Term Paper on "Outsourcing Europe vs. US"

Quoted Instructions for "Outsourcing Europe vs. US" Assignment:

Economic Analysis Paper

Instruction:

Economic Analysis Paper

The economic analysis paper requires you to select an article from the popular media (newspaper, news magazine, media web site, and/or trade publication), and then both summarize the economic issue presented in the article and critique the economic analysis contained in the article. The article summary should be brief (1 – 1.5 pages) and should provide a synopsis of the issue presented in the article. This synopsis should be in your own words rather than citing and or copying the author’s words directly. The most important part of the economic analysis paper is the critique, in which you evaluate the author’s understanding of economic theory relevant to this particular issue: Is the author’s analysis supported by economic theory or inconsistent with the predictions of theory? Is the author’s analysis superficial, ignoring important economic dimensions of the question. You are not required to use external sources and “research” the issue; the economic analysis paper is meant to demonstrate your ability to apply economic theory to a real-world issue. I am most interested in how you present and structure your analysis, and I want to read your critique rather than the analysis of others (e.g. from external sources).

A useful format for the paper is the following

Introduction (1/2 page in length) The introduction should clearly state the economic issue(s) addressed in the article and why they are of interest.

Synopsis (1 pages in length) In your own words, characterize the economic analysis contained in the article. Ideally, the synopsis should provide me with an overview of the article sufficient to understand your subsequent critique.

Critique ( 3 pages in length) The critique is the most important part of the paper, in which you present your own analysis of the economic issue(s) presented in the article, noting points of agreement and/or disagreement with the author’s analysis? If you support the author’s analysis, cite what economic theory and/or theories buttress the author’s arguments. If you disagree with the author’s analysis, indicate what economic theory predicts, and how these predictions are at various with the analysis provided by the author.

Conclusion (1/2 page in length) Provide a brief summary of the issue you analyzed, and conclude with a brief observation on what your critique of this article implies more largely for the quality of economic an*****s in the popular media.

Paper Format

The paper must be typed, 5pages in length, using a typeface no larger than 12 point Times New Roman. All margins should be set at 1.25 inches. The paper should include a title page, indicating your paper’s title, your name and the course number and title. All pages of the paper should be paginated, and the last page should include the citation of the paper (Author, article title, publication title, date, page number(s).) Within the body of the text, indirect and direct citations can be handled using the inline citation method. For example:

Varian characterized Amazon’s 2001 pricing experiment as “clear evidence that Amazon believes pricing strategies ‘too low’ to be consistent with static models of pricing under market power might suggest dynamic strategies to build market share.” (Varian, p. D1) If this is accurate, we would expect Amazon to implement price increases over time.

Please be careful to attribute all “borrowings,” either direct quotations or indirect paraphrasings of the author’s ideas. Please submit a photocopy of the article along with your paper.

You DO NOT need to reference other authors or seek out the writings of others on this topic. Again, I am not interested in what others have to say about the issue, but rather how you structure and present your economic analysis through the form of critiquing the author’s economic analysis. In simple terms, reading and citing outside works won’t improve your grade.

Guidelines

The article must discuss some facet of microeconomic theory. You cannot write a paper about the Fed’s decision to change interest rates, or discussions of other macroeconomic aggregates.

The article that the paper is based on.It's from the Economist.

SINK OR SCHWINN

> Nov 11th 2004

>

> Sourcing from low-cost countries works only in open and flexible

> labourmarkets. Europe's are neither

>

> WHEN Hal Sirkin was growing up in 1960s America, the bicycle that

> everyregular American child wanted was a Schwinn. In 1993, Schwinn

> filed for

> bankruptcy. The firm had been overtaken by imported Chinese bicycles.

> In 2001, a company called Pacific Cycle bought the Schwinn brand

> out of

> bankruptcy. Pacific Cycle, now owned by a Canadian consumer-goods firm

> called Dorel Industries, says the secret of its success is "combining

> its powerful brand portfolio with low-cost Far East sourcing." Schwinn

> bicycles now line the aisles at Wal-Mart.

>

> Mr Sirkin is a consultant with the Boston Consulting Group who helps

> his customers do what Pacific Cycle has done to Schwinn: move

> production to East Asia, especially to China. Wal-Mart buys $15

> billion-worth of Chinese-made goods every year. Obtaining goods and

> services from low-cost countries helps to build strong, growing

> companies, such as Dorel Industries, and healthy economies. But the

> Schwinn story also contains the opposite lesson: failing to buy in

> thisway can seriously damage a company's health.

>

>

> Sourcing from low-cost countries brings many economic benefits.

> Cheaper labour brings down production costs. This keeps companies

> competitive, raises profits and reduces prices as firms pass their

> lower costs on to their customers. Higher profits and lower prices

> liftdemand and keep inflation in check. Companies spend their

> profits on

> improving existing products or introducing new ones. Customers buy

> moreof the things they already consume, or spend the money on new

> goods and

> services. This stimulates innovation and creates new jobs to replace

> those that have gone abroad.

>

> Moving work abroad may also help to speed up innovation directly, as

> American, European and Japanese companies get some of their R&D

> done by

> Chinese, Russian or Indian engineers. Randy Battat, the boss of

> Airvana, a telecoms-equipment start-up, has spent the past 18 months

> setting up an R&D centre for his company in Bangalore. This will

> complement the work of Mr Battat's engineers in Chelmsford,

> Massachusetts. The ones working in America will develop the next

> generation of the company's technology. The Bangalore centre will

> elaborate Airvana's existing technology. "They are adding bells and

> whistles that could not be added otherwise because it would not be

> cost-effective," says Mr Battat.

>

> By making IT more affordable, sourcing from cheaper countries also

> spreads the productivity-enhancing effects of such technology more

> widely through the economy. Ms Mann of the Institute for International

> Economics calculates that globalised production and international

> tradehas made IT hardware 10-30% cheaper than it would otherwise

> have been.

> She reckons that this price reduction created a cumulative $230

> billion-worth of additional GDP in America between 1995 and 2002 as

> more widespread adoption of IT raised productivity growth.

> Sourcing IT

> services (which account for 70% of overall corporate spending on IT)

> from countries such as India will create a "second wave of

> productivitygrowth", predicts Ms Mann, as cheaper IT spreads to

> parts of the

> economy that have so far bought less of it, such as the health-care

> industry and smaller companies.

>

> McKinsey calculates that for every dollar American firms spend on

> service work from India, the American economy receives $1.14 in

> return.This calculation depends in large part on the ability of

> America'seconomy to create new jobs for displaced workers.

> America's labour

> market is a miracle of flexibility: it creates and destroys nearly 30m

> jobs a year.

>

> However, in countries such as Germany, France and Japan a combination

> of social legislation, stronger trade unions, regulations and

> corporate-governance arrangements make employment practices more rigid

> and sometimes keep wages higher than they would otherwise be. This

> reduces demand for labour and pushes unemployment higher.

> According to

> McKinsey, in Germany, the re-employment rate for IT and service

> workersdisplaced by sourcing from low-cost countries may be only

> 40%. As

> unemployment at home rises, that process could actually make Germans

> poorer (see chart 7).

>

> RELUCTANT EUROPEANS

> Udo Jung of the Boston Consulting Group says that, by and large,

> Germans accept that manufacturing companies such as Hella, Bosch and

> Siemens must get supplies from China. Degussa, a chemicals

> manufacturer, recently invited its workers' council on a trip to

> China.The idea was to take emotion out of the debate, says Mr

> Jung. Nor do

> continental Europeans seem bothered about white-collar work being done

> in low-cost countries. But that may be because they are doing so

> littleof it.

>

> At present, perhaps 80-90% of the service work being done remotely in

> India comes from either America or Britain, with which the country has

> linguistic and cultural links. Such links are absent from its

> relationship with Germany or France. Germany, like America, introduced

> a special visa programme for Indian IT workers in the 1990s as its

> domestic supply of engineers ran dry. But most Indians that went to

> work in Germany failed to learn the language and came back again, says

> Infosys's Mr Murthy. The opposite is true of Indians in America. Those

> who have gone there to work or study are often reluctant to return

> hometo their families.

>

> Cultural ties appear to be important in forming business

> relationshipsin remote-service work, says Rajendra Bandri of the

> Indian Institute of

> Management in Bangalore. Mr Bandri has studied five examples of

> European firms outsourcing white-collar work to Sri Lanka. In each

> case, they chose that country because a well-placed Sri Lankan worked

> for the European firm, says Mr Bandri.

>

> Eastern Europe and Russia, which brim over with skilled,

> underemployedengineers, present fewer cultural barriers for

> European companies.

> French is spoken in Russia, German in Hungary and elsewhere. Yet

> neither German nor French firms have yet shown much appetite for

> buyingservices work from their neighbours, either. Arkadiy Dobkin,

> the boss

> of Epam, which claims to be the largest supplier of IT services from

> eastern Europe and Russia, is based in Princeton, New Jersey, rather

> than in Paris or Berlin.

>

> BEYOND ECONOMICS

> A survey of 500 European firms last summer by IDC, a research firm,

> found that only 11% of its sample were sourcing IT work from low-cost

> countries, and that nearly 80% would not even consider doing so.

> Attitudes were hardest in Italy, where 90% of firms were against the

> idea, followed by France and Germany. An American study released

> at the

> same time by Edward Perlin Associates, a consulting firm, found that

> around 60% of the companies it surveyed had some of their IT work done

> in low-cost countries.

>

> In continental Europe, companies may outsource for reasons that have

> little to do with favourable economics, says Francis Delacourt, the

> head of outsourcing at Atos Origin. In what he describes as "social

> outsourcing", firms such as Atos Origin may take on surplus IT

> employees from companies that no longer need them. Europe-wide social

> legislation requires the new employer to provide the same wages and

> benefits as the old one. The alternative is costly redundancy. Mr

> Delacourt says this works for his company, up to a point, because

> demand for IT workers in Europe is growing, and Atos Origin has found

> ways to re-employ such people profitably. But he concedes that his

> company needs to be careful not to take on too many.

>

> How well this system stands up to competition from India is anybody's

> guess. A manager at one firm in Europe privately muses that Germany,

> France and other countries might introduce barriers to IT imports to

> counter the threat to their domestic employment. If McKinsey is right

> and sourcing from abroad does make unemployment in Germany and

> elsewhere worse, protectionist sentiment will grow.

>

> In the end, Europe's big service firms are likely to get round to

> sourcing production from abroad, as its manufacturing companies have

> already done. But by that time, says Andrew Parker of Forrester,

> British and American companies will already have developed much

> stronger ties with India and other cheap countries, and costs will

> haverisen. This will especially hurt Europe's big financial firms: the

> biggest banks spend billions of dollars a year on IT. Mr Parker

> speculates that some European financial firms could be so badly

> damagedby this loss of competitiveness that they may fall into the

> arms of

> fitter American and British rivals. Schwinn could tell them all about

> it.

>

One of my drafts:

In the article “ Sink or Schwinn” of the Economist, the author makes several interesting points as to why outsourcing is not popular in certain Continental European countries.

As a preliminary matter, it is not self-evident, at least from an economic perspective, why outsourcing has not been enthusiastically adopted by countries like Germany, France and Japan. Basic economic theory assumes that economic actors are motivated by the pursuit of profit. Under this maxim, one would assume every country would be flocking to outource. Cheaper labor brings down production costs, maximizes profits and stimulates economic growth. Prices go down, resulting in inflation keeping in check. New jobs are created to fill the gap for the jobs that are outsourced. In addition, innovation is encouraged because of the cost of the overhead is lowered so that new products can be developed. In turn, information Technology is more affordable because lower production costs have speeded up innovation and kept prices low.

Further, according to Ms. Mann of the Institute of International Economics, “….globalised production and international trade has made IT hardware 10-30% cheaper than it would otherwise have been.”(p.18) We can see that technological changes like the IT revolution create new possibilities for productivity growth. These new technologies allow labor to be used more efficiently so it can produce better quality goods. Higher profits from growth in labor productivity create capital that is used in better and more machinery and thus makes productivity even greater. With this, I agree.

All firms in industry have goals to maximize profits. In perfectly competitive markets the firms produce until prices are equal to marginal cost. We know that the amount of labor and capital depends on the prices of inputs.

Industries are so large in scale that workers can specialize at work and be more productive. A big industry like Wal-Mart can negotiate better prices because it is buying in big quantities so some production inputs have lower cost.

Small changes in price create big changes in output. When quantity goes up the purchasing price goes down.

However, the author notes at least one possible economic reason for the lack of outsourcing’s popularity in these countries – government and union intervention in the local labor pool. For example, the author notes that in countries like France, Germany and Japan, because of government intervention through social legislation and strong labor unions, the cost of labor is greater and more stable thus discouraging the hiring and firing of new people. Because the labor costs of companies in these countries is essentially “fixed,” such companies would not achieve any significant labor cost savings by outsourcing to foreign countries. In other words, outsourcing would not be profit maximizing as companies in these companies would still need to pay for their otherwise fixed local labor costs.

In addition, the author also describes how cultural phenomenon can amplify or entrench conduct that can otherwise be explained in purely economic terms. For example, the author also gives a number of other “cultural” reasons for why outsourcing is unpopular in countries like France and Germany. First, business relationships between these European countries and countries such as India are more complicated because of cultural barriers. India shares many similarities with England and the US, especially in language, resulting from years of English rule. Most people in the world learn English as a second language as opposed to French, Italian, German or Japanese. People are more likely to stay in a country where they can already speak the language than staying in a country where they must learn another.

The importance of such cultural, non-economic, factors is illustrated by the fact that government intervention in the labor pool does not encourage profits. This is illustrated in the western European countries by the high unemployment rate. Even if the consumer surplus and the producer surplus are in equilibrium there will be a net loss from government policies that shift surplus from one group to another. Labor costs erode a higher profit margin and result in higher prices for the products. If Europe doesn’t change labor and social legislation it may no longer be able to compete with the countries involved in outsourcing. it may not always be bad, especially in countries whose primary goal is not economic efficiency.