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The Impact of Protectionism on Offshoring

Two decades ago, we were bombarded with the "Buy American" and "Buy British" slogans. While anyone parking a Honda or Toyota in a public place was liable to find themselves with a flat tire or modified paint job, these sentiments never took hold to any great scale, and they never resulted in damaging protectionist policies. This was fortunate as the ensuing two decades saw incredible growth and efficiency, thanks in no small part to strategic offshoring by western companies.

Today, many Western governments are in a very similar position. Unemployment is nearing double digits in many industrialised countries, and the calls for tightening controls around offshoring labor are growing louder. This commentary will look at how protectionist measures could impact local economies by degrees of policy severity.

Moderate protectionist measures - say a 5 to 10% offshoring tax and stronger restrictions on incoming visas - would primarily affect small and mid-sized businesses. Large enterprises that have established processes & sufficient scale would likely continue as before, altering the overall competitive balance. Conversely, smaller offshore outsourcers would be likely to feel the greatest pinch as these providers often target smaller companies and do not have an established onshore presence. Therefore, restrictions in visas or onsite travel may make it impossible for them to service local companies.

Serious protectionist measures - say a 20 to 30% tax and highly prohibitive controls on the movement of labour - would likely deter all but the most heavily-scaled offshorers. At this point, offshore governments would almost certainly block incoming goods and services, and turn their efforts on building their economies from within. The scenario can then unfold in two ways: First, the big offshore economies like China and India are successful in developing fully home grown economies, paving the way towards relative irrelevance for the West. Second, the offshore economies could falter or even fail. With respect to China, MSN Money's Jim Jubak notes that, "Economic growth of 7%, moreover, wouldn't do anything to reduce the country's supply of unemployed and underemployed workers. With the country already experiencing a rising level of domestic protest caused by the growing gap between incomes in the cities and the country, letting the economy slow further was just too risky." Both scenarios point clearly to smaller and weaker Western economies, and a more unstable environment to conduct trade.

Full protectionist measures - where countries essentially shut down the borders - is for obvious reasons, completely untenable. Five decades of globalization have left Western economies all but completely dependent upon its offshore neighbors for outsourced services. By focusing on developing "core competencies", and outsourcing and offshoring "support processes", we are in effect riding the crest of a wave rolling into the future. Closing borders would be akin to yanking the surfboard right out from under us, allowing the wave to drive us into the ocean floor.

Luckily, it seems that governments have learned the lessons of the past, and are taking a very pragmatic view towards balancing short-term local interests with the long term viability of their economies. As noted in a report from a world trade conference, economist Charlene Barshefsky noted that governments "have then realized that trade between countries is a critical factor to allow economic growth", and that "Trading is a critical factor that will prevent the global finances from stagnating".

The recent penalties imposed by Obama appear to be more symbolic than impactful. Even a minor increase in taxes or penalties for opting to use offshore labor should have little impact on the overall cost savings of offshoring to India, China or other lower cost destinations. It may, however, deter those companies looking at a very marginal benefit from going abroad - which in itself is probably a benefit to both local companies and the offshorers engaging in those types of contracts. As noted by Martin Hart of the NOA, "It is refreshing to see a government moving forward with election promises and Obama has done this without disrupting the business world, whilst at the same time keeping voters happy. The fact is, US companies will happily take this tax increase on the chin without bringing processes back home. As a Business Week article stated, having 80,000 staff in India perform work for a fifth of the cost of their US counterparts, to the same quality, is simply too attractive a proposition to ignore."

While the risks of protectionism are hotly contested, cooler heads at the top should ensure that while companies do take a critical look at what goes abroad and what stays home, they should not be deterred from making strategic decisions that will benefit everyone in the long term.  

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