Over the last few decades many companies have looked to cheap labor in other countries to increase their profits. Developing countries offer an advantage over richer nations, thus creating a natural benefit that companies take advantage of. This is especially true for companies in the United States, which have outsourced a lot of manufacturing jobs to countries like China, Vietnam, India, and many others. These countries can make the same product but for a fraction of the cost, making moving jobs there very attractive. However, despite these advantages, in recent years there has been some push back, as some have called for these companies to bring these jobs back to American soil. Therefore, what follows below is a brief discussion about the economic theory behind outsourcing, some reasons why these companies might consider returning home, and a look at a specific American company that outsourced jobs and is now rekindling their US based manufacturing.
On the surface it seems to make sense that a company will seek to reduce their costs, but three concepts in economic theory help explain global trade and why some companies choose to move overseas: comparative advantage, opportunity cost, and supply/demand. First of all, comparative advantage can be explained as the ability of an economic actor to provide value of some sort in either goods or services. That is, a person, company, country, etc. needs to have an advantage over others if they want to compete. When it comes to the international economy, countries are competing in various ways to get their share of economic activity, and one of the ways they do this is by offering cheap labor. In other words, countries gain a comparative advantage by being able to manufacture goods cheaper than others. Because companies have the obligation to the shareholders and various other stakeholders to make a profit, they will naturally seek the countries that offer the lowest costs.
Furthermore, opportunity cost can be defined as the cost of a missed opportunity. That is, when doing a cost benefit analysis for a certain decision, it must be taken into account the cost of not taking advantage of a better investment. For example, when it comes to outsourcing a company calculates the difference between what they could be making if they moved manufacturing overseas versus what they are making staying in the same country. This type of calculation, for most companies, shows that they are losing money by not outsourcing. Therefore, with this in mind, it is easy to understand why so many companies have decided to relocate to countries with cheaper labor.
Lastly, supply and demand are essential concepts in trying to understand outsourcing. The law of supply and demand state that as one goes up the other goes down and vice versa. That is, the more there is of something the less people demand it, and the less people demand something, the more there is of it. When it comes to labor, the more there is of people that can do a certain type of job, the less it is going to pay. Therefore, a lot of manufacturing jobs move overseas because that type of work can be done by people in other countries for less money. In other words, there if the jobs were overly technical and could not be done by many people, they are less likely to be moved overseas. Therefore, companies that outsource are simply following the laws of supply and demand when it comes to the labor involved in manufacturing.
While basic economic principles explains why some companies move jobs overseas, there are a handful of reasons to change their minds. One big way to do this is to reduce the advantage offered by countries offering cheap labor. If labor costs go up or if the cost of importing the products back to the US goes up, then it would no longer make economic and financial sense to keep factories overseas. Furthermore, in recent years some companies have faced public and political ridicule that have turned some customers away from buying their products. Because of this backlash, the company has lost a certain percentage of their profits, thus making it more expensive to produce goods overseas. Overall, it will continue to make economic and financial sense for companies to manufacture their products in other countries that provide cheap labor, unless their profits are eroded.
This is what happened to General Electric (GE). According to an article by the Motley Fool, in 1973, the company employed 23,000 people at their facility in Kentucky, but by 2011, they had only 1,863. However, this facility is experiencing a resurgence, as the CEO has claimed that the business model of outsourcing the manufacturing of their appliances is quickly becoming feasible, even labeling the coming movement as an insourcing boom (Pino, 2013). The factors behind this are that the cost of shipping rose enough to hurt their bottom line significantly. That is, it made more sense to produce the products closer to the American consumer. Also, it was determined that having engineering in design in America and the factories abroad provided too much of a rift that hurt productivity and innovation. They found it was better to have them under the same roof. Lastly, it was also found that the factories had begun to age rapidly, adding a large amount of costs to keep them running (Fishman, 2012). Now GE is bringing thousands of jobs back home as it no longer made economic and financial sense to keep the factories overseas.