Foreign outsourcing—the importing of some intermediate product (i.e., a portion of a final product or some good or service needed to produce a final product) that was once produced domestically—is not a new phenomenon, nor is it one that is economically distinct from other types of imports in terms of its basic economic impact. A steadily rising level of trade in intermediate products is one of the salient characteristics of U.S. trade and world trade for the last 30 years. Lower transportation costs, improved international communication, and the reduction of government barriers to trade have helped propel the transformation to an ever more internationally fragmented production process in many industries. An obvious example of this is the automobile: no matter what the nameplate, the raw materials are produced in many different places, and parts are manufactured all over the world for final assembly often, but not always, in the destination country. It has been estimated that as much as a third of the growth of world trade since 1970 has been the result of such outsourcing worldwide. In the United States, large shares of both exports and imports are intermediate products. In the recent years, just the capital goods category by itself has accounted for about 50% of nonagricultural goods exports and around 30% of nonpetroleum goods imports. And the greatest change, for the United States has occurred on the import side. Using capital goods as an example again, in 1970 such exports were about 40% of total exports, while imports had a share of only 11%. Outsourcing may seem different from traditional notions of trade in that it involves exchange of a productive resource (capital or labor) rather than an exchange of a final good and service, but it can be analyzed within the same framework as increased importing of a final product or increased trade in general. The central economic question to be answered is whether increased foreign outsourcing increases or decreases overall economic well-being. To answer that question will certainly require an accounting of the deleterious effects of foreign outsourcing on domestic workers and industries who once produced the now outsourced product, but it will also require an accounting of the gains to domestic consumers of the now imported product as well as any induced benefits to exporting industries. If benefits exceed costs, then measures to constrain outsourcing will tend to reduce overall economic well-being. But even if it is clearly a "net gain" foreign outsourcing brings into conflict the goals of increasing economic efficiency and maintaining an equitable distribution of those gains. This intertwining of economic efficiency and distributional equity will mean that policymakers may find it difficult to take advantage of the increase in economic efficiency that foreign outsourcing affords without also establishing policies to assure equitable treatment of those whose jobs are lost and whose lives are disrupted by this market churning force. What economic analysis also highlights is the inherent "two-way" nature of trade, including foreign outsourcing. Something is given up and something is gained. More imports tend to beget more exports. If there are economic reasons for U.S. firms to outsource abroad, there are likely similar reasons for foreign firms to outsource to the United States. Jobs are created and destroyed. What is produced and what is traded for will not be determined just by relative wages, but rather the relative efficiency in the production of traded products. Low wages will likely attract certain types of production. However, because of differences among countries in their capacity for innovation, in their technical prowess, and in their workers' skills and productivity, there will be many things that can be produced more efficiently in high-wage economies such as the United States. Over time an economy's relative advantages may change but there need be no general deterioration in what it gains from trade. Perhaps foreign outsourcing is now more noticed because it is occurring with rising frequency in the service sector and adversely effecting a strata of the labor force that heretofore was more insulated than goods producing industries from the pressures of international competition. But the nature of the process is the same whether it is trade between individuals, regions, or countries; or trade of final goods or services; or trade of intermediate goods and services: increased economic well-being results from producing what one does best and trading for the rest . In this economic framework it follows that, for the nation, trade is ultimately not about competition, rather it is a process of mutually beneficial exchange. As noted above and developed more fully below, the overall macroeconomic impact of foreign outsourcing will be a net effect , involving negative and positive impulses that create and destroy jobs. Unfortunately, there are no public data series that allows a ready tallying of the net impact of foreign oursourcing on the economy. Therefore, beyond the predictions of economic theory, analysis of this phenomenon must use indirect evidence. Since foreign outsourcing has already occurred on a relatively large scale in the goods-producing sector of the U.S. economy, this report takes the approach that this experience will be the best predictor of the economic effects of outsourcing's spread to the service sector. Further, it is assumed that the tools of economic analysis used to isolate and evaluate these past economic effects are appropriate for judging the probable economic effects of current and future outsourcing, wherever in the economy they might occur. Foreign outsourcing destroys jobs in those parts of the economy that once produced the now imported product, but economic analysis tells us that due to off-setting employment effects in other parts of the economy, foreign outsourcing (or imports in general) is unlikely to cause a net loss of jobs economy-wide. A steady churning of labor markets is a normal characteristic of a dynamic market economy like the United States. Foreign outsourcing and increased imports can contribute to that "churning," and in doing that can be expected to change the composition of total output and the composition of total employment, but they do not necessarily permanently reduce the level of either. There are two complementary reasons for the relative steadiness of total employment and output in the face of foreign outsourcing and other disruptive market forces. First, the Federal Reserve, using monetary policy, can set the overall level of spending in the economy to a level consistent with full employment. While deviations from full employment can occur, a well run monetary policy will minimize the incidence and duration of such episodes and help keep the total level of employment high in most years with or without outsourcing, trade deficits, or trade in general. To give some perspective on the relation between "job loss" and total employment, as well as the potential significance of foreign outsourcing in this dynamic process, consider that in any quarter of 2000, at the peak of the last economic expansion, with total employment at about 111 million, gross job losses tallied between 8.5 and 9.0 million. Nevertheless, the economy at that time was operating at the lowest rate of unemployment in 40 years. Over the whole course of that expansion gross job loss actually rose as the unemployment rate steadily fell. But with adequate economy-wide spending, it was possible to create job gains that more than offset job losses. In the somewhat more tepid labor market conditions of the current economic expansion, gross job losses per quarter between 2002 and 2005 have averaged around 7.4 million—compared with gross job gains in this period that have averaged about 7.8 million per quarter and, as a result, led to a rise in total employment during the 2002-2005 period. In either time period gross job losses occurred on a scale well beyond what is currently attributed to foreign outsourcing. Second, against the economic backdrop of adequate aggregate spending, any increase in the purchase of imports will tend to generate an equal increase in the sale of the country's exports of goods or assets . This outcome follows from the fundamental economic requirement that imports must be paid for and exports are the only means for making that payment. The export sold does not have to be a currently produced good or service, it can also be the sale of an asset such as a deposits in a bank account, shares of stock, bonds, or real property, but in the end when tallied across transactions in goods and assets, a nation's trade is always in balance in the sense that any imbalance in goods trade must be offset by a compensating imbalance in asset trade. Both types of export sales will have a positive effect on domestic output and employment, countering across the whole economy the negative effect of increased imports. In short, the U.S. deficit in trade is offset by the surplus in capital flows. Consider, for example, a situation where a service once provided domestically is now imported from a country such as India. Since foreign suppliers do not spend dollars, the U.S. importer will have to buy the foreign currency needed from its foreign exchange market or pay in dollars and let the foreign supplier buy local currency from its foreign exchange market. Either way, to generate the foreign exchange the United States must export something. It can sell U.S. goods or services, or it can sell U.S. assets (i.e., bank deposits, stocks, bonds, real property, etc.). The positive stimulus of the increased export of goods is direct. When foreigners purchase U.S. goods, U.S. output and employment rise to offset the loss of service jobs to India. If exports increase less than the amount needed to offset jobs lost, the United States then must, in effect, borrow the money needed to pay for the increased imports through the sale of an asset. The stimulus from an increased export of assets is indirect. Because the sale of an asset is equivalent to an increase in the flow of saving available to the U.S., it exerts a downward push on domestic interest rates, stimulating interest-sensitive activities such as spending on consumer durables and residential construction, and raising output and employment in these sectors. Therefore, whatever negative effects increased imports have on output and employment are offset by the positive economic effects of increased exports of goods or assets.