President Obama’s Offshoring Rhetoric

Thus sprach President Barack Obama to a joint session of the Congress – “we will restore a sense of fairness and balance to our tax code by finally ending the tax breaks for corporations that ship our jobs overseas.” Everyone stands up to applause and I am a little confused.

First, how does someone even implement this proposition? I am yet not sure of the legal fine print but does it mean GE (example) will lose its tax breaks if it offshores customer support to Wipro Technologies in India (example) but will not if it sets up GE India Pvt Ltd for the exact same purpose? Most offshoring happen like this. An US company signs an outsourcing contract with an US subsidiary of (say) an Indian outsourcing vendor, which then sub-contracts the job out to its Indian parent at a price. The Indian company pays tax on the profit it earns from the arm’s length transaction with its US subsidiary while the US subsidiary pays tax as per the laws of its domicile country, that is the United States of America. The US earnings attracts Indian taxes only if the US subsidiary repatriates profits earned in the US in the form of dividend to its Indian parent company. Given this situation it is not intuitive how President Obama can implement his rhetoric.

Secondly, a country loses jobs to offshoring when it no longer enjoys comparative advantage of performing a function or a task. The per transaction cost of answering a phone in Manila is way too low compared to Minnesota, so it is a given that Philippines becomes a preferred destination for that function. The folks at Minnesota graduate to doing stuff they are relatively more efficient in doing (like designing marketing campaigns for which the phones will ring in Manila). This outward movement of functions have been happening for a very long time with the US, especially in manufacturing. It can be argued that at a macro level the skill of car making shifting out of Detriot into South Korea and Japan is some sort of factor-induced non directed offshoring. So is it even possible to reverse an economic process by constructing non-tariff barriers? Or have we reached a situation where Americans have lost their relative advantage in significantly high number of functions and offshoring is a consequence of that rather than mere cost (or tax law) arbitrage? President Obama goes on to say – “… I do not accept a future where the jobs and industries of tomorrow take root beyond our borders – and I know you don’t either. It is time for America to lead again”.

I wonder how it is possible for America to resume leading by doing tasks that Manilla had been doing for it up until now.

Update: Kishore has a very clear minded and precise analysis of this issue in this post in his blog – View of My World

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2 thoughts on “President Obama’s Offshoring Rhetoric

  1. I agree with the premise of this blog. ‘Off-shoring’ activities to extract greater profitability from your core operations benefits the ‘US Corporation’ and its stakeholders (except for the displaced employees whose roles have been off-shored). Simply speaking, higher corporate profits lead to higher tax inflows, or at least they should. To compound the problem, unrealistic expectations from Wall Street lead to a very short term view of financial health, growth and progress. Further, there seems to be a phenomenon of perfect internal reflection in terms of consumption, whereby we Americans consume more than what we produce and then some. We realize now how our economy was not rich enough to buy everything we thought we could afford and that our spending had little or nothing to support it in the medium term. Going forward, we could see either generally higher savings (to support investments and mobilize capital domestically, thereby keeping returns at home) and lower consumption (lower turnover per dollar in the money supply) levels OR we might focus on renewing our leadership in exporting products and services of high value to a global market (technology, processes, expertise and maybe even a super-efficient electric car) which allow us to maintain our relatively higher standards of living and keep up the high money supply (corrected for inflation) times the high turnover (consumer consumption) leading to a healthy GDP growth. We could start by entering and dominating the domestic market of our largest trading partner, China and turn that trade deficit around.

    • Excellent insight, Ambrish and thanks for taking the time.
      The savings rate has already started ticking up, which is a good thing. You make a nice point about decreasing velocity of money. This has direct implications for the Banking and Financial Services sector. Typically, these institutions grow at a rate equal to GDP growth rate times velocity of money. With both factors in the equation poised to head south, it is obvious that the sector will feel a lot of pain ahead. With top line growth is stunted, this sector, which offshores the most, will have to look at bottom line management techniques. And it is here that offshoring could have played a huge role. So the trade off pretty much becomes a fist fight between opportunity cost of forgoing tax breaks (which may be reversed when the economy recovers and the focus gets back to deficit management) versus a economic cost saving through off-shoring. It will be interesting to see how this pans out.

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