Offshoring of Business Services and its Impact on the UK Economy

Abstract

This Briefing Note considers recent trends in specialisation, outsourcing and offshoring of business services. Specialisation within a firm happens when a firm organises an activity in a specialised unit, for example, when a firm moves payroll activities out of the back office of a factory, and into a specialised payroll office. Outsourcing is specialisation outside the firm. This occurs when firms opt to ‘buy’ rather than ‘make’ in-house. Outsourcing involves greater specialisation as firms switch from sourcing inputs internally to sourcing them from separately owned suppliers. Offshoring occurs when firms move production overseas - either its own specialised unit or outsourced services. Business Services are services that are provided to other business, rather than directly to the public. They include Computer Services, Professional Services (Legal, Accountancy, Market Research, Technical, Engineering, Architectural, Advertising and Consultancy), Research and Development, as well as other services such as Labour Placement Agencies and Call Centres. The findings in this Briefing Note, which are significant for thinking about business practice and public policy, are: -Business services have accounted for over 50% of job growth in the UK over the past two decades. In the 1980s, business services were not very significant as a separate industry. Employment in UK business services grew by 92% or 1.9m jobs between 1984 and 2001. This accounted for over half of the total growth in jobs. In 2002, a total of 4m people were employed in this sector, accounting for around 1 in 7 jobs in the whole economy. -UK production of business services also grew significantly faster than the rest of the economy over the last two decades. This has been driven mainly by increased demand from UK companies for UK-produced business services. The business service sector is now substantially bigger, in terms of value added, than it was two decades ago. -More business services are purchased from the UK than the UK purchases from overseas; i.e. we have a trade surplus in business services, and it has been growing. -The growth in demand for UK-produced business services has come mainly from UK-based firms. UK businesses are now outsourcing a substantially greater proportion of service activities than they did two decades ago. This domestic outsourcing has played a more important role in the growth of business services than demand from foreign-based businesses. -While there has undoubtedly been an increase in UK-based firms sourcing business services offshore, it is small relative to the increase in total output of business services. This shows up in the trade statistics: although the UK has rapidly increased both its imports (UK firms buying foreign-produced services) and exports (foreign firms buying UK-produced services), export growth has outstripped import growth. The UK has a substantial trade surplus in all business service sectors except one small industry. Figures for the latest 12 months suggest that the rate of growth may have slowed. -Between 1995 and 2001, exports of business services grew from £11.7bn to £31.7bn in nominal terms while imports grew from £6 bn to £14 bn. This has given the UK and increasing trade surplus in business services. This contrasts with an increasing deficit in trade in manufactured goods over the last two decades. But while trade in business services is increasing, it is still very small compared with trade in manufactured goods. -Most Business Service industries in the UK have experienced continued job growth. The fact that UK firms are increasingly sourcing business services offshore and foreign firms are increasingly sourcing business services in the UK may affect the total number of jobs in the UK, the type of jobs, the skills needed to do these jobs and the distribution of these jobs across regions and across people. The highest profile concern has been about job losses from sourcing IT software and services in India. It is hard to get precise numbers of jobs relocated abroad, and thus to tell how important this is for the UK economy. But looking at UK job growth, particularly in call centres, in combination with the number of jobs in India serving foreign clients shows that potential UK job losses from sourcing business services abroad are pretty small compared with total job creation in business services. The fastest growing sectors were Computer and related activities, which more than tripled in size between 1984 and 2002, and Other business activities, which doubled. Renting of machinery and equipment grew by 59% and Legal, technical and advertising grew by 71%. Research and development was the only sector not to grow, with employment declining slightly, by 4% between 1984 and 2001. Growth in the most recent years has slowed down somewhat. This growth has included in call centres, where the latest figures show that over half of the UK call centres sampled have increased the numbers of staff employed. The UK currently employs around 400,000 people in call centres. -UK productivity in Business Services has caught up with other G5 countries. We have substantially closed the productivity gap between the UK and the US, Germany and France in business services. This occurred while employment in the sector grew. Between 1984 and 2001, the difference between UK and US labour productivity (the productivity gap, as measured by value-added per hour worked) in two high-skilled sectors - Computer Services and Professional Services – was effectively eliminated. In 1984, US productivity in Computer Services was over twice as high as in the UK, while in 2001 it was only 10% higher. In Professional Services it was 80% higher, and is now at the same level. This simultaneous increase in employment and productivity contrasts with an earlier productivity improvement in manufacturing, which was achieved in large part through employment cuts.