Another Look at Offshore Outsourcing: Applying a Mathematical Analysis

Posted: February 2, 2009 at 1:00 am, Last Updated: November 30, -0001 at 12:00 am

Chinese worker
Hearing volatile discussions on the merits of offshore outsourcing stirred Mason engineering systems expert Janos Gertler to undertake a study of the issue.

By James Greif

Although the issue of offshore outsourcing was overshadowed by broader economic concerns during the 2008 presidential campaign, offshore outsourcing of U.S. jobs was a hot-button issue four years ago. The 2004 presidential candidates debated the subject, as did CEOs, unions, workers and even talk show hosts. These often volatile discussions made Mason engineering systems expert Janos Gertler want to see a detailed analysis of the data to help him to formulate his own opinion.

Janos Gertler
Janos Gertler

The professor, who is based in the Volgenau School of Information Technology and Engineering, explains, “In my engineering work, I have done a lot of modeling of various processes. I thought it would not be very difficult to develop a mathematical model of the process of outsourcing.”

Simply put, offshore outsourcing relocates business activities, such as manufacturing, production or services, from one country to another. As a result, domestic workers are often laid off.

Ideally, the process has a second phase in which some of the laid-off workers are rehired, perhaps by other companies whose production is expanding.

The business logic behind offshore outsourcing is to reduce operating costs. Cheaper labor and manufacturing costs in other countries give them a comparative advantage over the United States. China and India are frequent offshore destinations because of their abundance of cheap, skilled labor.

Good for the Economy, or Not?

While it is clear that this process is good for the companies and the countries that produce the offshore goods and services, what isn’t clear is whether this process is good for the U.S. economy.

Critics argue that offshore outsourcing weakens U.S. technological competitiveness in the world. Proponents believe that globalization is inevitable and offshore outsourcing allows U.S. businesses to remain competitive and U.S. workers to retrain for careers in emerging fields.

For his study, A Model Analysis of the Effect of Offshoring and Rehiring on the U.S. Economy, Gertler built a macroeconomic model of the national economy consisting of four sectors: manufacturing, service, government and personal (individuals).

Using this model, he then did a mathematical extrapolation to estimate the effect of offshore outsourcing and rehiring under various scenarios.

Specifically, his study examines the effect that offshore outsourcing has on the corporations conducting the outsourcing; the government as a whole, including federal, state and local levels; the foreign countries producing the outsourced goods; and the entirety of individual workers.

The model relies on data published by the Bureau of Economic Analysis (BEA) within the U.S. Department of Commerce.

“BEA publishes hundreds of data tables. It took a major effort first to understand those tables and then to condense them into a relatively compact model suitable for this study,” Gertler says, explaining that the condensed model contains about 55 different parameters.

“At the beginning, the effect of offshoring on the economy was not so clear to me either. It took about a year before I could formulate the results in a lucid way.”

Analyzing the Results

Gertler was also influenced by the work of a former student, Ron Hira. Hira, along with his brother Anil, wrote the book “Outsourcing America.” Now an assistant professor of public policy at the Rochester Institute of Technology, Hira studied engineering under Gertler and went on to earn a PhD in public policy from Mason.

The key findings of Gertler’s analysis are as follows:

  • Under offshore outsourcing, the foreign trade deficit and the government deficit grow, and income shifts from American wage earners to shareholders.
  • Any rehiring of domestic workers improves the government balance.
  • Rehiring domestic workers to increase production for domestic consumption increases the foreign trade deficit while personal expenditures outpace personal income.
  • Rehiring domestic workers to supplement offshore workers and increase production for export improves the corporate, government, foreign and personal balances. Though, just to offset the damage caused by offshore outsourcing, the exports need to exceed the total wages paid to foreign workers.
  • An ideal scenario expands production so that increased domestic consumption and export are coordinated to maintain a zero foreign trade balance. Achieving this situation would require government incentives.

While offshore outsourcing may be advantageous locally for business, Gertler believes that policy makers and citizens must understand the macroeconomic implications to develop policies that limit the negative effect on the overall economy.

“Proponents of offshoring say that one reason it is good for the U.S. economy is that it opens up export markets for U.S. goods and services; however, it is quite easy to see the long-term damaging effects of this process on the U.S. economy,” says Gertler, describing the most revealing thing about the study’s results.

“Offshoring is part of the globalization process, driven by corporate profit, and cannot be stopped.” But Gertler emphasizes that it “may be moderated to reduce the damage it could cause the U.S. economy.”

Gertler presented his analysis as a plenary lecture at the International Federation of Automatic Control Symposium on Computational Economics in Istanbul, Turkey, in October 2007 and at a special session of the American Control Conference in Seattle, Washington, in June 2008.

This article originally appeared in a slightly different form in Mason Research 2009.

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