• Technology
  • McKinsey & Co.

Exploding the Myths of Offshoring

Far from damaging the economy of the United States, offshoring should enable its companies to direct resources to next-generation technologies and ideas -- if public policy doesn't get in the way.

The current debate about offshoring focuses upon its impact on US jobs. But it is important to take a broad and long-term view of what best serves the interests of the United States, which also stands to gain by promoting a healthy and stable world economy, particularly in emerging markets. Research over the past 12 years at the McKinsey Global Institute has shown that the real alleviation of poverty comes from the growth of the private sector. And foreign direct investment by multinational companies is one of the best ways to promote private-sector growth.

Consider how India has benefited from foreign direct investment. Outsourcing IT and business processes generates more than $10 billion a year for the country and gives employment to half a million workers. Suppliers to the companies that provide outsourced services employ another half million people. With wages in the sector 50 to 100 percent higher on average than those for other white-collar occupations, a new middle class of educated workers is being formed. Foreign direct investment played a key role in the creation of these industries: the fast-growing Indian companies that now dominate the global sector got started only after multinational companies pioneered the approach, showed the world that India was a viable outsourcing destination, and trained a critical mass of local employees. (The CEO of Wipro Spectramind, for instance, started out at GE, and the CEO of Daksh came from Motorola.) Today foreign companies continue to provide healthy competition that forces Indian companies to improve their operations continually.

But the success of outsourcing in India is only one example of how foreign direct investment can benefit emerging markets. In 2003, the McKinsey Global Institute conducted a study of the impact of foreign investment on local service and manufacturing industries in Brazil, China, India, and Mexico. (“New Horizons: Multinational Company Investment in Developing Economies,” McKinsey Global Institute, October 2003.) MGI found a positive impact in 13 of the 14 industries examined (and a neutral impact in the remaining industry). Foreign direct investment boosted productivity and output in the sectors involved, raising national income while lowering prices and improving both quality and choice for consumers. Overseas companies honed the efficiency and productivity of the local industries by bringing in new capital, technology, and management skills. Equally important, they increased the level of competition, forcing less efficient domestic companies to improve or go out of business.

Much as specific groups of workers in the United States might lose out from offshoring, foreign direct investment in emerging markets does pose a threat to some incumbent companies that stand to lose market share. But the cost to specific local producers is outweighed by the benefits to a much larger group: consumers. In case after case, they enjoyed far lower prices, and often more choice and better goods, after markets were opened to foreign investment.

The price of passenger cars in China, for instance, fell by more than 30 percent from 1995 to 2001, years when Ford Motor, General Motors, and Honda Motor entered the market. In Mexico, the “everyday low prices” of Wal-Mart Stores ended a long history of hefty margins for leading domestic retailers and reined in fast-rising food prices so much that some analysts credit the company with helping to reduce the country’s inflation rate. In India, the price of air conditioners, television sets, and washing machines fell by roughly 10 percent in 2001 alone after foreign companies entered the market. Similarly, prices for cars declined by 8 to 10 percent a year during the 1990s after the government opened the door, and the number of models available has now risen from a handful to more than 30. Lower prices have unleashed demand, and India’s auto sector has grown by 15 percent a year.

Unfortunately, too many emerging markets remain skeptical of openness and therefore close off large parts of their economies to foreign companies. These nations are missing out on a tremendous growth opportunity that would benefit them as well as the broader global economy. In return for asking developed countries to go on allowing free trade in services, emerging markets would do well to go on liberalizing and opening the full range of their own domestic markets.

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