Outsourcing and the International Market in Highly Skilled Workers--Posner's Comment

"Outsourcing" is a form of vertical "de-integration." "Vertical integration" refers to the form of business structure in which a firm owns a supplier or distributor rather than buying (from the seller) and selling (to the distributor). Hierarchical direction within an organization is substituted for contracting for output. The tradeoff is between the agency costs involved in directing people’s work and the transaction costs involved in arms-length contracts. As markets grow, enabling greater specialization, there is a tendency to de-integration; vertical integration is attractive when the market for an input is so limited (maybe to just a single firm) that the supplier faces monopsony, which integration overcomes. Outsourcing is famously illustrated by IBM's decision to outsource the production of the operating systems for its computers to Microsoft; previously IBM made the operating systems itself. As this example shows, there is nothing in the definition of outsourcing to connect it to foreign commerce. But the current anxiety about outsourcing focuses on the outsourcing of software development and other high-tech services to foreign nations, particularly India, and hardship to American skilled American workers whose jobs are outsourced. Oddly, Americans who are opposed to free trade don't mind as much when Americans buy from foreigners as when they hire them, though the effect is the same. If Microsoft purchases software from an Indian company, the effect on American jobs is no different than if it hires Indian software engineers to work for Microsoft in India--or, for that matter, in the United States. If the latter arrangement is preferred, it makes no sense for Congress to make it difficult for American companies to hire highly skilled foreigners to work in the United States. In any event, the harder it is to obtain visas for highly skilled foreigners, the greater the incentive to outsource production to those highly skilled foreigners in their native lands. So restricting visas seems a futile measure for trying to protect American high-tech jobs. The obvious difference between outsourcing and importing labor is that the foreign immigrants would command higher wages in the United States than in their native country. But they would also be more productive, because they would be working side by side with their American colleagues. Despite sophisticated video conferencing, face to face interactions are still considered highly important to productivity. It is the low wages in countries like India that makes outsourcing so attractive, but as Becker points out, U.S. and other foreign (foreign to India, that is) demand results in bidding up the wages of highly skilled Indians in India, which acts as a brake on outsourcing. It could be argued that outsourcing high-tech jobs creates human capital in the outsource nations, like India, and that the result may be greater competition from the high-tech sectors in those nations in the future. A U.S. company might not take this effect of its outsourcing into account in deciding whether or how much to outsource, because of free-riding problems. Its forbearance to outsource would benefits its competitors, but it would not be compensated by their for conferring the benefit. If this is a concern, it argues for relaxing visa restrictions on high-tech foreigners, since once established in the United States they are unlikely to take the skills they learn here back to their native country. Some will, but most will rapidly become assimilated Americans. However, there would be no externality if the foreign workers in their outsource jobs pay for their own training in the form of accepting lower wages. The costs of outsourcing are concentrated on Americans who lose their jobs or are paid less because of outsourcing to foreign countries, and the benefits, though they probably exceed the costs, are diffuse. The benefits in the form of consumer surplus and greater labor demand (but not necessarily in the jobs that are outsourced) in the United States as a result of the reduction in costs that the outsourcing firms experience as a result of outsourcing--if there were no net reduction in quality-adjusted costs, there would be no outsourcing. When the costs of a policy or practice are concentrated but the benefits diffuse, there is an asymmetry of political pressure, and this may explain the visa resterictions. But from a neutral standpoint of aggregate (and average) economic welfare, there is no compelling case for limiting outsourcing--or for stinginess in granting work permits to highly skilled foreigners.

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