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					     Research Report
       Fisher Center for Real Estate and Urban Economics · University of California, Berkeley · Fall 2003


                                   The New Wave of Outsourcing
                                  Ashok Deo Bardhan and Cynthia A. Kroll

    There     is growing apprehension         payroll and other back-office related                                to 38% (See Figure 1). These data
                                              activities.                                                          continue a long history of foreign out-
    among business leaders, economists,
                                                                                                                   sourcing in US manufacturing and the
    and ordinary Americans that we are
                                              In this short overview we address the                                associated loss of blue-collar jobs in
    witnessing what may well be the
                                              following questions: Have jobs been                                  many industrial sectors. Indeed, one
    largest out-migration of nonmanufac-
    turing jobs in the history of the US      transplanted from the US? How sig-                                   of the attributes of the modern stage
    economy. This concern has been fu-        nificant is this phenomenon and how                                  of globalization for advanced indus-
                                              sustainable is it? What is the potential                             trialized countries is the offshore pro-
    eled by newspaper reports and eco-
                                              impact on future job creation and                                                               n
                                                                                                                   duction of intermediate i puts, usually
    nomic news highlighting the layoffs
                                              wage inequality in the US? How is it                                 in low-cost developing countries. The
                    f
    of thousands o people in high-tech,
                                              likely to impact the real estate sector?                             motivation, on the part of US firms,
    software and service sector compa-
                                                                                                                   has been driven by the low costs of
    nies in the US, and the practically
    simultaneous, seemingly coordinated       The First Wave: Outsourcing of                                       manufacturing abroad, primarily in
    establishment of offices and devel-       Manufacturing                                                        the East Asian countries, such as Tai-
                                              Between 1987 and 1997, the share of                                  wan, China, South Korea, Malaysia
    opment centers, most often in India,
                                              imports in inputs used in US manufac-                                and others, as well as the availability
    resulting in hiring of thousands of
                                              turing increased from 10.5% to 16.2%                                 of skilled labor, the promotion of a
    new employees in that country. For
                                              and in high-tech manufacturing, such                                 business-friendly environment and the
    example, tabulation by the authors of
                                              as computers and electronics, from 26                                existence of production and supply
    reports in Indian newspapers and
    business journals for the month of
    July 2003 alone gave an estimate of
    25,000 to 30,000 new outsourcing                                                                     Figure 1
    related jobs announced by US firms.                                                  Imported Inputs as a Share of Total Inputs
    In the same month, there were 2,087                                                  Total Manufacturing and High-Tech Sectors
    mass layoff actions carried out by US
                                                        Imported Inputs as % of Total




    employers resulting in a loss of                                                    40%
    226,435 jobs.1 The jobs being created                                               35%

    in India and elsewhere are in a wide                                                30%
                                                                                        25%
    range of services sectors such as geo-
                                                                   Inputs




                                                                                        20%
    graphic information systems services
                                                                                        15%
    for insurance companies, stock mar-                                                 10%
    ket research for financial firms,                                                   5%
    medical transcription services, legal                                               0%
    online database research, and data                                                            1987                 1992             1997
    analysis for consulting firms, in addi-                                                      Total Manufacturing    High-Tech Manufacturing
    tion to customer service call centers,
                                                        Source: Bardhan, Jaffee and Kroll, Globalization and a High-Tech Economy,
                                                        forthcoming.
1
    Bureau of Labor Statistics.
networks in those countries. At the           economies created the conditions for a      the US3 . India’s National Association
same time, the higher value-added,            major burst of outsourcing in the           of Software and Service Companies
better paying jobs in management,             1990s, in hitherto primarily domestic       (NASSCOM), the primary trade or-
finance, marketing, research and de-          segments of non-manufacturing sec-          ganization of all IT related firms,
velopment have been retained in the           tors, such as telecommunications, re-       forecasts that exports would hit the
home country.                                 tail trade, and finance (including          $50 billion mark in the next five
                                              banking and insurance). While the           years. By that time, the business proc-
Considerable research has been car-           “push” factors for business process         ess/ business servic es outsourcing
ried out on the phenomenon of out-            outsourcing (BPO) or business ser-          segment would employ over 2 million
sourcing in manufacturing and many            vices outsourcing (BSO) are similar to      people, and the total exports of the IT
of the economic insights and conclu-          those for manufacturing and are             industry would support over 8 million
sions are applicable to Business Proc-        largely cost-driven, the “pull” factors     jobs.
ess/Services Outsourcing (BPO/BSO)            and attributes of countries and
as well. As pointed out by Bardhan,           economies providing outsourced ser-         The growth of the IT sector in general
Jaffee and Kroll in their forthcoming         vices are somewhat different. In addi-      and the BPO segment in particular is
book, Globalization and a High-Tech           tion to cost advantages similar to          not confined to India. Firms involved
Economy, the outsourcing of parts of          those offered by the manufacturing          with software services outsourcing
the supply chain of manufacturing has         centers of East Asia, the ongoing out-      and BPO are rapidly gaining ground
resulted in a shift of demand, and            sourcing of business services jobs to       in the Philippines and Malaysia (call
hence jobs, from blue-collar to white-        India, Malaysia, Philippines and            centers and other back-office BPO),
collar and from manufacturing to ser-         South Africa among others is also due       China (embedded software, financial
vices, increased wage inequality be-          to the widespread acceptance of Eng-        firm back-office BPO, some applic a-
tween blue-collar and white-collar            lish as a medium of education, busi-        tion development), Russia and Israel
jobs, and increased profitability of US       ness and communic ation in these            (high-end customized software and
firms. They also note that recession-         countries; a common accounting and          expert systems), and Ireland (pack-
ary downturns seem to prod firms into         legal system (at least in some of the       aged software and product develop-
making major restructuring moves,             countries), the latter based on the         ment). While it is difficult to estimate
and that a recession might be the             common law structure of UK and US;          the exact number of jobs created in
mother of innovation and dynamism.2           general institutional compatibility and     these countries in these sectors, let
                                              adaptability; the time-differential de-     alone those transplanted and created
The New Wave: Outsourcing of                  termined by geographical location           by US firms, tentative evidence col-
White Collar Jobs                             leading to a 24/7 capability and over-      lected by the authors suggests that
The software sector was the first ser-        night turnaround time; simpler logis-       business process outsourcing and
vice sector to transfer significant ac-       tics than in manufacturing, and a           software outsourcing have together
tivity to foreign locations, leading to       steady and copious supply of techni-        generated, at the very least, over a
the creation of a critical mass of ex-        cally savvy graduates.                      million jobs in the 1990s and hun-
pertise and resources in concentrated                                                     dreds of thousands more since the turn
locales, such as the city of Bangalore        India’s information technology en-          of the century.
in India. The rapid dissemination of          abled services (ITES) sector, the pri-
the Internet, the transnational net-          mary destination of business services       BPO/BSO Impact on the US
works set up by immigrants in the US,         outsourcing from Western countries,         Economy
and liberalization of emerging market         now directly employs over 200,000           The second half of the 1990s was a
                                              people with around $2.3 billion in          time of high employment and robust
                                              exports, of which over 70% are to the       growth for the software-related sec-
2
  Most economists believe, however, that      US. While the sector is still small it is   tors, as well as the services sector at
outsourcing should not lead to job loss in    growing at a rate of 60% per annum.         large. The job creation from outsourc-
the long run but to a reshuffling of jobs     The software services sector overall        ing in countries around the world dur-
and a new composition of occupations in       has exports of approximately $9.5
the economy. This recovery of jobs lost
                                              billion, of which over $7 billion are to    3
to outsourcing still requires major changes                                                National Association of Software and
in the industrial and employment structure                                                Service Companies, India, at
of the economy.                                                                           www.nasscom.org .


2
ing this period can be seen as spin-     sectors of the economy that felt a dis-   communications, software publishing,
offs from the US because of tight la-    proportionate impact of outsourcing.      and Internet services providers. Be-
bor markets, rather than job transfers   These include the computers and ele c-    tween first quarter 2001 and second
out of the US in search of lower labor   tronic products manufacturing sector      quarter 2003, i.e. in the course of just
costs. However, the recent downturn      (including its sub-sector, semiconduc-    over 2 years, the employment in these
and the continuing jobless recovery      tors and electronic components); pro-     sectors has plummeted by 15.5% in
have legitimately given rise to the      fessional and business services sectors   the US as a whole, and 21% in the
question whether services outsourcing    such as business support services,        state of California, corresponding to a
involves the transfer of US jobs and     which include call centers, and com-      job loss of over 1 million and 200,000
occupations to other countries. Table    puter systems design services; and        respectively in these sectors alone.
1 shows employment data for those        information industries such as tele-


                                              Table 1
                        Employment Change in Industries At Risk to Outsourcing*
                                          US Employment (Thousands)        California Employment (Thou-
                                                                                       sands)
Industry Name                            Q1-2001    Q2-2003      % Change Q1-2001 Q2-2003 % Change
                                                                 2001-2003                    2001-2003
Nonmanufacturing Sectors
Software Publishers (except Internet)       276.1        247.9       -10.2%          55.8         47.1       -15.6%
Internet Publishing and Broadcasting         50.6         33.7       -33.4%
Telecommunications                         1323.4       1138.9       -13.9%         150.5        123.5       -18.0%
ISPs, Search Portals, and Data Proc-
                                            516.0        433.2       -16.0%          60.2         48.0          -20.2
essing
  Data Processing and Rel. Services         320.9        292.2        -8.9%          24.4         18.9       -22.8%
Accounting, Bookkeeping & Payroll           976.3        875.7       -10.3%         108.8        103.1        -5.2%
  Payroll Services                          158.9        124.6       -21.6%
Computer Systems Design and Rel.           1341.2       1148.1       -14.4%         218.2        163.2       -25.2%
Business Support Services                   784.4        746.2        -4.9%          56.2         57.2         1.7%
 Telephone Call Centers                     406.2        363.2       -10.6%
    Telephone Answering Services             54.8         50.9        -7.1%
    Telemarketing Bureaus                   351.4        312.3       -11.1%

Manufacturing Sectors
Computer and Electronic Products           1862.1       1415.9       -24.0%         443.1        336.8       -24.0%
 Semiconductors and Electronic
                                            308.7        237.9       -22.9%         162.1        115.2       -29.0%
 Components

Subtotal: At-Risk Industries               6853.9       5791.8       -15.5%         980.8        774.6       -21.0%

All Nonfarm                             131,073.0 130,515.3            -0.4%     14,608.2 14,491.8             -0.8%
  Manufacturing                          16,932.3     14,757.7        -12.8%      1,849.0     1,587.2         -14.2%
  Nonmanufacturing                      114,141.3 115,757.7             1.4%     12,759.2 12,904.6              1.1%
* The authors have chosen those industries which, in our judgment, have been most often noted as outsourcing to
India and East Asia. These industries have a substantial share of the occupations discussed in the next section.
Source: Authors from US Bureau of Labor Statistics data.




                                                                                                                         3
                                                                                     Table 2
                            Figure 2                                     Average Salaries of Programmers
                 Attributes of Jobs Outsourced                             Country               Salary Range
                                                                  Poland and Hungary            $4,800 to $8,000
    • No Face-to-Face Customer Servicing Requirement              India                         $5,880 to $11,000
    • High Information Content                                    Philippines                         $6,564
                                                                  Malaysia                            $7,200
    • Work Process is Telecommutable and Internet Enabled
                                                                  Russian Federation            $5,000 to $7,500
    • High Wage Differential with Similar Occupation in           China                               $8,952
      Destination Country                                         Canada                             $28,174
    • Low Setup Barriers                                          Ireland                      $23,000 to $34,000
    • Low Social Networking Requirement                           Israel                       $15,000 to $38,000
                                                                  USA                          $60,000 to $80,000
                                                                  Source: CIO magazine, November 2002, Smart
                                                                  Access Survey, Merrill Lynch.



Indisputably, most of the job loss is     ing also has the potential to affect di-  programmers in the emerging market
due to the technology downturn, the       verse segments of retail and wholesale    countries of Asia and Eastern Europe
dot-com bubble, and the cyclical          trade, utilities and healthcare, to the   are a factor of ten less than corre-
downturn in the US economy. How-          extent that record-keeping, account-      sponding salaries in the US. The cost-
ever, outsourcing that began as a re-     ing, sales, and information aspects of    differentia l in BSO is more difficult to
sponse to very tight labor markets in     these sectors can be performed sepa-      pin down, since the range of occupa-
the US in 1999-2000 has continued,        rately from other functions.              tions is so wide. Table 3 shows hourly
becoming a factor in the “jobless” or                                               wages for some sample occupations
“job-loss” recovery of 2003. As in the    Outlook for Services                      from the July 2002 National Compen-
last downturn in the early nineties,      Outsourcing                               sation Survey of the Bureau of Labor
recession-based cost-cutting by firms     The occupational mix of a sector may Statistics matched with comparable
may end up as the permanent loss of       determine      its    vulnerability.   In occupations in India. The wage differ-
jobs that remain abroad even during       BPO/BSO circles it is said half- ential varies widely by occupation,
the subsequent recovery. The laid-off     seriously that any job that involves with differences partic ularly high for
US workers must then be absorbed          mostly “…sitting at a desk, talking on lower wage, nonprofessional occupa-
either in new sub-sectors, brought        the phone and working on a com- tions and less extreme, although still
about by innovation, or in other          puter…” is a job under potential quite significant, at the upper end of
lesser-paying, non-tradable services      threat. Figure 2 summarizes the es- the wage spectrum.
jobs.                                     sential attributes and features of jobs
                                          and occupations that might find them- A lower wage scale is even more at-
Vulnerability to outsourcing extends      selves in jeopardy.                       tractive if it comes with a well edu-
well beyond the sectors shown in Ta-                                                cated labor force. The three major
ble 1. The employment services sec-       While institutional and cultural com- emerging market economies—China,
tor, for example, lost over 300,000       patibility and proliferation of the Eng- India, and Russia —have a sizeable
jobs between June 2000 and January        lish language are key components of higher education sector. While Rus-
2001 and over 150,000 between Janu-       comparative advantage for countries sian expertise in many basic sciences
ary 2001 and June 2003 (again a mix       that are destinations for BPO invest- and engineering subjects has been
of recession-based losses and out-        ment and activity, it is the cost differ- justly famous for decades, both the
sourcing). Links to outsourcing in this   ential, along with the availability of annual output and quality of science
sector come through temporary em-         well-educated graduates, that provides
ployee agencies, which provided           the critical competitive edge. As Ta-
short-term employees to many of the       ble 2 shows, the salaries of computer
industries listed in Table 1. Outsourc-


4
             Table 3
    Hourly Wages for Selected
          Occupations                                                                                          Figure 3
     US and India, 2002/2003                                                                      Yearly Graduates with Natural Science
Occupation            Hourly      Hourly                                                             and Engineering Degrees 1998
                      Wage,       Wage,
                      US          India                                                 250,000




                                                        Degrees Granted
Telephone Op-                     Under                                                 200,000
                      $12.57
erator                            $1.00                                                 150,000
Health Record                                                                           100,000
Technologists/                    $1.50-
                      $13.17                                                            50,000
Medical Tran-                     $2.00
scriptionists                                                                                 0




                                                                                                                                                                  US
                                  $1.50-




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Payroll Clerk         $15.17




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                                  $2.00




                                                                                                                                      Ge


                                                                                                                                               uth
                                                                                                                                             So
Legal Assistant/                  $6.00-             Source: National Science Foundation (Science and Engineering Indicators, 1998).
                      $17.86
Paralegal                         $8.00              Note: Figures are by country where degree granted and may include foreign nationals.

                                  $6.00-
Accountant            $23.35                  tional underdevelopment, erratic re-                                            developed countries, but from the
                                  $15.00
                                              forms and the gradual deterioration                                             point of view of the US labor markets
Financial Re-         $33.00-     $6.00-      of the higher education system. The                                             that is no consolation.
searcher/Analyst      $35.00      $15.00      overpowering Chinese success in
                                              manufacturing may well be repli-                                                Despite these barriers, the phenome-
Source: US wages are from US Bu-              cated later in the services sectors, but                                        non of services outsourcing is sustain-
reau of Labor Statistics, National            as yet business services outsourcing                                            able for the foreseeable future, unless
Compensation Survey, July 2002; In-           faces heavy language, institutional                                                                                  n
                                                                                                                              there is a major disruption of the i -
dia wages are from interviews, busi-          and cultural barriers. Rising wages                                             ternational economy or a severe back-
ness literature search and review of          and costs in these countries may spur                                           lash in the developed countries lead-
employment Want Ads by the authors.           secondary outsourcing to still less                                             ing to establishment of regulatory

and engineering graduates from India
                                                                                                   Figure 4
and China have been increasing rap-
                                                                              US and California High-Tech Manufacturing Sectors
idly and are now comparable to the
advanced countries4 (see Figure 3).                                                 Annual Value-Addition Per Employee
These countries face some constraints
                                                        Thousands of dollars per year




in exploiting this ongoing opportunity.                                                 180

India’s inability to provide education                                                  160
at the basic school level could stifle                                                  140
further growth in highly trained                                                        120
graduates. Russia faces growth con-                                                     100
straints from a combination of institu-                                                 80
                                                                                        60
4                                                                                       40
 The figure for the US includes graduates
who are foreign citizens. However, the                                                                 1987                    1992                        1997
proportion of foreign citizens is consider-                                                                              US     California
able only at the PhD and MS level, not so
much at the basic undergraduate level of              Source: Bardhan, Jaffee and Kroll, Globalization and a High-Tech Economy,
higher education.                                     forthcoming.



                                                                                                                                                                       5
hurdles. The benefits to US firms are     sense of the potential size of the long   There are 22 broad occupational cla s-
the increased value addition and prof-    term impact on jobs and occupations.      sifications listed by the Bureau of La-
itability resulting from savings due to   The authors have tried to arrive at an    bor Statistics.5 Within these 22 broad
low-cost outsourcing. Figure 4 shows      estimate of the outer limit of jobs po-   categories there are 770 detailed o   c-
the constant increase in value-addition   tentially at risk to outsourcing by       cupations. Table 4 shows the aggre-
per employee in high-tech manufac-        adopting the following methodology:       gate and detailed occupations which
turing from 1987 to 1997, a period of                                               we judge to be consistent with the
intense outsourcing activity in manu-  a) We focus not on economic and              criteria a, b and c listed above. Of
facturing overall. The impact of the      industrial sectors, as in Table 1,        course not all jobs are under threat in
present cycle of BPO/BSO is perhaps       but rather on the occupational            any of these categories. Table 4 lists
reflected as well in the latest produc-   make-up of the US economy,                the outer limit of potential direct job
tivity figures released by the US Bu-     given by the detailed Occupa-             loss in these occupations, without tak-
reau of Labor Statistics: Nonfarm         tional Employment Statistics,             ing into account many of the dynamic
business output per hour worked i -  n    2001, published by the US Bureau          adjustments that may take place or
creased by 5.4% in 2002, and by a         of Labor Statistics.                      changes that may occur in qualific a-
sizeable 6.8% in the second quarter of b) We are guided by the occupa-              tions, skill requirements and task d  e-
2003.                                     tional “outsourceability a  ttributes”    scriptions.
                                          listed in Figure 2.
Outlook for US Jobs and                c) We only take into account those           Data on these occupations are avail-
Occupations                               occupations where at least some           able for 2001 and some earlier years.
If both the supply and the demand         outsourcing has already taken             The data indicate that these jobs span
side suggest a sustainable outlook for    place or is being planned, accord-        a wide range of compensation levels,
business services outsourcing, it is      ing to business literature.               from salaries one-third below the av-
imperative to get at least a heuristic                                              erage to almost twice the average sal-
                                                                                    ary. In some outsourceable occupa-
                                                                                    tions, job growth was strong at least
                            Table 4                                                 through 2000, but the occupations
        US Employment in Occupations at Risk to Outsourcing                         most vulnerable to outsourcing began
                                                           Average Annual           losing jobs. For example, data entry
                                             Employment        Salary               positions dropped by 115,000, or
                 Sectors                        2001            2001                22%, between 1999 and 2001, even
All Occupations (Total US Employment)          127,980,410         $ 34,020         though employment in computer oc-
Occupations at Risk of Outsourcing                                                  cupations as a whole was increasing.
Office Support*                                   8,637,900           $   29,791    As occurred earlier in manufacturing,
 Computer Operators                                 177,990           $   30,780    it was the lower paying, more routine
 Data Entry Keyers                                  405,000           $   22,740    jobs that were being outsourced most
                                                                                    rapidly. This is consistent with the
Business and Financial Support**                  2,153,480           $   52,559
                                                                                    particularly wide wage differentials
Computer and Math Professionals                   2,825,870           $   60,350
                                                                                    found in the lower paying occupa-
Paralegals and Legal Assistants                     183,550           $   39,220
                                                                                    tions.
Diagnostic Support Services                         168,240           $   38,860
Medical Transcriptionists                            94,090           $   27,020

Total in Outsourcing Risk Occupations            14,063,130          $ 39,631
                                                                                    5
Percent of All Occupations                           11.0%                            Many categories of these broad occupa-
Source: Authors using data from Bureau of Labor Statistics web site. *Office        tional classifications, such as “personal
support aggregates data from 22 detailed Office and Administrative Support          care and service” occupations, “food
categories. ** Business and financial support aggregates data from 10 detailed      preparation and serving related” occupa-
Business and Financial Occupations. Further details on sectors available from       tions, construction, repair and mainte-
                                                                                    nance related occupations, community
the authors.                                                                        and social service occupations and others
                                                                                    are obviously “non-outsourceable”.


6
There have been many different esti-
mates of potential job losses in the US
from future business services out-                                                          Figure 5
sourcing. A report by Forrester R     e-                                Occupations at Risk to Outsourcing as a Share of
search forecasts that by the year 2015,                                        Employment in All Occupations
approximately 3.3 million jobs will                                                    Selected US MSAs
have been irretrievably lost, almost




                                                   Percent of Employment in all
one fourth of our estimate of total em-                                           20%
ployment in outsourcing occupations                                               15%




                                                           Occupations
at risk in 2001. This translates to a                                             10%
little over 250,000 per year, a number
                                                                                        5%
which seems conservative, based on
                                                                                        0%
the rate of outsourcing over the last
few years, the experience of outsourc-




                                                                                                       US

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ability of an increasing number of




                                                                                                            Sa
countries to compete for these jobs,                                    Office Support                                 Business & Finance Support
the higher tradability of services due                                  Computer and Math Professions                  Legal and Medical
to better communications, increasing
use of English and US standards in                 Source: Authors from Bureau of Labor Statistics data.
business and commerce, and the obvi-
ous benefits to US firms and employ-
ers, the primary decision-makers in
this process. This outsourcing of jobs
could result either in net job loss in                                      Figure 6
some occupations and sectors or in a               Salaries in Occupations at Risk of Outsourcing Relative to
slower pace of job expansion than                         Average US Salaries in At-Risk Occupations
would otherwise occur.                                               2001, Selected MSAs
                                                             1 = Salary at US Average for




Outsourcing Has Regional                                                                    1.6
                                                                                            1.4
Implications
                                                                     Occupation




                                                                                            1.2
As with manufacturing outsourcing,                                                          1.0
the process of services outsourcing is                                                      0.8
likely to vary geographically, among                                                        0.6
different regions of the US and within
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metropolitan areas. Figure 5 shows
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occupations at risk for some of the
                                                                                                                              nF
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largest metropolitan a   reas in the US,
                                                                                    All Occupations                     Office Support
while Figure 6 shows wage levels by
                                                                                    Business & Finance Support          Computer and Math Professions
occupation, relative to the US, for the
same metropolitan areas. Most of the                          Source: Authors from Bureau of Labor Statistics data.
nation's large metropolitan areas have
a higher proportion of jobs in occupa-
tions at risk than is found in the US as   shuffling is likely to reflect these dif-                                   office support occupations, at average
a whole, suggesting that many of           ferences. Detroit has lower than aver-                                      wage levels. Possibly an earlier r   e-
these urban centers may share dispro-      age shares of services jobs at risk to                                      cipient of jobs spun off from more
portionately in the wave of outsourc-      outsourcing and may share less in the                                       costly metropolitan areas, places like
ing. However, the occupational com-        impacts of this round of outsourcing                                        Atlanta may be at risk of losing more
position of the at-risk jobs varies        (but has no doubt suffered from                                             of their lower-wage outsourceable
widely among these MSAs, as do             manufacturing outsourcing in earlier                                        jobs, although it could also continue
wage levels, and the type of job re        years). Atlanta has a high share of                                         to be the recipient of jobs outsourced


                                                                                                                                                            7
domestically from higher-wage areas.      of the largest overseas migrations of                                                             still the highest in a decade, as shown
Within California, there is a wide        services jobs have been in occupa-                                                                in Figure 7.
variation among places. Los Angeles,      tional categories that were once the
with less than average shares of most     core of suburban job development,                                                                 Because office construction tends to
services sectors at risk to outsourcing   such as data processing and call cen-                                                             involve years of preparatory planning,
and close to average salaries within      ters. Suburban locations that built up                                                            much of the new space came on line
these sectors, may have less to lose      an employment base of back office                                                                 just as the dot-com bubble collapsed
from the next wave of outsourcing         jobs could see these tenants shrink, or                                                           and employment in office-related sec-
than high priced markets elsewhere in     expansion opportunities evaporate, as                                                             tors began to shrink. Employment in
the state.                                these occupations shift overseas.                                                                 key office sectors, on a national level,
                                                                                                                                            has dropped by 6.5% in the US and by
High-tech markets such as San Jose,       Present and Future Impact on                                                                      almost 10% in California since its
San Francisco and Boston are partic u-    Office Markets                                                                                    peak in 2000, in both cases returning
larly at risk of services outsourcing     The office building sector faces con-                                                             to b etween 1998 and 1999 levels, as
over the next decade. San Jose, the       siderable uncertainty going forward.                                                              illustrated in Figure 8. The most vul-
heart of Silicon Valley, has below        CB Richard Ellis reports that close to                                                            nerable sectors have been computer-
average shares of outsourceable office    17% of for-lease US office space is                                                               related industries, telecommunic a-
support and business and financial        vacant. Rosen Consulting Group                                                                    tions, and employment servicesthe
support occupations, but almost four      (RCG) figures show at least 700 mil-                                                              temporary employment services that
times the average share of computer       lion square feet are vacant in the of-                                                            helped fuel the technology expansion.
and math jobs (relative to its total      fice-leasing market of major US met-                                                              Many of these are the same sectors
share of US employment). At salary        ropolitan areas. Building activity in                                                             now undergoing extensive outsourc-
levels well above the US average, the     the late 1990s, although more con-                                                                ing.
region has already lost many of the       strained than in the late 1980s, was
lower-wage occupations to other parts
of the country or abroad. Its vulner-
ability now lies in the very high share                                                                Figure 7
of high-wage outsourceable profes-                                                    Annual Value of Office Construction in Place
sional occupations, many of which are
                                                                                             Constant Dollars, 1972-2002
similar to the types of positions grow-
ing in the lower cost foreign locations
described earlier. Businesses that                                                 70000
                                                  Millions of Dollars, 1996 base




forged a relationship with an overseas                                             60000
supplier at the height of the dot-com                                              50000
boom may continue to take advantage
of the cost savings, despite the dot-                                              40000
com collapse and easing of demand                                                  30000
for these occupations in US locations.                                             20000
                                                                                   10000
Outsourcing has intraregional implic a-
tions as well, especially in the more                                                 0
                                                                                           1972
                                                                                                  1974
                                                                                                         1976
                                                                                                                1978
                                                                                                                       1980
                                                                                                                              1982
                                                                                                                                     1984
                                                                                                                                             1986
                                                                                                                                                    1988
                                                                                                                                                           1990
                                                                                                                                                                  1992
                                                                                                                                                                         1994
                                                                                                                                                                                1996
                                                                                                                                                                                       1998
                                                                                                                                                                                              2000
                                                                                                                                                                                                     2002




moderately priced urban areas. Some
                                                 Source: US Bureau of the Census.




8
                                                                                                                                          to the total stock from owner-
                                                                                                                                          occupied buildings becoming for-
                          Figure 8                                                                                                        lease buildings is actually a further
    Employment Trends in Selected Information, Professional                                                                               sign of declining demand.
             and Business Services Sectors, US
                                                                                                                                          Figures 9 and 10 also highlight a shift
                                                                                               Other Information Services
                                                                                                                                          that is occurring between suburban
                               16000
                                                                                                                                          and downtown areas. During the
      Thousands of Employees




                               14000                                                           Telecommunications                         1990s, suburban markets led in net
                               12000                                                                                                      absorption, and suburban vacancy
                                                                                               Software+ISP/Web+Data
                               10000                                                           Proc                                       rates dropped below downtown rates
                                                                                               Employment Services
                                8000                                                                                                      for most of the decade. By 1997, the
                                6000                                                           Consulting/Scientific R&D                  amount of space vacant had shrunk to
                                4000                                                                                                      under 350 million square feet in the
                                                                                               Computer Systems Design
                                2000                                                                                                      73 markets tracked by RCG, with the
                                  0
                                                                                               Arch/Design/Oth PST                        vacant space almost evenly split b   e-
                                                                                               Legal/Accounting/Advertising               tween suburban and downtown loca-
                                                              98
                                   0

                                          2

                                                 4

                                                        6



                                                                      0

                                                                             2




                                                                                                                                          tions. During the economic expansion
                                199

                                       199

                                              199

                                                     199



                                                                   200

                                                                          200
                                                            19




                                                                                                                                          in the late 1990s, close to 85% of new
     Source: Authors from Bureau of Labor Statistics data.
                                                                                                                                          construction occurred in suburban
                                                                                                                                          areas, and downtown vacancies
Office vacancy rates responded
quickly to the combination of declin-
ing employment and new space com-                                                                                               Figure 9
ing on line. Nationwide, rates dou-                                                                         US and California Office Vacancy Rates, 1996-2003
bled, from below 8% in December
2000 to over 16% in June 2003, as                                                                           20%
shown in Figure 9. In California, va-
                                                                                  Percent of Space Vacant




                                                                                                            18%
cancies rose to an estimated 15.3%,                                                                         16%
ranging from below 10% in Sacra-                                                                            14%
                                                                                                                                                             US Metro
mento to above 20% in Silicon Valley                                                                        12%
                                                                                                                                                             US Suburban
markets.                                                                                                    10%
                                                                                                                                                             US Downtown
                                                                                                             8%
                                                                                                                                                             CA Metro
                                                                                                             6%
Two factors are at work when va-                                                                             4%
cancy rates risechanges in the                                                                              2%
amount of space occupied and                                                                                 0%
changes in the total amount of space                                                                              1996 1997 1998 1999 2000 2001 2002 Q2
                                                                                                                                                     03
available. Figure 10 shows occupied
and vacant space nationwide since
                                                                                      Source: US data is from CB Richard Ellis. California data is from the authors,
1991, as distributed in downtown and                                                  as compiled from data from CB Richard Ellis, Cushman and Wakefield, Grubb
suburban markets (the four segments                                                   and Ellis, and Keegan and Coppin. Except for 2003, all years are for 4th quarter.
of each bar add up to total square
footage). Despite job losses due to a                                     construction or from existing build-                            dropped well below suburban rates.
range of factors, the decrease in                                         ings entering the for-lease market (for                         Suburban areas were hit much harder
square footage under lease (i.e. occu-                                    example, owner occupied buildings                               in the slowdown of 2001 and 2002.
pied) in suburbs and downtown areas                                       made available for lease). This sec-                            Several factors are likely at play. On
combined has been modestabout                                                                      i
                                                                          ond element of supply ncrease may                               the supply side, new suburban con-
4% since 2000. The rest of the rise in                                    account for the difference between the                          struction can proceed more readily
vacancy comes from a 6.6% increase                                        percent change in office employment                             than infill development in many mar-
in supply, which may come from new                                        and the percent drop in space under                             kets. On the demand side, the types
                                                                          lease. The new for-lease space added                            of office occupations that have been


                                                                                                                                                                               9
                                                                                          surpassing the amount of space cur-
                                                                                          rently vacant in for-lease buildings
                                                       Figure 10                          nationwide. Not all of these jobs are
                                            Occupied and Vacant Office Space              in sectors heavily present in for-lease
                                           US Major Office Markets, 1991-2003             office space. Nevertheless, many
                                                                                          types of office markets could feel the
        Millionss of Square Feet




                                   4,000
                                   3,500                                                  effects of outsourcing. Those most at
                                   3,000                                                  risk may be back office suburban
                                   2,500                                                  markets in slow growth or declining
                                   2,000                                                  metropolitan areas, but the high-tech
                                   1,500
                                   1,000                                                  markets that are just beginning to re-
                                     500                                                  cover from the dot-com bust may also
                                       0                                                  feel the effects of the occupational
                                                                                          restructuring that comes with services




                                         02
                                         94



                                         96
                                          1

                                          2

                                          3



                                          5



                                          7

                                          8

                                          9

                                          0

                                          1



                                          f
                                        03
                                       199

                                       199

                                       199



                                       199



                                       199

                                       199

                                       199

                                       200

                                       200

                                       20
                                       19



                                       19




                                                                                          outsourcing.




                                      20
                                              Suburban Occupied     Downtown Occupied
                                              Suburban Vacant       Downtown Vacant       Concluding Remarks
                                                                                          The US economy underwent a major
       Source: Authors from data supplied by various brokers to Rosen Consulting Group.   wave of outsourcing in manufacturing
                                                                                          industries, a process that gathered
                                                                                          momentum in the 1980s and 1990s
                                                                                                           o
                                                                                          and continues t day. The experience
outsourcing most rapidly have been with space, some space is being held                   of that phenomenon provides a useful
those that are historically located in off the market, either in whole build-             benchmark for evaluating the current
suburban areas.                          ings “mothballed” for the short term,            wave of outsourcing in the services
                                         or as empty space being held in an-              sectors. Business process and business
Figures 9 and 10 may actually under- ticipation of future growth in demand.               services outsourcing will have a sig-
state the current vacancy situation in These spaces could accommodate a                   nificant impact on the economic land-
office space. Figure 10 includes both significant increase in demand with-                scape in the US. Several major differ-
unleased space and space available for out an apparent effect on vacancy                  ences distinguish services outsourcing
sublease in the vacant category, while rates. As demand grows, firms that                 from the previous wave of outsourc-
some of the brokerage reports used for have become more dependent on the                  ing of manufacturing jobs. Services
Figure 9 are less consistent and report bottom line may choose a more cau-                outsourcing is structurally simpler
only unleased space as vacant. Nei- tious route to space utilization than in              than manufacturing outsourcing in
ther chart takes into account buildings the last expansion, making more effi-             terms of resources, space and equip-
that have been taken off the market in cient use of existing space before tak-            ment requirements and thus may pro-
            m
the most i pacted areas because of ing on obligations for additional                      ceed much more quickly. Services
the lack of leasing opportunities, or square footage.                                     outsourcing affects overwhelmingly
vacancies in owner occupied space                                                         white-collar middle class jobs and
that has not yet been offered for lease. Outsourcing will further dampen the              occupations, unlike manufacturing
                                         growth in demand for space, and                  outsourcing, which impacted primar-
Growth in demand for office space in could even lead to declining demand                  ily blue-collar workers. In addition,
the US will be tempered by a number in some markets. The Forrester Re-                    this time around it is a different set of
of factors of which services outsourc- search estimate of 3.3 million jobs is             countries that are in contention for
ing is only one. Other factors include equivalent to b  etween about 500 and              these jobs. Figure 11 summarizes
underutilized space currently under 800 million square feet of office space               these differences and their implica-
lease, the flexibility of square footage (depending on the ratio of square feet           tions for the economy.
usage, and lessons in caution learned per employee)6 at the higher end
from the recent boom. These factors
                                                                                square feet per employee, but also notes
also are likely to interact with one 6 The ULI Office Development Handbook that in some markets the ratio may be as
another. In markets already glutted reports industry standards at 200 to 250    low as 150 square feet per employee.


10
                                                                                    pact on the demand for office space
                                                                                    would initially be reflected in lower
                                                                                    rents and prices, and higher v  acancy
                              Figure 11
                                                                                    rates. In the long run, with increasing
                         Impact of Outsourcing                                      employment in other jobs and occupa-
             Manufacturing                              Services                    tions, rents and prices would settle on
                                                                                    a lower growth path trajectory with
    • Impacts blue-collar jobs             • Impacts white-collar jobs              vacancy rates returning to their long-
    • Affected individual industrial       • Affects individual occupations         run equilibrium.
      sectors and some specialized           in many industrial sectors
      occupations within them                across the economy
                                           • May lead to different                 As an alternative to this troubling sce-
    • Job losses offset and even                                                   nario, a backlash against globalization
                                             composition of occupations in
      reversed by increases in               the economy; unclear how the          could occur, both worldwide and
      services employment                    labor market adjustment will          within the US, slowing down the
    • Led to increased inequality            work.                                 process of business services outsourc-
      between blue-collar and              • Will lead to increased                ing. Opponents of globalization are
      white-collar occupations               inequality within white collar
                                             occupations                           already discussing protectionist meas-
                                                                                   ures and regulatory roadblocks in the
                                                                                   form of restricting the kind of jobs
                                                                                   that can be outsourced. If successful,
                                                                                   this kind of protectionism, although
While our report has focused primar-        ment that accompanied the outsourc- inefficient from the point of view of
ily on the US economy as a whole, the       ing of manufacturing production, it is the economy, may result in the reten-
economy of California is equally vul-       not clear how the economy will adjust tion of some of the outsourceable
nerable. As seen in Table 1, the state’s    to the present burst of services out- jobs. In the short run, this would
sectors at-risk to outsourcing have         sourcing. At least four different out- moderate the negative impact on the
fared more poorly in the last two and       comes are possible.                    real estate sector.
a half years, than the US average. In
terms of future impact, bear in mind  One possible scenario is that services        A third possibility is that the industry
that while the state does not have toojob outsourcing proves more costly to         shrinkage shown in Table 1 may come
many of the call center and data entrythe economy than the earlier round of         in part from domestic outsourcing,
level type jobs anymore, it has a     manufacturing outsourcing. As cen-            indicating a redistribution of jobs
heavy presence of the computer re-    ters of skilled high-tech professionals       within the US rather than a net loss.
lated occupations, as well as office, build up in other parts of the world,         This could involve vertical disintegra-
legal and healthcare support jobs.    the US and California may no longer           tionthe shifting of jobs from large
Moreover, the cost differential with  dominate the next wave of innova-             employers to smaller firms in support
the rest of the world is higher, thus tions, and we would observe slower            sectors--as well as the ongoing proc-
                       n
suggesting a higher i centive for job growth of high-wage jobs within the           ess of domestic outsourcing from
migration abroad. Finally, large num- US and California. In this extreme            high-cost regions such as California to
bers of temporary foreign employees,  situation, economic adjustment, in the        relatively low-cost regions elsewhere
such as computer engineers from In-   absence of continuing innovation              in the United States.7 This process
dia in large California based firms,  originating in the US, first might take       would mitigate the differences in
sensing the way the wind is blowing,  the form of prolonged unemployment.           prices and rents among different r     e-
have requested within-firm transfers  Then, workers losing their jobs to out-       gions within the nation and would
to subsidiaries in their home coun-   sourcing would finally be absorbed in         leave the nationwide vacancy and ab-
tries.                                lesser-paying services jobs. Alterna-         sorption rates relatively unaffected.
                                      tively, there could be a downward
While evidence from the recession of adjustment of salaries and wages,              7
                                                                                     To the extent that the outsourced work is
the early 1990s suggests that a major making the outsourced occupations
                                                                                    done by start -up firms, employment num-
benefit of globalization has been the internationally competitive again. U n-       bers may currently be undercounting the
growth in high-tech services employ- der this worst-case scenario, the im-          current employment situation.


                                                                                                                          11
Rents in some of the higher priced       the more routine activities are out-       placement employment at similar
markets could continue to remain de-     sourced. Under this scenario, innova-      wages, but overall, the jobs lost to
pressed, even with expanding em-         tion would lead to a continuing stream     outsourcing would be replaced by
ployment nationwide.                     of new service and manufacturing           higher-wage jobs in the new sub-
                                         activities, and hence new jobs and         sectors brought about by innovation.
Finally, the most positive scenario is   occupations, while competition and         Increasing wages, incomes and com-
that the US and California economies     the need for lower-cost supply would       pany profits would then impact the
continue to fashion their outsourcing    force more mature services operations      real estate sector positively through a
activities in light of the new produc-   overseas. Depending on their educa-        recovery and eventual increases in
tion paradigm, keeping the “cream” of    tion and skills, individual workers        prices, rents and occupancy rates.
the new development at home, while                                             e-
                                         might still find it difficult to find r


Ashok Deo Bardhan is Senior Research Associate and Cynthia A. Kroll is Senior Regional Economist at the Fisher Cen-
ter for Real Estate and Urban Economics. Further information on outsourcing trends in high-tech manufacturing and
services sectors and more generally on globalization and the high-tech economy is available in their forthcoming book,
Globalization and a High-Tech Economy, coauthored with Professor Dwight M. Jaffee, Willis Booth Professor of
Banking, Finance and Real Estate at the Haas School of Business and Co-Chair of the Fisher Center for Real Estate
and Urban Economics.




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