Reading the tea leaves: What the past and the present tells us about the future of outsourcing

January 1, 2010

Looking back into the past, various forms of globalization have ebbed and flowed and this history, along with the present trends in the areas of regulation, trade and immigration, hold clues about the future of outsourcing. Hence, and depending on how one wants to read the tea leaves, this future may hold significant promise or future pain for those whose livelihoods depend upon it.

1. What History Tells Us
o gain clues about the future of outsourcing, one should look at the history of globalization as globalization itself is not an entirely new phenomenon. After all, one could easily say that the early Greek, Roman and Islamic civilizations over a millennium ago were the first civilizations to take the path towards globalization via military conquest along with the trade of both goods and ideas.

However, the period from 1870 to the eve of World War I in 1914 gives us the best history lesson about globalization in general as this era greatly resembles our own. It was during the late 19th and early 20th centuries that laissez faire capitalism became the order of the day with government intervention in the economy and in the flow of trade, capital and people being at a minimum. Furthermore, this era would also see the rise of new communications technology in the form of the telegraph and later the telephone that created the first true information age where information and hence decisions could be made and dispensed in a matter of hours rather than over the course of weeks or even months.

Ironically though, while Britain had practiced free trade since the beginning of the 19th century and other European countries began to move towards it in the 1860s (mostly in the form of most-favored-nation clauses), tariffs actually increased in most developed countries. However, while the handful of countries that made up the developed world largely practiced protectionism for themselves, free trade was imposed upon the developing world (most notably by the British in India, China and Latin America plus the Dutch in the East Indies and the Americans in Japan) either by war or via gunboat diplomacy.

futureOfOutsource 300x226 Reading the tea leaves: What the past and the present tells us about the future of outsourcing

At the same time that trade was largely opened up, capital flowed freely with British capital in particular flowing into infrastructure and other investments in its colonies and to other emerging markets such as Argentina, which would become one of the richest nations on earth by the end of the 19th century, and the United States which would ultimately surpass Britain in wealth and global power. In turn, the income from these investments flowed back to Britain and other developed countries which further expanded their empires or made new investments around the world.

Meanwhile, people flowed almost as freely as trade and capital with millions of poor Europeans leaving Europe for the new emerging economies of the United States, Argentina, Brazil, and the major British colonies of Australia, New Zealand, South Africa and Canada. This wave of immigration would further fuel the industrialization and rapid economic development of these countries which, for the most part, soon joined the ranks of the developed world.

However, the outbreak of World War I and the devastation that followed largely destroyed this laissez faire economic order and eventually replaced it with the an assortment of “isms” such as Bolshevism/Communism, Fascism/National Socialism, Fabian Socialism, Peronism and various forms of protectionism. In the United States, new immigration laws slowed immigration to a trickle and the Smoot-Hawley Tariff Act helped to turn an otherwise bad recession into a global depression while the rise of Peronism would take Argentina from riches to rags in less than half a century. Meanwhile, instead of exporting free trade, capital and people, the British began to export Fabian Socialism – much to the detriment of their now former colonies and for India in particular.

Ultimately, World War II would pull the world out of the depths of the Great Depression while the Cold War called for a new economic order that could return the developed world to prosperity and halt the spread of Communism in the developing world. Thus and slowly over the course of decades, much of the developed world returned to the laissez faire economic order of the late 19th and early 20th centuries with the gradual re-liberalization of trade, capital and people flows leading to the rise of the multinational corporation (MNC). Furthermore, new advances in communications technology and the development of the internet in particular created a second communications revolution and an entire new information age where vast amounts of information could flow in a matter of seconds.

2. Where We Are Now and Where We Might be Heading
Today however, the world is in the grips of what could be described as the worst economic downturn since the end of World War II and the Great Depression. However, as the Wall Street Journal recently noted, the current economic crisis is not entirely new as the history of the United States is filled with bubbles and “panics” dating back to the first one at the end of the Washington presidency. Meanwhile Europe has seen its share of bubbles and “panics” as far back as the Tulipmania of the 1630s and the South Sea Bubble of 1720. Nevertheless, the current economic crisis could bring about potentially dramatic changes in the three key areas of regulation, trade and immigration.

2.1. Regulation
As the New York Times recently conceded, open economies grow faster than closed ones; however, countries with closed economies seem to be better at weathering the current economic storm. One such economy cited was that of India where there are fairly stringent restrictions on international capital flows along with a strong and fairly bureaucratic regulatory framework. In fact, India is one of the few economies this year that is still projected to have some economic growth.

In contrast, the spectacular rise and implosion of Iceland, which Thomas Friedman likened to a hedge fund with glaciers, showed the perils of a completely open economy. Starting in 2002 when the country began freeing up its banks from state control, the nation’s banking sector went on a borrowing and a lending binge and began offering sky high deposit rates that attracted savers from all over Europe and from Britain in particular. However, when the global credit markets began to freeze up and the Krona loss value, Iceland’s banks could no longer finance their debts and depositors rushed in to take their money out – causing the country’s entire financial system to completely melt down. As a result of this collapse, roughly US$1.8 billion in British banking deposits, including US$170 million in deposits from more than 120 British municipal governments, became frozen.

Thus, Friedman concludes that the central (and ugly) truth of globalization today is that we are all connected but nobody is in charge. Hence, he and others argue that since capital tends to flow to the places that are the least regulated (and also offer the highest rates of return), countries will feel that it is increasingly necessary to adopt more capital controls to limit their exposure to countries like Iceland that are taking on more risk. This will ultimately reduce opportunities for international banks and investing in general but it may also limit the spread of a contagion, whether it is from unsustainably high Icelandic deposit rates or risky American subprime mortgages, from spreading throughout the entire global economy and financial system.

2.2.Trade
Meanwhile and in the same manner that many observers are rethinking the free flow of capital, there is a growing backlash against free trade. While no one will argue that free trade has not delivered benefits in the form of plentiful supplies of low cost goods available in the Wal-Marts of America, many Americans have now come to the conclusion that free trade has also brought stagnant wages and does them more harm than good. In fact and roughly a year before the last US presidential election, the Wall Street Journal reported with some irony that even Iowans, whose state has been a big winner because of free trade and economic globalization, were remarkably ambivalent about trade. Moreover, the Wall Street Journal reported in 2008 that significant majorities in 21 out of 34 nations polled by the BBC World Service agreed that the pace of economic globalization is moving to quickly.

However, the Journal also notes that the countries that initially adopted the Euro continue to use it while governments still obey rulings from the World Trade Organization (WTO) – even if it means rewriting their own laws in order to comply. Furthermore, no serious effort is underway to withdraw the United States from NAFTA or other free trade agreements.

Nevertheless, the developing world is moving more towards economic nationalism and protectionism as countries like Brazil, India and China (among others) increasingly press for more limited market openings at home while seeking more agricultural liberalization abroad. Furthermore, when food prices began rising in recent years, some developing countries even began to erect export barriers in order to protect their own domestic food stocks – sending countries (like the Philippines) that rely on food imports scrambling to secure new food supplies.

2.3. Immigration
Meanwhile, as the backlash over free trade grows, another backlash is brewing over immigration. As Business Week recently reported, one in five members of Generation Y in Europe is already unemployed and the situation of their counterparts in the United States is only markedly better while Japan continues to struggle with the consequences of its own “lost generation” that was created when its bubble burst in the 1990s.

Furthermore and more than a year before the full impact of the economic crisis hit, the Wall Street Journal had pointed out that both technology and globalization are boosting demand for the most-educated workers who are prized for their abstract or conceptual skills while at the same time sustaining demand for unskilled and low-wage immigrants to fill relatively menial jobs. The jobs that were being lost (at least at that time) were middle class jobs as these were (and still are) being replaced with technology or were being outsourced offshore.

Hence, with so many members of Generation Y and increasing numbers of those in the middle class becoming unemployed, a truly global backlash against immigration is emerging – whether it’s over H1B visas in the United States to Japanese plans to send Japanese immigrants from Brazil back home to South African violence against Zimbabwean refugees. In fact, the Wall Street Journal reported back in early 2008 of a poll of 47 countries by the Pew Research Center where 44 countries had majorities who favored further restrictions on immigration.

3. What Does All of this Mean for Outsourcing?
Reading the tea leaves of history and the above trends, one could be either optimistic or pessimistic about the future of outsourcing. For starters, more regulations will undoubtedly raise the cost of doing business and lead to more cost-cutting measures that will benefit outsourcing but it will also undoubtedly crimp future economic growth and may even make outsourcing, at least offshore outsourcing, much more difficult. Moreover and although a repeat of the tariff mistakes of the 1930s is unlikely, it may only be a matter of time before more politicians take notice that support for free trade is declining and begin to act accordingly. On the other hand, immigration restrictions that keep the best and brightest at home in developing countries may benefit outsourcing as undoubtedly the work will need to come to them rather than they move to where the work is.

Nevertheless, one must also remember that jobs that no longer exist because technology has eliminated them or slower economic growth has simply not created them cannot be outsourced. However, in the same manner that some manufacturers are now finding it more cost effective and less risky now to set up closer to home (or even at home), outsourcers are increasingly becoming more flexible and are considering nearshore or even homeshore locations as viable alternatives to offshore locations across the globe. Hence and moving forward, the most likely scenario for the future of outsourcing is that it will continue to evolve with both winners and losers while staying one step ahead of both history and current economic and political trends.


Comments

2 Responses to “Reading the tea leaves: What the past and the present tells us about the future of outsourcing”

  1. Good article on April 3rd, 2010 8:40 am

    Good article, interesting to read

  2. J Henry on April 12th, 2010 5:15 am

    Many experts believe that outsourcing is an attractive temporary balance sheet move, with potentially devastating long-term implications if the association isn’t more than skin deep. For example, when companies delegate manufacturing, and increasingly, R&D, to lower-cost countries, they can cut prices and present better product selections here in the US. But if all those dealings are superficial, it’s only a matter of time before the parent companies start experiencing a backlash.

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