Wednesday, June 25, 2008

Why We Outsource in Technology

Hint: Taxes and Flexibility

by Lego Acies

Slavering marxists, protectionists and chattering union workers and other pre-modern die hards, who declaim against off-shoring or extending production processes to other countries, belie a xenophobia premised on market and economic ignorance. Technological development in either software or hardware uses off-shore labor for many reasons- none of which imperil local jobs. In fact, the opposite occurs. Offshore production increases jobs domestically (statistics prove this), buttress investable profits, accelerates innovation and drags developing nations into Global Trade.

Why do firms outsource? From my own experience I would say there are two negative and two positive factors which impel a move to establish an offshore production process of same variety. On the negative side it is obvious that high welfare state tax levels and government created price and cost of living burdens (through over-spending and deficit financing), which find their way into “fees”; sur-taxes; coerced “contributions”; and high living and housing costs; compel a search for lower cost production alternatives. On the positive side, an increase in flexibility and skill, as well as the ability to employ motivated, hungry and non-unionized labor, makes offshoring attractive. A lowered cost base is of course a source of competitive advantage, but this is not the main, nor the most significant aspect of off-shore development.

What anti-market, and anti-global pundits such as Lou Dobbs don’t understand, (or refuse to see), is the deleterious effects of ruinously high, and quite complicated, taxation systems. The welfare state which consumes 5% of GDP in 1920 now gorges itself on 35-60% depending on the state in question. There are a myriad of direct and indirect taxes, regulatory fees, service fees and marginal taxes, on all factors of capital, profits, and assets, which rigidifies a business operation. Predatory taxation and fee collection makes production quite onerous. When loopholes, adjustments, rebates, tax holidays, subsidies, deductions and sundry credits are added in, ostensibly to reduce the corporate tax rate, we are left with the unappetizing spectacle of politicians and bureaucrats choosing winners and losers in the market place, securing corporate support to get elected, or favoring vote-sensitive industries and jobs to posture for electoral gain. This is not how a tax system should work.

If you add to the above the costs and rigidities afflicted upon firms by unions, then you have a perfect combination for disaster. In the US only about 15-20% of private workers are unionized- about 40% of Canadian and EU levels. Greater American labor flexibility has resulted in a more comprehensive adoption of Global Offshore production, though Europe in starting to catch up. Breaking union power through the creation of a globalized supply chain process is mandatory in some sectors outside of technology.

But even in technology, firms can suffer labor rigidity, even outside a union environment. In Western States there is a prevailing ethos of entitlement. In technology Microsoft, IBM, Yahoo, EBay and Google, amongst countless other top-tier firms, have programs, campuses, benefit packages and all manner of perquisites, to attract and retain employees. There are three problems with this. First, the long term overhead cost base rises. Second, the entitlement culture breeds arrogance, unwarranted expectations and a degree of apathy in the workplace. Third, smaller firms and start-ups have a hard time attracting good talent (for lower benefits), especially now that options are being expensed.

Outsourcing helps alleviate these bottlenecks. As with legal immigration, judicious outsourcing opens up a global labor pool of talent, renews labor competition, and keeps local engineering talent on alert, lest their production piece is shipped overseas. Offshore production allows smaller firms the flexibility to compete with larger firms through a lowered cost-base; flexibility in responding to market forces and client demands more quickly (time zone differences aid in this); as well as releasing themselves from local labor constraints (your firm can be based anywhere) and government tax-coercion. The benefits for society, as well as for market actors, are also quite compelling.

According to the US Bureau of Labor statistics, only 1% of its jobs are outsourced (about 100,000). These off-shored jobs are more than replaced by in-shored job creation. If an Indian firm handles back-office software development, than “front-end” jobs including client management, design, on-site consultancy, and final on-site “assembly” are created. Indian offshore firms have created across North America, thousands of jobs in every major city, thanks to the offshoring of product development. By lowering development and implementation costs, the offshoring of technology production reduces investment costs for companies, induces more corporate buying, generates innovation and productivity enhancements and (it is hoped) increases profits for all concerned, and Indian Firms are only a small part of the IT off-shore story. Literally thousands of firms in North America and Europe have established affiliates or subsidiaries to handle production across Asia, Eastern Europe, and Russia. In globalized trade, the overall effect for both local and foreign markets is massively positive.

Currently more engineers work in Silicon Valley, Toronto, Ottawa, Boston, Salt Lake City, Chicago, and New York than in 2000. Google, IBM and hundreds of other IT firms have added tens of thousands of people to their North American, as well as their overseas payroll. Increased revenues in the IT sector, thanks in large part to offshoring, fill government coffers. Corporate Tax Revenues in both the US and Canada are going up by 10-15% per year. More efficient and productive IT practices, premised on a global supply, simply benefit all parties involved. The dynamism of the sector does induce job turnover, but it also manufactures future job opportunities, as new products, services and indeed markets are created.

In short, offshoring is a healthy and positive response to circumvent government taxation greed; rigidified labor practices and avoid technological stagnation and irrelevance. We need more offshoring, not less.