depressing U.S. exports and that more can be done to “level the playing field” of international trade. One concern is that while the U.S. has opened up its markets to foreign competition, some foreign governments have not opened certain of their markets, especially for services in which U.S. companies are globally competitive, such as financial services. Where trade agreements are in place, some have raised concerns that certain foreign governments may be violating them, such as by providing subsidies to their own industries or imposing nontariff barriers to their markets. A further concern that has been expressed is that some foreign governments may be artificially lowering the value of their currencies relative to the dollar so that their exports are relatively inexpensive, while U.S. exports become relatively more expensive. Policies that have been proposed to redress these concerns and enhance U.S. exports include the following: Continuing to negotiate trade agreements that will open foreign markets in which U.S. companies have export opportunities.

Taking more aggressive actions to challenge foreign government actions that may violate existing trade agreements, such as bringing actions at the World Trade Organization (WTO) and imposing retaliatory measures allowed under WTO rules. Such violations could include foreign countries’ tax incentives to U.S. companies that offshore or inadequate protection of intellectual property rights of U.S. imports, which harms the sales of U.S. products forced to compete with unlicensed versions.

Continuing to persuade countries that may have undervalued currencies to raise their currency values or to otherwise engineer a controlled decline in the value of the dollar.

Proposals to Assist Workers Affected by Offshoring

Proposals to address concerns about offshoring’s effects on workers seek to reduce the costs borne by some individuals when an economy becomes increasingly open to foreign trade and competition. Many of these proposals would provide assistance to workers during their period of unemployment and to help them obtain new jobs. While some of these proposals put particularly strong emphasis on retraining displaced workers, not all observers agree that retraining policies would be effective. Other proposals would expand broad social insurance programs that would cover all workers and provide benefits to anyone who loses a job.

Assisting Displaced Workers in Transition to New Employment

Many proposals to help workers affected by offshoring focus on programs designed to help workers adjust to job losses and to facilitate their reemployment. These include the following proposals: Amending the Worker Adjustment and Retraining Notification (WARN)

Act to increase the notice that employers must give employees from 60 to 90 days when offshoring will cause a mass layoff or plant closure.

Extending the Trade Adjustment Assistance (TAA) program to services workers. The TAA program provides extended unemployment benefits and subsidized training to workers involved in the production of articles who can demonstrate that they were displaced due to increased imports or shifts in production to foreign countries. It generally serves workers who have been laid off from the manufacturing sector.

Expanding or developing income support and reemployment programs that would assist displaced workers in general, not just those who meet TAA criteria. Several policy advocates and researchers who have studied offshoring have stated that existing government programs to serve displaced workers do not provide adequate protections or assistance for a changing economy in which global trade affects more workers. For instance, they have questioned the effectiveness of existing worker retraining programs or expressed doubts that retraining will be an effective response as international pressures begin to affect higher-skilled occupations and workers who already have advanced educations.

Establishing wage insurance, a program that would pay displaced workers who find reemployment at a lower wage a percentage of the difference between their previous and new earnings for a limited time. Proponents of wage insurance contend that it would provide incentives for dislocated workers to reenter the labor market quickly, even if they must do so at lower wages. In addition, proponents maintain that wage insurance could encourage workers to take jobs in unfamiliar fields where their inexperience commands lower wages, but where the job imparts new in- demand skills, and allow them to build new careers.

Broader Reforms of Social Insurance Programs

Some have proposed broader reforms to strengthen the social safety net and mitigate some of the hardships generated by the economic insecurity associated with an increasingly integrated global economy. Proponents of these policies emphasize the need to accompany open trade policies with enhanced social protections for all workers who are increasingly exposed to risks by international competition, such as job loss, job insecurity, or downward wage pressure. In addition, proponents contend that government policies should compensate workers who bear the costs of trade-induced economic disruptions. Such proposals would potentially affect large segments of the population and would require extensive rethinking and redesign of U.S. social policy, but proponents maintain that they could increase public acceptance of open trade policies. Such proposals include the following: Making health and pension benefits portable and/or universal so that workers who lose their jobs can retain their access to medical care and retirement plans. Some favor the government’s providing universal health care coverage, and others propose preserving or expanding portable or universal retirement coverage.

Requiring employers that move jobs offshore to pay some of the costs for worker assistance programs. Proponents contend that government should play a role in redistributing some of the gains from offshoring to workers who have been negatively affected. Proponents believe that such proposals would serve this principle and could mitigate some concerns about offshoring’s effects on income inequality.

Proposals to Protect Security

Proposals to address concerns about security seek to reduce the added risk that information sent to foreign locations could be used in ways that could impair U.S. national security, critical infrastructure, or personal privacy. Proposals include restrictions on certain types of work with security implications and strengthening standards governing how information is handled.

Protecting National Security and Critical Infrastructure

Concerns that offshoring could pose increased risks to national security or critical infrastructure have led to proposals to restrict some services work from being sent to foreign locations or performed by foreign nationals and to improve security standards for work that is performed offshore, including the following proposals: Requiring that certain projects involving defense acquisitions or military equipment be performed exclusively in the U.S.

Requiring that work on critical infrastructure projects such as electricity grids or pipelines be done within the U.S.

Increasing the standards and review procedures that apply to use of offshore services. For example, GAO has previously recommended that DOD adopt more effective practices for developing software and increasing oversight of software-intensive systems, such as ensuring that risk assessments of weapons programs consider threats to software development from foreign suppliers.

Protecting Personal Privacy

Concerns that offshoring could pose added risks to the privacy of personal information have led to a variety of proposals to enhance protections, including the following: Requiring companies to keep work involving sensitive private information in the U.S.

Requiring companies to notify and obtain consent from U.S. residents before sending personal information to be processed in other countries.

Ensuring that consumers have legal recourse against U.S. firms for privacy breaches by foreign contractors.

Strengthening U.S. laws and regulations concerning the handling of personal information, regardless of whether the data are handled domestically or overseas. Those who propose this option contend that U.S. laws and regulations do not provide adequate protections for personal information in general, regardless of where the information is handled.

Proposals to Reduce the Extent of Offshoring

Another type of policy that has been proposed to address the various concerns raised by offshoring focuses on reducing the extent of offshoring. Some of these policy proposals focus on offshoring by government agencies, while others seek to modify firms’ incentives with respect to where they source their work.

Restricting Offshoring by Government Agencies

There have been numerous proposals to limit or constrain offshoring by federal and state governments, including the following examples: Legislation proposed to prohibit federal work or federally funded work from being performed in foreign countries, unless the foreign goods or services are for use in that country.

Legislation proposed to require contractors with the U.S. military and executive agencies to have at least 50 percent of their workforce in the U.S.

Legislation proposed to prohibit the federal government from providing assistance to, or doing business with, companies that in the last 5 years offshored jobs previously performed in the U.S., unless the company also creates significant replacement jobs in the U.S.

Legislation proposed in several states to restrict the procurement of state- funded services from overseas.

Proposals to prohibit government contracts from going to countries that have not signed trade agreements with the U.S. on non-discrimination in government procurement.

Modifying the U.S. Tax Code to Reduce Incentives for Offshoring

Another proposed means of reducing offshoring is to change tax policy to alter the relative costs of domestic versus foreign production. Many economists and policy analysts believe the current tax system provides incentives for U.S. multinational firms to locate work at their overseas affiliates because it allows them to defer taxes on profits earned on some activities in foreign countries until the profits are brought back to the U.S. However, some note that this tax treatment helps U.S.-owned businesses compete in foreign markets against foreign-owned businesses. Proposals for changing the tax code include: Eliminating the ability of firms to defer foreign-earned income by taxing foreign profits at the same rate as domestic profits in the year they are earned. This proposal would affect only offshoring that takes place between U.S.-based multinational firms and their foreign affiliates. It would not affect offshoring that involves outsourcing work to separate firms located overseas.

Establishing a value-added tax (VAT) system, in which a tax could be applied to products imported to the U.S. and rebated on products the U.S. exports. However, as GAO and others have reported, many economists believe that such border tax adjustments would not affect the trade balance in the long run because exchange rates would adjust to offset the border adjustments.

Providing Incentives for Businesses to Locate Work in the U.S.

Other policy proposals would enhance incentives for firms to locate work domestically. Proponents of these policies note that foreign governments award incentives, such as providing buildings, infrastructure, and tax exemptions, to companies that export service products. In response, some suggest that the U.S. provide similar incentives, including the following proposals: Providing tax reductions or subsidies to companies that employ domestic workers. One specific proposal is a tax credit for companies in certain industries identified as affected by offshoring that would cover the payroll taxes of newly hired employees.

Providing federal assistance for regional economic development plans, including infrastructure improvements and grants targeted at attracting work that might otherwise be offshored.

Additional Research in Key Areas May Help Advance the Offshoring Debate

Determining appropriate policy responses to the offshoring phenomenon is challenging for several reasons. Services offshoring is a relatively recent phenomenon that raises a broad range of issues. No federal data series directly measure the extent of offshoring or its effects. Moreover, experts have expressed differing views about the potential impacts of offshoring. Nevertheless, there are some key areas where further research might help to provide more information about the impacts and policy implications of services offshoring. These areas include impacts of offshoring on various sectors of the U.S. economy, and especially the sectors that are emerging as new sources of comparative advantage; impacts of offshoring on the workforce, such as numbers of workers displaced and their reemployment experiences; impacts of offshoring on the U.S. income distribution, including trends in wage levels of jobs moving offshore; and any increased security-related risks posed by offshoring and the extent to which these are mitigated by current practices and laws.

Further research in these areas could help inform policy making by providing more information about the nature and magnitude of the benefits and costs resulting from offshoring. For example, research on whether offshoring is negatively impacting important sectors of the economy could help to inform the need for new policies to enhance U.S. competitiveness. Further information on the number of job losses resulting from offshoring as well as how workers fare in the labor market after their dislocations could help inform the need for new policies to assist displaced workers and to target these policies appropriately. Research on how offshoring is affecting the distribution of income in the U.S. could help to inform policy makers whether new policies are needed to address income inequality. Research that examines whether offshoring increases risks to national security, critical infrastructure, and consumer privacy can help to inform policy makers whether there is a need for additional security protections. Finally, research in all of these areas may help to advance the debate about whether policies to reduce the extent of offshoring are warranted.

Researchers are conducting studies that can shed light on some of these areas. For example, some researchers have conducted case studies that examine the effects of offshoring in the semiconductor, call center, and radiology industries. Among other issues, these studies examined the types of work that are conducted offshore and the types of work that are conducted in the U.S. In their study of the radiology industry, for instance, Frank Levy and Ari Goelman conclude that radiology work conducted overseas is unlikely to displace radiology work done in the U.S., noting that offshore work primarily consists of preliminary readings of radiological images conducted at night when few radiologists in the U.S. would be available. However, the radiology industry may not be comparable with other industries in which offshoring takes place. Other researchers have utilized statistical methods for analyzing existing data series. For example, Martin Baily and Robert Lawrence have used a variety of methods to analyze trade and employment data and examine offshoring’s effects on unemployment. In some instances, researchers may be able to apply statistical methods that were utilized in research on offshoring and trade in the manufacturing sector to conduct research on services offshoring.

There may also be opportunities to expand or improve current federal data series to obtain more information on this topic. For example, some have raised concerns that there is a significant discrepancy between data on the levels of services imports from India as reported by U.S. federal government sources and the data reported by India. In a review of BEA and Indian services data, we identified several factors that contributed to this discrepancy, such as differences in each country’s definitions of trade in services. We also recommended ways in which BEA can further improve its services trade data. Other examples of limitations of current databases identified by offshoring researchers are that data on services trade are not available at a sufficiently detailed industry level, trade data may not capture services that are bundled with goods or other services, and data on foreign affiliates of multinational corporations lack information on occupations of workers employed overseas.

Table 1 illustrates some key areas where further research might contribute to a better understanding of the effects and policy implications of offshoring. The table identifies some pertinent data sources, though none of the sources can directly answer the research questions. Generally speaking, these data sources can provide information on a phenomenon, such as changes in employment in a given occupation or changes in the output produced by an industry, but they cannot provide information on the extent to which these changes resulted from offshoring. For example, BLS collects data on employment levels in various industries and occupations, but the data capture job losses and gains that occur for all reasons, not only because of offshoring. Table 1 also identifies some of the methodological approaches that have been, or could be, used in these areas of research. These include conducting in-depth studies of firms and industries and using statistical methods for analyzing existing data. Table 1 also highlights some potential challenges and limitations of the various approaches. For example, while in-depth studies of services offshoring in particular industries may shed light on some dynamics of the offshoring phenomenon, their findings are not necessarily reflective of what is occurring nationally. Our overview of research questions, data sources, research methods, and limitations is not meant to be exhaustive. Researchers will continue to pose new questions and approaches to gain further insights into offshoring.

Concluding Observations

Services offshoring is likely to remain an important public policy issue for years to come. The extent of offshoring could increase in the future as technology advances, U.S. firms become more adept at offshoring, and other countries continue to improve their abilities to provide services for the global economy. Because the services offshoring phenomenon is relatively new, little is known about its effects on the U.S. economy and society. Due to limited data and empirical research thus far, the debate about offshoring has largely been theoretical in nature. Policy makers and analysts face data challenges as they seek to assess the wide range of policies that have been proposed in response to offshoring. In making these assessments, they may consider various relevant factors, such as the magnitude of the problems that policy proposals seek to address, likely effectiveness of the proposals, potential negative consequences, financial costs to government, and feasibility of administration.

As the offshoring phenomenon continues, researchers in both the public and private sectors are likely to conduct more studies and collect more data that will provide a clearer understanding of offshoring and its effects. We have highlighted some key areas where further research might help advance the debate about the impacts and policy implications of offshoring. While such research faces numerous challenges and limitations, it offers some prospect for additional insights on diverse aspects of services offshoring.

Agency Comments

We provided a draft of this report to the Departments of Commerce, Labor, Treasury, and the Office of the United States Trade Representative. We received written comments from Commerce, which are reprinted in appendix III. Commerce stated that it appreciated the thoroughness of our review and that the report will be a useful reference starting point for discussions of the causes and impacts of offshoring. Commerce also stated that offshoring may raise living standards for the average American and affect fewer workers than the headlines seem to indicate, but that all of us must be troubled when any American workers lose their jobs, for whatever reason. Commerce added that the most powerful remedy for this problem is a growing economy that can ensure every American who wants a job is able to find one. Commerce, Treasury, and the Office of the U.S. Trade Representative provided technical comments, and we modified the report as appropriate to address these comments. The Department of Labor did not have comments.

Copies of this report are being sent to the Departments of Commerce, Labor, and Treasury; the Office of the U.S. Trade Representative; appropriate congressional committees; and other interested parties. Copies will be made available to others upon request. The report is also available at no charge on the GAO Web site at http://www.gao.gov.

If you or your staff have any questions about matters discussed in this report, please contact me at (202) 512-7215 or at nilsens@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this report. Other contacts and staff acknowledgments are listed in appendix IV.

Appendix I: Scope and Methodology

Our objectives in this study were to: (1) describe experts’ views about the potential effects of services offshoring on the U.S. economy, workforce, national security, and consumer privacy; (2) describe the types of policies that have been proposed in response to offshoring; and (3) discuss areas where further research could advance the debate on offshoring. Our methodology consisted of an extensive literature review and interviews of selected experts. In addition, we attended several conferences on services offshoring during the course of our work. We conducted our work from May 2004 to November 2005 in accordance with generally accepted government auditing standards.

We reviewed literature on services offshoring produced by academic experts, think tanks, business groups, labor groups, and government agencies such as the Congressional Research Service. Our literature review built upon work conducted under previous GAO studies of services offshoring. We collected additional literature by reviewing research databases such as Econlit and Proquest and through general Internet searches. We also conducted targeted searches of the literature produced by various think tanks, interest groups, and other government agencies. In addition, we were referred to literature through citations in other literature, through media accounts, and by experts we interviewed. Through the course of our work, we sought to obtain a diverse body of literature that described various views on the potential effects of services offshoring and policy proposals. For studies summarizing empirical research findings, GAO reviewed these studies solely to describe the views of various experts on the effects of offshoring and the research methodologies they used. The inclusion of studies in this report does not imply that we deem them definitive or that the evidence presented in them is conclusive. Additionally some of these studies contain estimates of job losses due to offshoring of services that are of undetermined reliability. These estimates are presented for illustrative purposes and should not be considered in the same manner as the official government data on employment and trade discussed in the report. See the bibliography for a list of key literature reviewed for this report.

We interviewed experts from government agencies, academia, think tanks, and organizations representing business and labor interests. We met with government officials at the departments of Commerce, Labor, and Treasury, and at the Office of the U.S. Trade Representative because each of these agencies analyzes issues related to offshoring. We selected other experts to interview based upon literature they published related to the offshoring phenomenon and through referrals by other experts. We strove to obtain a balance of views among the experts we interviewed. In addition to interviewing experts, we also reviewed interviews conducted for other GAO work on services offshoring. See appendix II for a list of experts interviewed for this report.

We also attended several conferences related to services offshoring to obtain further viewpoints on this topic, including conferences organized by the Brookings Institution, William Davidson Institute at the University of Michigan Business School, CATO Institute, Labor and Worklife Program at Harvard Law School and the North American Alliance for Fair Employment, Stanford Business School’s Sloan Masters Program and World Affairs Council of Northern California, Asia-Pacific Research Center at Stanford University, and the Bernard and Audre Rapoport Center for Human Rights and Justice of the University of Texas School of Law.

Appendix II: List of Experts Interviewed

Jodie Allen Senior Editor Pew Research Center Robert Atkinson Vice President & Director Technology & New Economy Project Progressive Policy Institute Ashok Bardhan Senior Research Associate Fisher Center for Real Estate & Urban Economics, Haas School of Business, University of California Berkeley William Baumol Professor of Economics New York University Jagdish Bhagwati Professor of Economics Columbia University Josh Bivens Trade Economist Economic Policy Institute Susan Collins Senior Fellow, Economic Studies The Brookings Institution Ralph Gomory President Alfred P. Sloan Foundation Ron Hira Assistant Professor of Public Policy Rochester Institute of Technology and Vice President for Career Activities, Institute of Electrical and Electronics Engineers-USA Josh James Manager of Research American Electronics Association Matthew Kazmierczak Director of Research American Electronics Association Martin Kenney Professor of Human and Community Development University of California Davis Lori Kletzer Professor of Economics University of California, Santa Cruz Cynthia Kroll Senior Regional Economist Fisher Center for Real Estate & Urban Economics, Haas School of Business, University of California Berkeley Jeff Lande Senior Vice President Information Technology Association of America Robert Lawrence Professor of International Trade and Investment Center for Business & Government, John F. Kennedy School of Government, Harvard University Thea Lee Assistant Director for International Economics AFL-CIO Robert Litan Senior Fellow Economic Studies The Brookings Institution Catherine Mann Senior Fellow Institute for International Economics Lee Price Research Director Economic Policy Institute Robert Reich Professor of Social and Economic Policy Brandeis University Dani Rodrik Professor of International Political Economy John F. Kennedy School of Government, Harvard University Enrique Sanchez Director Bank of America (retired)

Appendix III: Comments from the Department of Commerce

Appendix IV: GAO Contacts and Staff Acknowledgments

Staff Acknowledgments

In addition to the contact named above, Andrew Sherrill, Assistant Director; Yunsian Tai and Katrina Ryan, Analysts in Charge; Rhiannon Patterson; Eric Wenner; Margaret Armen; Lawrance Evans, Jr.; and Tovah Rom made significant contributions to this report.

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