How France Can Win From Offshoring

When it comes to offshoring, France is a newcomer compared with the United States, the United Kingdom, and even Germany.1 From 2002 to 2004, offshoring accounted for only 4 percent of all jobs lost in France, and most of them were in manufacturing rather than the office work that UK and US companies increasingly move to countries with low labor costs. But the offshoring of service jobs is bound to accelerate as French companies strive to match the efficiency of their foreign rivals. With French unemployment above 10 percent, offshoring has already created anxiety among workers in France and sparked protectionist sentiment there. The entry of ten lower-wage countries into the European Union in 2004 raised the level of angst, as did recent government-commissioned reports on the challenge France faces in restoring its competitive position in the global economy.2

Recent research by the McKinsey Global Institute (MGI), updated with 2005 figures, shows that the offshoring of service jobs, while wrenching for the people affected, can create wealth both for the country that exports jobs and for the one that receives them. (The full report, How Offshoring of Services Could Benefit France, is available free of charge online.) In the United States, where a dynamic job market helps many laid-off workers find new employment with relative ease, offshoring produces a gain of $1.14 to $1.17 for every dollar of costs sent abroad.3

France is a different story. MGI assessed the impact on the country's overall welfare of offshoring three types of work—software development, call centers, and back-office functions. We found that for every euro of spending on corporate services moved offshore, France earns back only €0.86—higher than the return in neighboring Germany, which (according to similar MGI research in 2004) earned back only €0.74 for every euro of costs offshored.4

To capture more benefits from offshoring, France must help its companies create higher-value jobs and make it easier for its laid-off workers to find new employment. Instead of resisting what seems to be an unavoidable trend, French businesses and policy makers should aim to make the most of it.

The economic impact of offshoring

Three factors together explain why France reaps less benefit from offshoring than the United States does. First, French companies, like German ones, save less than their US counterparts do when they send work abroad: for every euro of corporate spending they transfer offshore, they get back only €0.36 in cost savings that can be passed on to customers and investors. By contrast, US companies get back 50 to 53 cents per dollar. They benefit more because they shift their service functions primarily to India, which has the world's largest business-process-offshoring industry and a huge pool of very low-wage labor with a good grasp of English. French companies tend to offshore many jobs to Central Europe and North Africa, where fluent French speakers are more plentiful but wages are higher than they are in India. Indeed, offshoring to India and China cuts costs by 85 to 90 percent, while offshoring to North Africa and Central Europe reduces costs by only 70 percent and 55 to 75 percent, respectively.

Second, France gains only €0.05 through increased exports to offshore locations and repatriated profits from offshore providers, as compared with 7 to 9 cents for the United States (and €0.03 for Germany). US companies benefit more than their French counterparts do, because the US ones not only have a very large share of the high-tech exports that offshore providers seek but also generally export more goods and services to emerging economies. What's more, many US companies wholly or partly own Indian outsourcing providers and thus benefit from their profits. Indeed, foreign-owned (mostly US) companies generate 30 percent of the revenues of India's offshoring industry. But few European companies own stakes in offshore service providers.

Third, for each dollar of work offshored, the US economy gains 57 cents from the rapid reemployment of laid-off workers. But France gains only €0.44 and Germany only €0.34 in this way, because a less flexible labor market and a lower level of job creation mean that fewer workers find new employment quickly. About 60 percent of French workers find new jobs within a year, we estimate—higher than the rate in Germany (39 percent)5 but lower than the one in the United States (69 percent). Given France's high level of unemployment and the difficulty of creating new jobs, raising the reemployment rate of the workers affected by offshoring is a key challenge for French policy makers and businesses.

An inexorable trend

French companies have been slow to offshore service functions because of practical hurdles and regulatory constraints. They have so far resorted to alternatives such as developing shared services, reengineering their operations, and outsourcing work locally, but as global competition heats up they will probably follow the lead of their UK and US competitors in offshoring. The reason is simple: potentially huge cost savings. Consider the banking industry. One UK institution moved more than 5,000 jobs offshore from 2001 to 2003 and has generated annual savings in excess of €250 million, thereby reducing its cost-to-income ratio by almost six points. We estimate that cost savings from offshoring could reduce the cost-to-income ratio of a universal bank in France by four to seven points—the difference between best-in-class and less successful companies.

France's IT services industry could be similarly revolutionized. Currently, only 2 to 6 percent of its workforce is based abroad. But financial analysts are starting to regard the percentage of jobs that IT services firms move offshore as a key component of their valuations, since larger numbers of offshore workers are correlated with higher margins and better growth prospects. Moreover, as offshoring gains strength among US companies, prices may fall, putting even more pressure on margins in France. As a result, many French IT firms may think about moving current operations abroad or expanding offshore rather than at home.

Ultimately, offshoring could generate new jobs and additional revenues. Lower costs help companies grow by allowing them to develop new operations that wouldn't have been profitable at home: as a result of moving accounts-receivable operations offshore, for instance, some companies can chase delinquent customers they previously ignored as too costly to pursue. One airline is collecting €65 million annually in previously unpaid invoices, in addition to the €40 million it has saved each year by moving some of its operations to India. Banks can increase their income from fees by offering advisory and other services to customers with lower account balances.

Seizing the opportunity

A new dynamic is emerging in sectors exposed to global competition, so adopting protectionist policies to curb offshoring would be a mistake. Offshoring is a powerful way for companies to reduce their costs, to improve the quality and variety of the products they offer, and to invest in next-generation technology. In all these ways, companies that embrace offshoring early in the game create new jobs, both locally and abroad. Those that resist the trend are increasingly at a cost disadvantage that erodes their market share and eventually destroys jobs even at home.

To realize the full economic advantage from offshoring, France must capture more of the potential cost benefits: moving operations to North Africa, for instance, could generate larger savings than moving them to certain countries in Central Europe. Integrating the offshoring trend with the Euro-Med initiative, which aims to create a free-trade area between the European Union and the countries of the southern Mediterranean, would encourage offshoring to North Africa and benefit French consumers and investors. Policy makers must also encourage innovation and transform France's labor regulations in order to make it easier for workers to change jobs—moves that would increase the reemployment rate of people displaced by offshoring.

Creating the jobs of tomorrow

In France as in other developed economies, the services sector—accounting for 70 percent of total employment across the European Union and for nearly all net new jobs—could create the largest number of new positions. Increasing the growth rate in services could help France to boost the reemployment rate of its workers and thus to benefit more fully from offshoring.

Recently, for example, the Camdessus report outlined the possibilities for raising employment levels in health care and social services, which serve France's growing elderly population.6 In fact, employment in sectors such as social services, retailing, and tourism, which could provide millions of new jobs that can't be offshored, is lower in France than in other Western economies.7 Call centers are another potential source of employment (even though they are gradually moving offshore) because France could create up to 200,000 more jobs in them than it sends abroad if it allowed more flexible working conditions and raised consumer confidence in call centers.

Other sectors could create new jobs, as well. In a 2002 study, MGI compared the performance of six industries in France, Germany, and the United States and found that France could significantly raise its productivity and employment through a better diffusion of innovation if the government ensured strong and fair competition and corrected market distortions.8 To boost the competitive intensity of the French economy, the government must further open it to foreign companies, particularly those from outside Europe, and adjust the many product market, zoning, and labor laws that hinder competition.

The French automotive industry shows the potential for growth in both productivity and employment. Limits on Japanese car imports were completely lifted in 2000, a move that spurred French manufacturers to improve their productivity and introduce process innovations, such as the application of lean-manufacturing techniques. Rather than suffering from more intense competition, French car companies thrived: PSA Peugeot Citroën, for instance, created almost 10,000 new jobs in France—10 percent of its French workforce—from 1998 to 2004.

France can also do better in product innovation. The recent Beffa report9 shows how the country has a strong presence in sectors such as basic materials, foods, luxury goods, and railway equipment but a smaller footprint in high tech. It suggests that France could refocus the economy on higher-value industrial activities and boost R&D in potential growth areas by creating programs (financed through public-private partnerships) to encourage innovation.

Increasing the labor market's flexibility

To speed up the transition from today's jobs to tomorrow's, policy makers must also make the French labor market more flexible. Today, a raft of regulations on working hours, minimum wages, and the hiring and firing of workers combine to make companies reluctant to hire new employees. France's comparatively generous minimum wage, for instance, has led the retailing industry to rely more on automation and less on labor, and as a result French retailers employ as few as half as many workers in proportion to the country's population as do their US counterparts. Lower-wage retailing jobs may not be particularly attractive, but for many workers they are an important entry point into the labor force. The social objective of the minimum wage should be addressed by different mechanisms, such as financial incentives for unemployed people who return to work or for companies that hire them.

In addition, policy makers can target specific categories of employees who lose their jobs to offshoring. Since workers in the back offices of retail banks, for example, tend to be relatively old, unskilled, and female—all factors that decrease the reemployment rate—many will likely have difficulty finding new work. Policy makers who understand the profiles of the people most affected (software programmers, call-center agents, back-office service workers) should be able to develop specific programs to raise the reemployment rate and reduce the social impact of offshoring (Exhibit 3). Such programs could include government job-retraining efforts, incentives for companies to hire and retrain displaced workers, and relocation help for them when needed.

Chart: Varying social impact among different types of service jobs

France can also adapt its education system in order to reflect the needs of a changing labor market more closely. The offshoring of IT jobs may very well aggravate overcapacity in the youth job market, for example, but engineers can focus on higher-value, less commoditized activities that are significantly less prone to offshoring. A study of the US labor market from 1999 to 200310 suggests that although offshoring probably did reduce demand for lower-end computer programmers, the number of software engineers and network systems analysts working on higher-end activities actually increased greatly over the same time period.

Finally, policy makers can help ease the plight of French workers displaced through the offshoring of jobs. By using a share of the cost savings that companies reap from it in order to complement the French benefits system, the government could finance income protection and other mechanisms that would help people deal with the transition between their old jobs and their new ones.

In the short term, offshoring can have painful consequences for workers who are—something that policy makers simply cannot ignore. Nonetheless, the offshoring of service jobs should be viewed as an opportunity for France to increase its productivity and to ensure that it remains competitive in international markets. To realize the total potential value of offshoring, however, policy makers must both make the French labor market significantly more flexible and spur innovation.