Why Western managers are incentivised to outsource overseas and why this is bad for society

I met with a partner of an accounting firm recently who said that his partners had concluded that most of the accounting work that is not face to face with their customers can be done anywhere in the world.

With this realisation, his firm looked at a map of the world to find the cheapest place where all this non face to face work could be done, whilst maintaining the required levels of quality.   They picked a city in India, which was miles from most of the normal Indian outsourcing destinations.  Why?  To help prevent his expensively trained accountants from leaving for other jobs with other western financial institutions that were doing the same thing.




He now has PhDs doing accounting due diligence work which is both technically difficult and mind bogglingly boring.  He is able to charge his European clients the Western rate for doing this, but able to pay his Indian PhDs a mere €8,000 per year.    His is happy, as his profit margins are high and his Indian PhDs are happy, as the income is sufficient for them to afford a nice house, with a driver and a maid.

Eventually, he agreed, this situation would have to end.

Firstly, his clients will ask why he is charging so much for work that is costing the firm so little to actually perform. This will put downwards pressure on his fees, so that they end up being only a small percentage above the cost of the Indian for doing it. Revenues for this activitiy, as as result, will collapse.

Secondly, there is nothing stopping his Indian PhDs from setting up a competing business, going back to all of his existing clients and informing them:  I have been doing all of this work for you for the past 5 years. You are happy with what we have done.  Why don’t we cut out the middleman who is not adding any value?  This way you can save money and we can increase our fees.  A win-win for both parties.

His story is no different from that of countless other law and accountancy firms in the West.  Being a partner in such a firm used to be a ticket for a very comfortable upper middle class existence.

So if you are a senior accountant or lawyer and have been invited to become a partner in a law firm or accounting practice you need to ask yourself a simple question before you pay your partnership investment:  is this such a good idea?

The answer is, probably, no.

This is a real problem for Western societies.  Individuals who have service sector jobs today are incentivised to find ways to cut costs. There are two basic ways of doing this.

First, you can pay someone less money to do the job.   Since people in the West have a cost of living that is higher than in the rest of the world, it is hard to persuade Westerners to cut their salaries. It is very possible, however, to persuade people living in the rest of the world to take a lower salary because their cost of living is so low – as in the example of the Indian PhDs just mentioned.  So if your Western employee wont take the pay cut it makes sense to make them redundant and hire someone living in somewhere like India to do the job instead.

Second, you can automate the work, essentially outsourcing it to a computer or a machine.  In doing this you eliminate the job function completely, which means that your Western employee is made redundant and you never hire the potential recruit in low cost country.

In both scenarios there are fewer jobs left for Westerners.

This private sector gain – the reduction in cost – has a social cost – the loss of employment.  In a society and an economy where there were many new jobs available this would not be an issue.

Today, however, it is, for the simple reason that the world is significantly more interconnected that it has been in history.  It is possible, through technologies such as Skype, Dropbox and broadband internet access to work with eager, highly qualified, cheap people thousands of miles away.

For many Westerners who lose their job in this way it is hard to see why another accounting practice or law firm in the West would hire them – after all they are doing exactly the same thing.

This is also a significant issue for our young, who are getting increasingly into debt to pay for expensive educations and qualifications for law and accounting, and are finding it very hard to find a job.  Why would a Western law firm or accountancy practice hire a recent graduate with no experience, for three times the cost of a more qualified, more experienced lawyer or accountant in India?  Clearly, they would still want to hire some, to nurture into the partners who will have face to face contact with their customers.  But for all the work that can be done without customer interaction, there is no need at all.

Eventually, enough of this type of outsourcing will result in an expanding underclass of young, qualified Westerners with no jobs. They will need social security benefits to keep them off the street and will not be paying taxes, a double whammy for government finances.  Governments will be forced to raise taxes to pay for this, which means that those people who have jobs will be shouldering an increased tax burden, making them even more expensive to employ as their take home income is reduced.  That will make the cost gap between them and their equivalents in the rest of the world even greater, and thus increase the incentive to make those who still have jobs redundant too.

Ultimately, the outsourcing of Western jobs provides a short term private benefit, an immediate heavy public cost and a long term private and public cost.

The only way of this dilemma that I can think of is for the cost of a Westerner and someone from the rest of world to be the same.  You might be able to do this in the following ways:

Firstly, you could reduce the cost of living in the West to a level similar to places like India.  This means that the entire economy would need to contract.  House prices would have to drop to 10% of their current values, as would food, clothing and entertainment.  This would not be comfortable and I am uncertain as to how this could be achieved.  Perhaps opening up the country to hyper free trade or a currency devaluation might work.

Secondly, you could impose tariffs and restrict the ability to out-source work.  Imposing tariffs on goods is relatively straight forward.  I am not sure how you could impose tariffs on services, however.  Making it illegal to do business with the rest of the world could be possible, but highly unlikely to be practical or achievable.

Neither example is, quite frankly, any good and it might be that we just have to settle ourselves into society that is highly polarised between employed and unemployed.  The employed will be able to afford more people services and the unemployed will be happy to accept any job they can get, no matter how menial it may appear.

To someone in Eastern Europe or the former Soviet Union, this may sound eerily familiar.  When the collapse of the Eastern Block took place in the early 1990s, millions of talented engineers and scientists found themselves without a job.  Men with advanced degrees took jobs as taxi drivers and thugs, women with advanced degrees became maids and prostitutes.

This is not very comforting and I hope that some of you have a better way forward.

Please let me know in the comments section.




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