Path to growth: Service centres such as this one in Chennai hold the key to improved productivity of many US firms

Cross-border outsourcing has become a hot button in American politics, as the pace of total job losses from structural changes and skill rebalancing has accelerated to 1.2 million per year. However, better jobs are being created in the US everyday in growth sectors and specialised segments. The unemployment rate is relatively low-6.1 per cent, despite the economic downturn. The underlying strength of the US economy is evident from the rate of job creation over the past decade-3.5 million jobs per year. Focusing on job losses in America without recognising the corresponding job gains is like managing a bank account by counting the withdrawals, and not the deposits; disregarding the improvements in the quality of jobs is like ignoring the interest payments.

Disrupting to Create

This is not the first time Americans have become very concerned about their job security. In the early 80s, the US was losing jobs at the rate of 200,000 jobs per year. The unemployment rate crossed 10 per cent. Japanese imports received the bulk of the blame in public debates. Japanese workers seemed like the obvious culprits, with twice the productivity of their American counterparts. Companies like Honda, Komatsu, Fujitsu, Canon, and Sony increased their marketshare in the US offering products at globally competitive prices. Investors around the world bet big on Japanese companies. The market capitalisation of Japanese companies grew to be twice that of the US companies.

This did not last for long. Spurred by global competition, American companies invested in productivity and innovation. Manufacturing output and productivity continued to grow. Investors also rewarded the performance improvements by channeling capital back to the US. Aided by the productivity growth and lower prices, the American economy expanded. Over 20 million new jobs were created in the 80s, mostly in services and advanced manufacturing.

The American economy experienced another wave of 'disruptive creation' in the 90s. Based on Department of Labor data, during 1989-99 about 1.3 million jobs (net) were eliminated due to technological changes, business restructuring, and repositioning. Over 40 per cent of the jobs in coal mining disappeared in the 90s. Over a million manufacturing jobs went to lower cost destinations like Mexico, Canada, and China. However, the American workforce continued to grow and the wages increased. Overall the economy created over 22 million jobs (net) during the 90s, in sectors such as business services, health services, personal services, computer services, construction, education, and entertainment. Both labour productivity and GDP grew by about 20 per cent during this period.

Today, American companies enjoy a market capitalisation of around $15 trillion-about half of global capitalisation, and five-times that of Japanese companies. This is a wholesome measure of the profit growth and wealth creation that happened in America over the past two decades. The US unemployment rate is around the long-term average of 6 per cent. America is going through a new wave of disruptive creation that will accelerate the dynamic of wealth creation, this time triggered by cross-border outsourcing.

Outsourcing manufacturing and services to other countries has already generated billions of dollars in savings for American corporations and has improved their global competitiveness. Yet, there is hysteria around the projected job losses-200,000 per year-arising from cross-border outsourcing. One needs to take a longer-term perspective to understand the macroeconomics of outsourcing.

Higher Productivity, Better Jobs

Cross-border outsourcing is good for American shareholders, consumers and workers alike. US companies and their shareholders benefit from the lower costs (50 to 70 per cent savings) and productivity improvements that result from outsourcing; they also profit from the new exports of equipment and software to outsourcing destinations like China and India. American consumers and taxpayers benefit from the higher quality of life made possible by cheaper costs of goods and services. American workers benefit directly from the higher-paying jobs that would be created in the economy, as corporations reinvest their profits in new markets and products.

Cross-border outsourcing also contributes to global trade and integration. It unlocks the skills, dedication and enterprise lying locked up in countries like India, China, and the Philippines. This will no doubt improve the standard of living of millions of people, just as NAFTA helped millions of people in Mexico. But outsourcing will help Americans the most. A McKinsey study found that every dollar of labour cost outsourced offshore creates over $1.45 of value; 78 per cent of this value is retained in America and only 22 per cent of the value goes to outsourcing destinations like India.

The current paranoia in America around cross-border outsourcing is not only unwarranted, but also self-destructive. According to the National Association of Manufacturing, the US economy is close to its full employment level. The US will experience a shortfall of skilled employees and factory workers from 2004 due to its demographic and educational structure. The US workforce will peak at 160 million, and the labour shortage will grow to 5.3 million by 2010. America will need to open its borders far wider for outsourcing and immigration to address this structural problem. Outsourcing low-skill jobs to other countries helps America solve the problem with minimal disruption. This is far less demanding on national resources than massive inflow of immigrant workers.

The reality is that cross-border outsourcing alone cannot replace enough jobs to avoid the imminent skill shortages and associated inflation. For example, India's 250,000 outsourcing workers represent less than 0.2 per cent of the US workforce. These educated workers have a comparative advantage in delivering low-skill services. They cheerfully perform repetitive jobs in calls centres and data centres at 15 per cent of US pay. They are a part of the solution to upgrade the jobs in the US. Every job outsourced generates cost savings to be invested in a better job for an American. These savings improve the productivity of US companies, and enable them to deliver products and services at competitive prices to consumers around the world.

When technology, market shifts, imports or outsourcing disrupt jobs, they tend to create higher-skilled positions elsewhere. Most people who lost their jobs in the 90s got a better job after a few months of search and retraining. Only about 1 per cent of the US workforce remains unemployed beyond six months-the period of unemployment benefits. This is the lowest long-term unemployment in the world. It is estimated that in the 90s, there were around 2.7 million people who found jobs requiring an improved skill set. Companies such as Intel are good examples of these job changes (not job losses). At Intel, technology and outsourcing have displaced thousands of employees, but its workforce has continued to grow. With each round of displacement, the employee skill levels were upgraded, and the jobs got better in terms of quality and pay.

The Macroeconomic Perspectives

Joseph Schumpeter propounded in 1942 that waves of destruction and creation would blow through all capitalistic economies from time to time, relentlessly renewing the economic structure from within. These waves should be viewed in the backdrop of the dynamics of wealth creation in capitalistic economies. Adam Smith in The Wealth of Nations asserted two centuries ago that the most productive and innovative companies will create the highest returns to shareholders, and employ more productive workers and increase returns further-a virtuous cycle enacted by the invisible hand of the capital markets. Business leaders and savvy investors recognise these patterns and profit from them. Some get caught up in the disruption, and overlook the creation of wealth that follows.

Most US economists see past the short-term indicators like weekly unemployment claims to form their views on what is good for America's future. William Poole, President of Federal Reserve Bank of St. Louis, recently stated that it is good for the US to displace low-wage, manual kinds of labour with higher-skill, higher-tech, higher-education-content labour. He compared the recent loss of jobs in manufacturing and low-wage services with the decline in agricultural employment of the early 20th century.

Larry Summers, former US treasury secretary, argued against make-work programmes, saying that the best social welfare programme is a dynamic economy where jobs are looking for people-as well as people looking for jobs. Robert McTeer, the far-sighted President of the Federal Reserve Bank of Dallas, recently argued against protectionism as follows: "Instead of counting jobs, we should make every job count. If you want jobs for jobs' sake, trade in bulldozers for shovels. If that doesn't create enough jobs, replace shovels with spoons.... There will always be more work to do than people to work. We will occasionally hit a soft spot when we have a mismatch of supply and demand in the labour market. But that is temporary. Don't become a Luddite and destroy the machinery, or become a protectionist and try to grow bananas in New York City."

Overcoming Resistance to Change

Some American leaders in their solicitude to preserve jobs have advocated outlawing outsourcing. Any such legislation will weaken productivity, innovation and wealth creation in the US, and will tax the same workers they are trying to protect. The savings and productivity improvements are large enough to provide extended unemployment benefits to American workers (as in Europe).

Global corporations like GE and American Express understand the dynamic of disruptive creation. They outsource selectively and responsibly, and pass on billions of dollars in savings to American consumers and taxpayers. Barriers to cross-border outsourcing in any form will undermine the productivity and profitability of American multinationals, and will derail the economic recovery that is underway in the US.

These economic debates will intensify as the US approaches the next Presidential election. Some arguments are based on macroeconomics; some are rooted in legitimate concerns of the aging American workforce; others are just myopic opinions. Indian business and political leaders should not get embroiled in these debates, lest India become the lightning rod that bears the brunt of the fury of the US workers. Let the invisible hand of the market make its way. Let US companies and their shareholders enlighten their consumers and workers on the merits of cross-border outsourcing.

McKinsey alumnus Max P. Michaels is the Co-founder of CRYZTAL Capital, a Corporate Member of the US India Business Council and the Chair of the CEO Council of TiE New York. He can be reached at mpm@cryztal.com