Technology and Investment, 2013, 4, 269-273
Published Online November 2013 (
Open Access TI
Economics of Offshore IT Outsourcing: An International
Trade Perspective
Bijoy Bordoloi*, Anne Powell
Computer Management and Information Systems, Southern Illinois University at Edwardsville, Edwardsville, USA
Email: *,
Received June 7, 2013; revised July 7, 2013; accepted July 14, 2013
Copyright © 2013 Bijoy Bordoloi, Anne Powell. This is an open access article distributed under the Creative Commons Attribution
License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
In recent times, offshore outsourcing of Information Technology (IT) products and services, including software devel-
opment and maintenance activities, has been an issue of much controversy in the United States, with popular sentiment
being against outsourcing in the mass media. Is offshore outsourcing really bad for the US economy? If yes, why did so
many US companies, including IT companies, start outsourcing to begin with and still continue to do so? For that matter,
why doesn’t the federal government simply ban it as a national policy? To provide some possible answers to these
questions, this paper examines the issue of offshore outsourcing from the perspectives of international trade theory and
the unique cost characteristics of “information goods”.
Keywords: Technology Economics; Economics of Offshore Outsourcing; International Trade Theory; Information
Economics; Position Paper
1. Introduction
In recent times, offshore outsourcing (or simply “out-
sourcing”) of service sector activities (and jobs) has grown
rapidly and has been an issue of much controversy in the
United States. Outsourcing is not new; in the US, it can
be traced back to the 1880s when New England textile
mills moved south to the Carolinas [1]. Historically, the
majority of outsourced jobs were in the manufacturing
sector. Today, because of technological advances, distri-
bution costs nearing zero with the use of cloud comput-
ing and the Internet, and increased availability of skilled
workers. It is the outsourcing of service sector jobs, many
in the relatively high-paying Information Technology (IT)
area, which is attracting attention. In a recent study, 40%
of firms within the technology-services and telecommu-
nications industry reported offshore outsourcing [2]. This
paper focuses specifically on the offshore outsourcing of
IT jobs. We define offshore IT outsourcing as “… the
organizational decision to turn over part or all of an or-
ganization’s IS functions to external service provider(s)
in order for an organization to be able to achieve its
goals,” [3, p. 209].
As jobs are being outsourced to India, China, Mexico,
and other countries, the mass media is quick to report on
the negatives and harm that outsourcing causes employ-
ees. Headlines such as “A Greater Threat than Terrorism:
Outsourcing the American Economy,” [4] or “Negative
Effects Outsourcing has on Companies,” [5] are common.
Mass media pay attention to outsourcing intensifies dur-
ing election years. During the US election year of 2012,
outsourcing came to the forefront of election issues.
Current President Barack Obama criticized his opponent,
Mitt Romney, for outsourcing American jobs when Rom-
ney headed Bain Capital Corporation. Republicans, in
turn, criticized President Obama for outsourcing energy
jobs [6], or simply not doing enough to slow the growth
of outsourcing [7].
Is offshore outsourcing really bad for the US economy?
If yes, why did so many US companies, including IT
companies, start outsourcing to begin with and still con-
tinue to do so? For that matter, why doesn’t the federal
government simply ban it as a national policy? And, if
outsourcing is so bad, why did 2012 legislation to elimi-
nate tax breaks to companies that outsource get voted
down in the US Senate?
While there has been published some economic theory
based research (e.g., Transaction Cost Economics [8]) in
the IT literature to examine the merits of outsourcing, in
*Corresponding author.
this paper, we provide an alternate theoretical perspective
based on international trade theory and the unique cost
characteristics of “information goods” to provide some
possible answers to the above questions.
The rest of the paper is organized as follows. In the
next section, at the firm level, we describe some recently
published findings regarding the benefits companies re-
ceived by outsourcing work to other countries. To look at
the issue of offshore outsourcing more objectively at a
macro or national level, we next discuss the trade theory
of Comparative Advantage to provide some basic under-
standing of foreign trade. Against the backdrop of this
trade theory, we then discuss the winners and losers in
the outsourcing battle and provide some possible answers
to the questions raised above. Finally, we conclude with
some future research questions that should, perhaps, be
asked regarding the consequences of offshore outsourc-
2. Why Outsource?
Many companies outsource. In a recent survey, 15% of
all companies reported offshore outsourcing. But the
same survey also showed that in 40% of the IT services
and telecommunications industry companies, offshore
outsourcing was occurring [2].
Research on Information technology outsourcing (ITO)
has been ongoing for over twenty years. During this time,
numerous studies have studied diverse topics on ITO
including factors related to the decision on whether to
outsource and factors related to the successful outcomes
of outsourcing by companies.
Lacity et al. [9], published a comprehensive literature
review on ITO in 2010 that reviewed 164 empirical arti-
cles on ITO between 1992 and 2010. The authors found
four core areas that have been studied extensively on the
decision to outsource. Most commonly studied is the
motivation of companies to outsource. What motivates a
corporation to outsource their IT function most is the
need to reduce costs. Tied to the need to reduce costs is
the desire of the corporation to focus on core capabilities,
and a corporation’s core capability may not include its IT
function. This, then increases the motivation to outsource
IT. In addition, access to more or better IT skills and/or
expertise, and a desire for business process improve-
ments also motivates the decision to outsource.
Alternatively, a corporation is less likely to make the
decision to outsource their IT if the company has a great
concern about security or fear of losing control of their
IT. Transaction attributes were also a frequent topic of
research on ITO decisions. The transaction attributes most
commonly studied are consistently related to the decision
NOT to outsource. Higher values of uncertainty, the criti-
cal role of IS, transaction costs, and business risks all
lead to less outsourcing. Prior IS department perform-
ance was also significantly and negatively related to the
decision to outsource while mimetic influence (percep-
tion that peer organizations are more successful) was
significantly and positively related to the decision to
outsource [9].
Of more interest is how companies have benefitted
from Information technology outsourcing. IT outsourcing
appears to occur most often because of costs savings or
access to skills [2,10]. Lacity et al. [9], report that out-
sourcing IT results in a positive outcome 63% of the time,
and no changes in performance 15% of the time. Only
22% of the outsourcing outcomes were negative. Out-
sourcing has been found to reduce costs [11,12], increase
exports [11,13], improve productivity and enhance an
organization’s flexibility [14] and increase new product
innovation [11].
In this paper we posit that offshore outsourcing, effec-
tively, can be viewed as “international trade” and nations
(and companies) benefit considerably from international
trade. To understand the economic benefits of interna-
tional trade, next we discuss the theoretical roots of the
modern day trade developed by David Ricardo (1772-
1823), known as the Princ iple of Comparative Advan-
tage [15].
3. The Theory of Comparative Advantage
Adam Smith (1723-1790), a classical economist, was a
champion of free trade or open markets. He argued that
free trade enables each trading nation to benefit consid-
erably by specializing in the production of goods that it
produces at a lower cost than the other nation, while im-
porting the good that it produces at a higher cost. Unlike
Smith, who emphasized the importance of absolute cost
differences among nations, Ricardo emphasized relative
or comparative cost differences. Ricardo showed that
mutually beneficial trade can occur even if one nation is
absolutely more efficient in production of all goods than
its trading partner.
To understand Ricardo’s trade theory based on com-
parative cost advantage, to keep things simple, let us
consider only two nations: US and India, and only two
goods: Aircraft and Software, as exemplars. As shown in
Table 1, suppose that the US can produce 2 aircraft or 12
billion lines of code (software) with 1 unit of resources,
and India can produce 1 aircraft or 8 billion lines of code
Table 1. Absolute advantage.
Output per unit of resources
Nation Aircraft Software
(billion lines of code)
United States 2 12
India 1 8
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with 1 unit of resources. Assume that both the products
in both the countries are comparable in quality. Under
these circumstances, the US is a more productive and
less costly supplier of both aircraft and software than
India, since it produces more of each good from a unit of
resources than India does. In other words, the US has an
absolute cost advantage over India in the production of
both of these goods.
However, according to Ricardo’s principle of com-
parative advantage, even if a nation has an absolute cost
advantage in the production of both the goods, the two
nations can still mutually benefit if they engage in trade
of these goods. The less efficient nation should specialize
in and export the product in which it is relatively less
inefficient, i.e., where its absolute disadvantage is least;
while the more efficient nation should specialize in and
export the product in which it is relatively more efficient,
i.e., where its absolute advantage is greatest [16].
In other words, a country has a comparative advantage
over another country in the production of a particular
good if the cost of making this good, compared with the
cost of making other goods, is lower in this country than
in the other country. Under the above circumstances, the
US has a comparative advantage over India in the pro-
duction of aircraft. Why? Because the cost of a aircraft in
the US is the same as the cost of 6 billion lines of code
(since both require 1/2 unit of resources), whereas in
India it is the same as the cost of 8 billion lines of code
(since both require 1 unit of resources). Thus, relative to
the cost of producing other goods (in this case, software),
aircraft are cheaper to produce in the US than in India.
By the same token, India has a comparative advantage
in software production. The cost of 8 billion lines of code
in India is the same as the cost of 1 aircraft (since both
require 1 unit of resources), whereas in the US it is the
same as the cost of 1 and 1/3 aircraft (since both require
2/3 unit of resources). Thus, relative to the cost of pro-
ducing other goods (in this case, aircraft), software is
cheaper to produce in India than in the United States.
If a country has a comparative advantage in the pro-
duction of a particular good and if it can trade freely with
other countries, it is likely to find that it can improve its
economic lot by specializing in the production of this
good and by importing those commodities for which it
does not have a comparative advantage. For example,
consider the US under the above circumstances. Figure 1
shows US’s production possibilities curve (PP’) rep-
resenting various amounts of aircraft and software it can
produce with its existing resources and a set of indiffer-
ence (utility) curves (IC1, IC2) representing different
levels of consumer satisfaction or betterment of its eco-
nomic lot1. The higher the indifference curve, the higher
is the betterment level of the nation’s economic lot. If the
US cannot trade with India, perhaps because of protec-
Figure 1. Economic benefits from free trade without foreign
trade, production and consumption in the US are at point B,
where indifference curve IC1 is tangent to the production
possibilities curve, PP’. With trade, the US can move from
point A along the trading possibilities curve, XY, to point C,
and reach a higher indifference curve, IC2.
tionist measures (tariffs, quotas, and the like) in both
countries, consumer satisfaction in the US will be maxi-
mized by choosing point B, where the marginal rate of
substitution between the two commodities equals the
marginal rate of transformation between them. Point B is
on indifference curve 1 (IC1).
Suppose now that free trade is permitted, and that the
US is able to trade the good in which it has a compara-
tive advantage, aircraft, for Indian software. The line XY
in the figure called the US’s trading possibilities curve,
shows the various amounts of aircraft and software code
that the US can end up with if it chooses point A on its
production possibilities curve, where it produces, say,
100 aircraft and 300 billion lines of code, and exports
various amounts of its aircraft to India. The slope of line
XY equals (in absolute value) the lines of Indian software
code the US can get by giving up one unit of its aircraft.
Assume that it is 7 billion lines of code for each air-
craft-more than an aircraft’s relative cost of production
in the US (6 billion lines) and less than its relative cost of
production in India (8 billion lines).
As shown in the Figure 1, US will increase consumer
satisfaction if it moves along line XY from point A to
point C, where line XY is a tangent to the indifference
curve IC2. In this way, it reaches a higher indifference
curve representing an increased level of betterment of its
economic lot. At point C, US is producing 100 aircraft,
but trading 50 aircraft for 350 billion lines of Indian
software code-which is much more than what it could
have produced at home by giving up the resources to
make 50 aircraft (note that the point C is outside the PP
curve). Since IC2 is considerably higher than IC1, US’s
consumers are much better-off than in the scenario when
trade is not permitted.
1Readers unfamiliar with these economic concepts are referred to any
college-level texts on Microeconomics such as (Mansfield, 1997) or on
International Economics such as (Carbaugh, 2012).
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At the same time, India will increase consumer satis-
faction if it specializes in the production of software
(where it has a comparative cost advantage) and exports
them to the US, while cutting back its production of air-
craft and importing them from the United States. Thus,
both countries will specialize in the production of those
goods for which they have a comparative advantage and
export them to the other country. This way, both coun-
tries attain a higher level of consumer satisfaction than
the scenario when trade is not allowed. Although, for the
sake of simplicity, we have used a trading model involv-
ing only two countries and only two goods, the theory of
comparative advantage holds even if the trading model is
expanded to many countries and many products. Further,
beyond the national level, the theory of comparative ad-
vantage holds even at the industry or firm level [16].
A key underlying assumption of this trade theory is
that the transpo rtation or distribution cos ts are zero.
This assumption may sound questionable or impractical
as this cost may be substantial for physical goods such as
an automobile, especially if the spatial difference be-
tween the trading nations is significant. But, when it
comes to information or digital goods such as software,
this is actually a very valid assumption. With recent ad-
vances in communications technology, namely the Inter-
net, the cost of distributing information goods, even at
the global level, has fallen substantially approaching al-
most “zero”.
4. Winners and Losers
Thus, as can be seen, “offshore outsourcing” is not really
bad for the US economy (rather, it is good) if one looks
at it in the light of international trade. However, whereas
free trade of this sort provides many benefits to people in
both countries, not everyone gains from it. In our exam-
ple, although the US aircraft industry (and the related
work-force) may make significant gains, the US soft-
ware workers, in particular, may be hurt considerably by
the reduction (not elimination) in software output in the
United States. Thus, it would not be surprising if this
group of workers were to oppose offshore outsourcing
and press for protection from imports.
In theory, the software producers in the US should also
incur losses, but not necessarily if they are also the pro-
ducers of software in India, which is true to a great extent.
Almost all leading American hi-tech companies (e.g., GE,
IBM, H-P, Texas Instruments, Intel, Microsoft, Oracle
etc.) have presence in India. Compared to other physical
goods such as an automobile or a computer (hardware),
the digital goods such as software have some unique cost
characteristics. One unique feature of information or di-
gital goods is that they are costly to produce but very
cheap to reproduce. In other words, production of infor-
mation goods involves high fixed costs but very low
variable costs [17]. Its total cost of production is domi-
nated by the “First Copy Costs” (fixed costs). Once the
first copy of an information good has been produced, the
cost of creating an additional unit (marginal cost) is very
small, almost “zero” if the product is “downloadable”;
otherwise, perhaps the cost of stamping a CD. Further,
and most notably, most of the fixed costs are sunk
costs—costs that are not recoverable if the production is
stopped. There is not much of a salvage value of flopped
software! Thus, it becomes economically imperative that
the software firms produce or source these products
wherever they can do so in the most cost effective way.
Perhaps, this is why we hear a lot of resentment from
the domestic software workers, but hardly any outcry
from the software companies. This is why we hear a lot
of hue and cry from populist politicians, but hardly any
opposition from the business and economic leadership at
the national level (just the opposite, in fact). An editorial
in The Wall Street Journal underscores this point very
well [18]. The editorial criticizes the New Jersey law-
makers for passing a bill that would ban all state contract
work from being performed outside the country. It points
out that the measure would not only mean a higher bur-
den on taxpayers and artificially increase government
expenditures, but it is also likely to end up costing more
local jobs than it protects. For, if the state contractor’s
costs rise because it has to dismiss its low-cost overseas
workforce, it will either have to drop the state contract,
accept lower profits, or lay off other workers. It further
opines that “the measure may also violate the US. Con-
stitution, which bars states from having an independent
foreign policy.”
5. Conclusions
In summary, there is really nothing new happening under
the sun! As discussed in this paper, “offshore outsourc-
ing” could be viewed as essentially nothing but “interna-
tional trade” and our country gains immensely from for-
eign trade, and so do businesses. Specifically, when it
comes to digital goods such as software, because of their
unique cost characteristics (both production and distribu-
tion), it becomes even more compelling for businesses to
produce or source these products wherever they can do
so in the most cost effective way.
While there has been a plethora of academic research
done on topics such as critical success factors of out-
sourcing, including what motivates a company to out-
source and what factors contribute to the success of out-
sourcing, research on the impact of outsourcing on the
individual employee seems to be less prevalent. A litera-
ture review of ITO published in 2006 reviewed 131 ITO
articles; only three of the 131 articles focused on the ef-
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fect of ITO on IS staff, and two of those were actually
looking at contract employees within the company [19].
While some more articles have been published on the
impact of outsourcing on the IT worker since 2006, re-
search seems to be still limited on this topic.
In this regard, some practical relevant and interesting
research areas might be to examine issues pertaining to
the retraining of US workers and what IT skills are in
most demand that are least likely to be outsourced. An-
other area for research could be examining the psycho-
logical impact of outsourcing on employees. For example:
How does outsourcing impact remaining employees’ mo-
tivation and commitment to the organization? How have
jobs in the IT field changed because of outsourcing? Do
these changes in IT jobs attract a different type of em-
ployee? Can theories used in studying downsizing and
job turnover be used to study the impact of outsourcing
on individual employees?
Although mass media and popular press continue to
debate whether outsourcing is good or evil, given that the
US is a champion of free trade, it is high time that we the
IT community (professionals as well as academics) ac-
cept offshore outsourcing as a business reality which is
here to stay. Instead of questioning the merits of offshore
outsourcing, we are, perhaps, better off learning how to
adapt to the changing work environments that offshore
outsourcing creates.
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