Offshoring

Here's an excellent, thought provoking working paper written by Princeton economics professor Alan S. Blinder on the subject of free trade and offshoring. His thesis, that information technology will allow a much larger number of service jobs to be offshored to places like India, is one I completely agree with.

Assuming Blinder's theory is correct, how does an investor respond? Does the American equity market suffer at the expense of India as more Americans lose jobs, lowering consumption and hurting the economy as a whole? Or, do American corporations profit due to lower labor costs and a larger global market for their services? I think it depends on the rate of the shift of jobs from the US to poorer countries, and how quickly those poorer countries develop and modernize. A sudden shift in jobs offshore would probably allow the US companies to move aggressively into foreign markets before local competitors could grow large enough to capture the market. A slow drift, on the other hand, would give local businesses the time to mature.

Of course, we're ignoring any possible barriers to trade that the US government may erect in the meantime. Given yesterday's announcement of new tarriffs on Chinese paper products, the Bush administration appears to be leaning toward making trade more difficult. My suspicion is that the US government, pressured by labor unions and voters in middle-class districts, will enact more and more barriers to trade, but will concentrate on protecting the farm and manufacturing industries and will generally ignore service jobs. This will probably allow foreign service industries to grow and gain market share both in the US and overseas. Perhaps going long some Indian equities would be an ideal core portfolio holding for long-term time horizons.

As a side-note, Blinder mentions security analysis as a possible industry to be offshored. I think security analysts and investment bankers are at very high risk. The sell-side is very much concerned with pedigree, particularly in i-banking. American banks will be very slow to consider offshoring. The buy-side, however, is much more concerned with results. Put together a bank in India that provides both research and investment banking that's just as good as the American alternative and costs one third as much, and you'll see a titanic shift of commissions and fees. Perhaps I should reconsider my current employment status...

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