The Paradox of Offshoring: IBM to Fire 150,000 US Workers

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According Robert Cringely at PBS, IBM is cutting at least 150,000 US jobs in its Global Services Division, and each US worker is to be replaced by a new overseas hire. This headcount cut, called Project Lean, bears out the populist view that corporate executives are greedy and outsourcing damages the American economy. As we noted in a recent post, models that analyze the benefits of free trade often omit the costs. In this case, one of the costs is wage suppression. 150,000 unemployed IT workers will have a significant impact on incomes of those with skills similar to that of the ex-IBMers.

Notice the comment in the article: this program is expected to go over badly with employees and customers. Cringely argues, convincingly, that it will damage IBM’s business. But the only constituency that counts is Wall Street. (Our colleague Susan Webber, in “The Incredible Shrinking Corporation,” discusses the phenomenon of “corporate dysmorphia” when companies cut expenses and investment so deeply that it hurts them).

Now why is this so terrible? American corporations are in the process of destroying the middle class. Henry Ford understood if you paid workers well, they’d buy more goods, including your products. A growing middle class created a virtuous circle: higher incomes and more jobs meant more consumption, which allowed business to expand and enabled them to pay workers even more.

Now companies are operating from a a self-destructive paradigm, a reversal of Ford’s virtuous circle. They increasingly see employees as a cost, rather than an asset. More and more companies exhibit a Wal-Mart mentality: get by with as few workers as possible, and pay them as little as you can. That pattern has been most common in enterprises that use hourly workers, like manufacturing and retail, but it’s becoming more and more common in the white-collar world. And the IBM move will make it respectable.

The only reason that this wage stagnation hasn’t shown up (yet) in lower consumption is that Americans have gone from being low savers to non-savers to dis-savers. For the first time since the Depression, America has had two years of negative savings rate (that is, spending exceeded income), and that trend continued into the first quarter of 2007.

But what will happen as more and more workers lose their jobs to offshoring? In a recent Foreign Affairs article, Princeton economist Alan Blinder depicted the offshoring trend as a development on par with the Industrial Revolution, which although it ushered in higher living standards overall, also created a great deal of poverty and dislocation, particularly among farm workers. In the Wall Street Journal, Blinder estimated the US job losses to offshoring as 30 to 40 million, out of a total workforce of 130 million. Those losses are on the scale of the Great Depression.

A reader mentioned that some of the arguments about trade reflect the fallacy of composition: what is true for the part is assumed to be true for the whole. Keynes “paradox of thrift” is an example. While it is prudent for individuals to save, too much savings across the economy can produce a recession. Similarly, we have a paradox of offshoring: while it might be beneficial for a business to offshore jobs, if too many companies pursue it, we won’t have much of an economy left.

From Cringely:

This is according to my many friends at Big Blue, who believe they are about to undergo the biggest restructuring of IBM since the Gerstner days, only this time for all the wrong reasons.

The IBM project I am writing about is called LEAN and the first manifestation of LEAN was this week’s 1,300 layoffs at Global Services, which generated almost no press. Thirteen hundred layoffs from a company with more than 350,000 workers is nothing, so the yawning press reaction is not unexpected. But this week’s “job action,” as they refer to it inside IBM management, was as much as anything a rehearsal for what I understand are another 100,000+ layoffs to follow, each dribbled out until some reporter (that would be me) notices the growing trend, then dumped en masse when the jig is up, but no later than the end of this year…

LEAN is about offshoring and outsourcing at a rate never seen before at IBM. For two years Big Blue has been ramping up its operations in India and China with what I have been told is the ultimate goal of laying off at least one American worker for every overseas hire. The BIG PLAN is to continue until at least half of Global Services, or about 150,000 workers, have been cut from the U.S. division. Last week’s LEAN meetings were quite specifically to find and identify common and repetitive work now being done that could be automated or moved offshore, and to find work Global Services is doing that it should not be doing at all. This latter part is with the idea that once extraneous work is eliminated, it will be easier to move the rest offshore.

All this is supposed to happen by the end of 2007, by the way, at which point IBM will also freeze its U.S. pension plan.

The point of this has nothing to do with the work itself and everything to do with the price of IBM shares. Remove at least 100,000 heads, eliminate the long-term drag of a defined-benefit pension plan, and the price of IBM shares will soar. This is exactly the kind of story Wall Street loves to hear. Palmisano and his lieutenants will retire rich. And not long after that IBM’s business will crash for reasons I explain below.

I am told there is a broad expectation at all levels of IBM familiar with the LEAN plan that it will cause huge problems for the company. Even the executives who support this campaign most strongly expect it to go down poorly with employees and customers, alike. But in the end they don’t care, which shows that only the reaction of Wall Street matters anymore.

So we can expect round after round of layoffs, muted a bit — as they were back in the Gerstner days — by some of those same people being hired back as consultants at 75 percent of their former pay (50 percent of their former cost to the company since they won’t be getting benefits). Throw in some overtime and it won’t look bad on paper for the people, but it is also very temporary.

Taking a pure business school approach to this news, it probably doesn’t look so bad for IBM. What’s wrong with a multinational corporation moving work to its own overseas divisions? Squint hard enough and it can even look like good management. Global Services IS overweight and inefficient. Something has to be done and the company has already considered (and apparently rejected) a range of options, right up to putting Global Services on the auction block.

The problem with LEAN is that offshoring on this scale creates huge communications and logistical problems, doesn’t generally improve customer relations, and won’t save money for years without the parallel gutting of the pension plan.

And it is just plain mean.

This is a policy based on perception. Streamlining and downsizing look good to customers unless it is their project that is being chopped, because implicit in LEAN is that Global Services will be eliminating not just employees but customers, too — customers whose contracts were underbid and whose projects may never be profitable for IBM. Maybe such axing of customers is necessary, probably it is inevitable, but it hardly has a ring of corporate honesty. Customers to be dropped haven’t yet been notified, either.

It is especially disconcerting for an action of this scale to take place at a time when many companies (including IBM) are complaining about a shortage of technical workers to justify a proposed expansion of H1B and other guest worker visa programs. What’s wrong with all those U.S. IBM engineers that they can’t fill the local technical labor demand? They can’t be ALL bad: after all, they were hired by IBM in the first place and retained for years.

What is unstated in this H1B aspect of the story is not that technical workers are unavailable but that CHEAP technical workers are unavailable. Lopping off half the technical staff, as Global Services is apparently about to do, will eliminate much of the company’s traditional wisdom and corporate memory in an act that some people might label as age discrimination.

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