Maverick's World

Outsourcing from US firms to India will likely continue even if the American demand drops

There is a view among some people that outsourcing from the US to India will remain viable only as long as there is sufficient demand in the US economy. If you follow this chain of logic, you might easily conclude that a recession in the US economy will lower the cost of labor and bring reduce the outsourcing to India.

Unfortunately it doesn't work like that.

There are three basic benefits to outsourcing to India.

1) You get better quality labor at a lower cost - The Indian education system produces sufficient quantities of highly skilled labor at a price that is much lower than its US counterpart. US workers tend to have a sense of entitlement that Indian workers currently lack. There is simply too much competition for a job in India, and so when you land one - you tend to do whatever is necessary to hold on to it. This makes the Indian labor more compliant than its US counterpart. In the US babyboomers still in the workforce aren't keen to acquire new skills and millennials don't want to hang around at a job for more than 5 years. This makes it very difficult for any corporation to develop and maintain a niche skill set.

2) If you have a non-US subsidiary you can use it to dodge corporate taxation in the US - there are loopholes in US tax law that all firms exploit. If you have a subsidiary outside the US, you can shuffle costs between subsidiaries (through inventory, "transfer pricing" and patent ownership) that make it possible to say that the US subsidiary has minimal profit. Once you do something like that you can effectively dodge taxation in the US. There is a similar loophole in India, if you exploit both the US and the Indian loophole you can rake in an addition 5-7% on your investment.

3)  Offshore banking offers investment flexibility - When you operate a non-US subsidiary, you typically have to build up financial channels that allow you to move money around. This channels tend to be ideally placed to invest your money on a global scale than a mom-and-pop investment fund on Main Street. With additional flexibility comes risk (obviously) but the reward can be quite significant too.

All these benefits make for fat corporate bottom lines which in turn make US firms attractive (and productive) places for US mutual funds. In essence this outsourcing way of doing business ends up feeding the IRAs (and "Entitlement" funds) that support the bulk of the US population.  A side benefit is that the high profits ensure that US firms can hold massive political clout inside the US parliamentary system.

This is analogous to oil - Yes the US pays a ton of money to Saudis for their oil, but there isn't shit to do in Saudi Arabia and most of the money comes right back into the US as investments in the stock market. That is why one of the biggest and most respected players in the US stock market is a Saudi prince. This is why sensible US politicians always have strong relationships with the royal family in KSA.

It has been predicted for quite a while now that the US economy will not be able to support outsourcing, but I feel like the opposite is true.

Even if the US economy goes into an even worse recession, US firms will simply have to do better - i.e. improve productivity. The only demonstrated way of doing that right now (on any meaningful timescale) is to outsource.

I am certain that as the US economy continues to be recessive, the US public will become very anti-outsourcing, but as long as the bulk of the population (i.e. Cohort I and II babyboomers) continue to want their retirement funds to keep paying out - there will be no shift in the outsourcing pattern.

Perhaps the most compact way of thinking about it is - just as the US can't do without Saudi oil - it can't do without outsourcing either.

Sure politicians can talk big, but it is just all talk. If they try to change anything it will rebound in politically unacceptable ways.

posted by maverick @ 4:49 AM