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Testing Offshore Waters

Prepared by: Lee Hudson Teslik
May 14, 2007

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Data from the last five years reveals a remarkable increase in “offshoring”—the shift of business operations across national boundaries to friendlier economic environments. According to the consulting firm McKinsey, offshore business operations tallied between $32 billion and $35 billion as a global industry in 2002. By 2008, McKinsey says they will be worth over $100 billion.

Within the United States, this drift tends to spark vehement protectionist sentiment, particularly among sectors like manufacturing that are highly susceptible to job shifts. A new Backgrounder examines the American healthcare system, which relies heavily on U.S. companies, increases their operating costs, and handicaps their global competitiveness. General Motors, for instance, estimates healthcare costs alone increase the ticket price of every automobile it makes by $1,500. Fears that companies will simply relocate to avoid such competitive burdens also run high within the information technology (IT) business, which has already seen significant job losses—though BusinessWeek notes other factors like task automation may in fact be more responsible for lost IT jobs than offshoring.

Besides job-loss fears, the most commonly cited critique of offshoring is that loose regulatory standards might enable illicit activity, from tax evasion to money laundering to terror financing. An article in the International Monetary Fund’s magazine, Finance & Development, looks at the role offshore financial centers, or OFCs, can play enabling illicit schemes (PDF) given their freedom from traditionally accepted international supervisory standards. An Economist special report on offshore finance seeks to dispel some of these concerns, saying initiatives to stamp out these kinds of crime are welcome but that broader fears about OFCs are overblown. The report’s author, Joanne Ramos, defends offshore centers in this podcast, arguing the added financial and tax competition they create far outweigh their costs.

Offshoring also sets off heated debate among economists. Alan S. Blinder, a former vice chairman of the U.S. Federal Reserve and self-termed “free trader down to my toes,” sparked ire with observations on the potential effects of offshoring. In March 2006, Blinder published a Foreign Affairs article arguing mainstream economists dramatically underestimate the potential consequences of offshoring on U.S. businesses and workers. More recently, writing in the Washington Post, he called offshoring “the biggest political issue in economics for a generation.” Blinder cites the addition of 1.5 billion new workers to the world job market and the development of new technologies allowing service jobs to be “electronically deliverable.” The consequences for American workers, he writes, could be “large, lengthy and painful,” despite bigger-pie-for-everyone reassurances from other economists.

Many of Blinder’s peers balked. N. Gregory Mankiw, a Harvard economist and former chairman of President George W. Bush’s Council of Economic Advisers, criticizes Blinder for failing to note that offshoring is a two-way street. Offshored jobs, Mankiw writes, are “equally onshorable.” But CFR’s Matthew J. Slaughter, another former member of the president’s Council of Economic Advisers, recently commended Blinder for challenging conventional thinking, adding that the issue of offshoring is dissolving traditional distinctions between technology and trade.

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