Evolution Discussion

The update on the Evolution of Offshoring generated all sorts of comments, from productivity to quality. I still didn't get any suggestions for the new kinds of jobs that the US workforce would pick up, however.

I've noted a few of the comments here in blue, with my responses in black.

Craig Davis of Product Genesis:

Some additional food for thought relative to productivity/quality. The full article, from http://www2.cio.com/info/releases/09020387_release.html raises some interesting productivity costs about culture (US workers will more readily speak up if they think something needs to be changed) and process (many clients' development processes are not explicit enough to transfer easily). This is a quality argument in the sense that while an outsourced firm may do exactly what is asked, it might not be addressing the right problem.

"Hidden" investments businesses must make in a successful offshore outsourcing arrangement:

The Cost of Selecting a Vendor: CIOs should expect to spend an additional one to ten percent on vendor selection and additional travel costs.
The Cost of Transition: CIOs should expect to spend an additional two to three percent in transition costs.
The Cost of Layoffs: CIOs should expect to pay an extra three to five percent on layoffs and related costs.
The Cultural Cost: CIOs should expect to pay three to twenty-seven percent on productivity lags.
The Cost of Ramping Up: CIOs should expect to spend an extra one to ten percent on improving software development processes.
The Cost of Managing an Offshore Contract: CIOs should expect to pay an additional six to ten percent on managing an offshore contract

These all relate to the major cost of offshoring, which is transition costs. Offshoring requires major change in the way people work. It's a pain in the butt, and extends your workday.

Paul Erling of Enera writes (in blue, and my responses in black):

I Offshoring and Productivity

I noticed a criticism of US productivity figures that argued that by using offshoring, the GDP per worker figures are skewed, because accounting for the number of hours worked by offshore contractors to US firms is flawed to make it look like the US is doing more with less. What do you think of that argument?

In strict productivity accounting, this shouldn't happen, because productivity measures output per hour -- it has nothing to do with relative prices. From what I've heard from folks who have offshored to India, for example, productivity is about the same, or a bit lower, in India. The prices are much lower, and that's what drives the switch.

I suspect, however, that the Labor Department doesn't capture productivity numbers this way. Rather, they look at domestic hours worked and total output. If this is true, then offshoring contributes to the increase in US productivity, even if it doesn't actually make anyone more productive.

It certainly frees up resources, however, 'cause folks are paying less for the hours in India.

II. What is high value anyway?

The other comment is, can you argue that in "rich countries", many things are overpriced because people can afford to pay, not that there is anything intrinsic to the product that requires a particular valuation? Global markets make things cheaper by increasing competition. Better communication also tends to even out wide variations in pricing. Is that "high value worker" turning to even higher value things, or has his work just been repriced?

Sometimes this is the case, especially when there are barriers to the free flow of people, goods or services. Prices are determined by "community standards," and those are different region to region.

In other situations, the price of the product relates to its formulation and packaging, which really is different, with higher benefits in a "rich country" than a poor one. For example, toothpaste in India is formulated using chalk, while in Europe or the US, toothpaste is formulated with silica. There's a very big difference in the price of these ingredients, and in their effect in the formulation.

And then there are pharmaceuticals ... manufacturing costs are low, but who pays for the research that generates the formulation? The emerging perspective is that poorer countries will be subsidized by richer ones in the form of lower drug prices.

III. The Book business (and Costco)

I think you could look at the book business as a model.

It used to be that you had people who made their living running around to different used book stores in Chicago and buying books from one used book store and selling them to another rare book store.(also known as arbitrage). Local booksellers with large inventories often didn't really know about high spots in their inventory. As interest and demand grew, this type of book jobber now sells direct to the Internet, in competition with the Used book dealer and the Rare book dealer both. Lots of people can learn what the more "easy to find" rare books are worth. This has put the "mid level rare book dealers" out of retailing. Now if you find a big inventory, they are marketing not to collectors, but to people who can't afford new books (which seems like a different business).

The business of marketing to collectors has consolidated at the high end, but spread out at the low end, and more pressure is on the high end vendors. Increasingly the Auction houses like Sotheby's or Christie's, are marketing directly to collectors, not to rare book dealers. The dealers are left to doing things like buying bound volumes of plates, and ripping them up to sell individually, because there is no easy way to find new inventory at the kinds of discounts that allow them to stay in business. Unless they pioneer new fields for collecting, they won't have enough business to stay in the traditional market.

The book business example is a classic one relating to collapsing of distribution layers. The internet famously collapses tiers of distribution, and this is what it's doing in the book business. In this way, it's like Costco -- allowing sellers to deal directly with buyers and drastically reducing the role of the middleman.

Mainstream economics has generally applauded these kinds of structural shifts in the economy. After all, technology has succeeded in replacing a whole layer of distribution -- the service provided by the mid-market dealers is no longer necessary, and now they are free to do something else, further adding to the value of the economy.

Historically, demand for new jobs complemented (and accelerated) the technologies that were making old jobs unnecessary. As farming became more mechanized, farmworkers found their way to factories; as factories became more automated and moved offshore, factory workers moved to services and knowledge work.

As this knowledge work becomes more automated, it also can move offshore. And it is doing it faster than has happened in previous generations. What will replace the work that is moving to India?