The Unintended Consequences of Outsourcing

The outsourcing of labor overseas is a natural result of the globalization of markets, and businesses' drive to cut costs to maximize profits. If workers in countries such as India or China can do the same job for a fraction of the price that domestic labor demands, those jobs will be sent abroad.

It's a good business strategy that allocates labor to its most efficient use, at least according to economists. In the end, the effect should ripple down and help consumers by lowering the costs of production which can be passed on to buyers, and to shareholders who will see increased profit margins. Without outsourcing, the United States may not have maintained its status as an economic superpower as the world became an integrated global marketplace.

But as with most things, outsourcing isn't all good; it does cause some unintended negative consequences.

Outsourcing Lowers Barriers to Entry and Increases Competition

While increased competition is encouraged by free markets and generally benefits consumers, it can hurt businesses that can't keep up. Outsourcing allows new entrants to industries where labor would have been too expensive otherwise.

A startup company seeking to manufacture electronic devices might not be able to get off the ground if it had to hire American factory workers, but can now easily find eager and cheap skilled laborers abroad. Barriers to entry that once existed due to the capital requirements needed at the startup phase can be greatly reduced. 

Early movers in an industry to outsource will have a competitive advantage initially, but that advantage will continue to be eroded as more competitors follow suit, and newcomers are incentivized to join. Once everybody is participating, the initial advantage is removed completely.

Outsourcing also encourages new competition by causing fragmentation and disintegration of the supply chain. In other words, new entrants can arise to exploit the fact that manufacturing may take place in a different geographic region from product design and customer support in yet another region. Each part of a business is effectively subcontracted out, and that means that any new company can hire those same contractors (or competitors of those subcontractors) and produce identical items for around the same cost as the big players.

Outsourcing Erodes Company Loyalty

If a worker knows that their job may be outsourced to cheaper foreign labor at any given moment, they may lose confidence in their employer and become discouraged. As outsourcing has grown from unskilled jobs to include administrative and intellectual positions, even managerial level employees cannot be certain that their jobs are safe and secure. Workplace satisfaction and worker productivity can be negatively impacted.

Additionally, if an employee, or group of employees, decides that they are being treated unfairly or are being underpaid, they can leave to start their own company in direct competition with their former employer. This possibility is more likely than ever before because of outsourcing's lower barriers to entry.

Consumers can also be turned off by outsourcing. The most ubiquitous case is the outsourcing of customer support or technical support to places like India. When customers hear a foreign accent answer their call to an American company, they may lose trust in the company and could even blame that company for eliminating American jobs. The situation becomes even more sensitive when customers have to share medical or financial information with strangers overseas. Customers may band together to boycott these companies or spread negative sentiments through social media.

Outsourcing Can Eliminate Jobs From the Domestic Workforce

While there is much debate as to whether or not outsourcing causes unemployment or actually adds jobs to the economy, it is obvious that it does eliminate certain kinds of work. Presumably, those workers who lose those jobs go on to get better jobs in new industries or through better training and education.

Manufacturing jobs are a prime example. Today, much of what is made by American companies actually gets produced in foreign factories. While it is true that U.S. manufacturing as a contributor to gross domestic product (GDP) has not changed much, the types of manufacturing jobs in America today are not the same as they used to be.

Today's U.S. factory jobs are dominated by information technology, robotics, precision machines, and engineering. The low-skilled jobs involving repetitive manual labor have been outsourced either to cheap labor abroad or to technology. As a result, entire towns and communities that relied on assembly lines and factories have become virtual ghost towns. The so-called Rust Belt is a prime example of this phenomenon. It refers to the staggering economic decline, population loss, and urban decay caused primarily by shrinking the domestic industrial sector throughout the Northeast, Mid-Atlantic, and Midwest.

Outsourcing Affects Insourced Countries

The rise of the Chinese middle class in the past few decades has been attributed, in part, to its rise as a global exporting powerhouse. But as more work is outsourced to that country, Chinese workers will begin to demand higher pay. The ripple effect predicts that China's competitive low-wage advantage will eventually be eliminated, and the boost to economic production that resulted will also depart.

Outsourcing also takes labor out of the workforce of a country and sets laborers to work doing tasks that may not be critical to their own country's development or growth, but pays better nonetheless. People may be enticed to leave agrarian or cottage industries to earn more money in a city as a call center operator.

And what happens when there are no more cheap labor regions to exploit? Companies may then turn to technology to replace workers causing unemployment of unskilled labor abroad as well as at home.

The influx of investment from abroad, especially for manufacturing, can also lead to a glut of factories that spit out pollution and carbon dioxide into the atmosphere, negatively affecting the health of workers and nearby communities. To try to offset the increase in pollution, China is planning to institute a national emissions trading system, whereby CO2 credits can be traded with other countries.

The Bottom Line

Outsourcing is a good business strategy for companies seeking a competitive edge in finding low-cost labor. This allows these companies to boost profits and pass lower costs on to consumers.

Outsourcing also has a number of unintended consequences such as lowering barriers to entry and increasing the level of competition a company has. It also has effects on brand loyalty and satisfaction; both for a company's employees and its customers.

Outsourcing can also lead to disruptions in the labor force and even cause entire communities to become deserted. Finally, the unintended consequences of outsourcing can eventually spread to the countries where the work is being sent.

Article Sources
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  1. Bureau of Economic Analysis. "Gross Domestic Product by Industry and Input-Output Statistics," Download

  2. Wiley Online Library. "Rust Belt Cities."

  3. Brookings. "Introduction: The Rise of the Middle Class in the Middle Kingdom."

  4. Global Economic Policy and Institutions. "China’s National Emissions Trading System," Page vii.

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