International Outsourcing: Legality of Xenophobia in Outsourcing
Posted October 9, 2009 by Bierce & Kenerson, P.C. · 
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Summary:
In the United States, layoffs during the downward economic cycle following the dot.com bubble and then the 9/11 attack have had a severe impact on the local economies. In the resulting legislative debate over the impact of outsourcing, some state legislators have proposed a reversion to the “Buy American” principle that conflicts with international trade under the World Trade Organization. This issue underlines an emerging internal public policy debate on the desirability of international outsourcing.
NOTE: Posted in 2003, this seminal article could be updated for more recent manifestations of xenophobia in outsourcing.
“Buy American” in State Government Contracting.
In March 2002, a New Jersey State Senator, Shirley Turner, introduced a bill that would impose a “Buy American” rule on all purchases in the state.
“The Director of the Division of Purchase and Property and the Director of the Division of Property Management and Construction in the Department of the Treasury shall include, in every State contract for the performance of services, provisions which specify that only citizens of the United States and legal resident aliens in the United States shall be employed in performance of services under the contract or any subcontract awarded under the contract.”
N.J. Sen. No. 1349, 210th Legislature, intro. Mar. 21, 2002, passed in the Senate (40-0), Dec. 16, 2002.
The bill was inspired by the fact that “Recent published reports have indicated that telephone inquiries by welfare and food stamp clients under New Jersey’s Families First Program were being handled by operators in Bombay, India after the contractor moved its operations outside of the United States as a cost-cutting measure.” The bill was intended to ensure that State funds are used to employ people residing in the United States and to prevent the loss of jobs to foreign countries.
As a “mini-Buy-American” Act, this legislation does not provide any exception for:
- a determination that a domestic procurement is “not in the public interest,”
- a determination that the cost of a domestic procurement is “unreasonable,” or
- a determination that the particular goods or services being procured are not available in such commercially available quantities or quality as are available abroad.
All of these are exceptions under the federal “Buy American” act.
If enacted, such laws would apply only to government procurement. But such legislation could have repercussions on the image of offshore outsourcing throughout the United States.
The bill does not address issues of cost, or availability of local American services in the particular procurement.
Legality for Governmental vs. Private Purchases of Foreign Services.
As a matter of law, “Buy American” (or “Buy Local”) laws are illegal under the World Trade Organization’s General Agreement on Trade in Services (“GATS”) when they relate to purchases by private buyers. But for governmental buyers of services, the GATS allows such favoritism to local service providers.
Impact on International Outsourcing by Private Customers.
Legislation limiting government procurement to local service providers should not have any impact on the right of private companies, as customers, to hire any service provider worldwide to render any service.
- Freedom of Contract.
In our view, nothing in the various laws of individual states in the United States that currently are in consideration could validly overcome such freedom of contract. - War.
In case of a war involving Iraq or other country, the United States federal government could validly adopt rules to safeguard its economy from foreign interests. As discussed below, this raises risks for contracting parties, but such risks may be surmounted through customary technical means for security, business continuity planning, redundancy and disaster recovery.
Buy American – Revival of the Past.
The “Buy American” legislation was originally adopted by the Federal government as a means of promoting local business. This legislation, at 41 U.S.C. 10a, is limited to the purchase of goods:
Sec. 10a. – American materials required for public use
Notwithstanding any other provision of law, and unless the head of the department or independent establishment concerned shall determine it to be inconsistent with the public interest, or the cost to be unreasonable, only such unmanufactured articles, materials, and supplies as have been mined or produced in the United States, and only such manufactured articles, materials, and supplies as have been manufactured in the United States substantially all from articles, materials, or supplies mined, produced, or manufactured, as the case may be, in the United States, shall be acquired for public use. This section shall not apply with respect to articles, materials, or supplies for use outside the United States, or if articles, materials, or supplies of the class or kind to be used or the articles, materials, or supplies from which they are manufactured are not mined, produced, or manufactured, as the case may be, in the United States in sufficient and reasonably available commercial quantities and of a satisfactory quality. This section shall not apply to manufactured articles, materials, or supplies procured under any contract the award value of which is less than or equal to the micro-purchase threshold under section 428 of this title.
This law has been rendered largely moot by the Government Procurement Agreement adopted at the Uruguay Round of the General Agreement on Tariffs & Trade. See Agreement Establishing World Trade Organization, Annex 4, Plurilateral Agreements, Government Procurement Agreement.
More recently, state legislatures in the United States have considered imposing some restrictions or prohibitions on the use of foreign service providers for contracts involving payment of state or local funds. In New Jersey, State Senator Shirley K. Turner introduced a bill that would prohibit any contracting or subcontracting to foreign service providers where the work could be done by American citizens or lawful permanent resident aliens. Similar legislation is reportedly under consideration (as of February 2003) in Connecticut, Maryland, Missouri and Wisconsin.
Policy Debate: Validity vs. Wisdom of Xenophobia.
As a matter of public policy, we must distinguish between law and policy. Would such legislation be lawful? Under the World Trade Organization (WTO) General Agreement on Trade in Services (“GATS”), it would appear valid for government procurement of services. As a “beggar-thy-neighbor” policy of keeping jobs at home, such legislation would help generate employment at a time of economic decline, reducing the costs of public welfare and other social costs.
Would such legislation be good public policy? Such legislation would deprive local governments of purchasing services at the cheapest price. It would hurt local taxpayers as consumers of government services.
World Trade Organization: No “Non-Tariff Barriers” for Private Trade.
Free trade under the World Trade Organization (formerly known as the General Agreement on Tariffs and Trade, or GATT) is based on certain fundamental principles:
- national treatment of foreign suppliers of goods and services, where each member state must “accord to services and service suppliers of any other Member, in respect of all measures affecting the supply of services, treatment no less favorable than that it accords to its own like services and service suppliers.” General Agreement on Trade in Services, Art. XVII(1), MTN/FA II-A1B, p.19).
- transparency of the laws and regulations governing international trade (subject to the supervening principle that disclosure is not required where it “would impede law enforcement or otherwise be contrary to the local public interest or would prejudice the legitimate commercial interests of particular enterprises, public or private.” See, e.g., Agreement on Trade-Related Investment Measures, Art. 6, MTN/FA II-A1A-7, p. 3.)
- non-discrimination.
Market Access to Foreign Services Providers under GATS.
The WTO’s General Agreement on Trade in Services embodies the principle that, in sectors where a member state undertakes to grant market access to service providers from another member state, that market access cannot be restricted either nationally or regionally. Specifically, it is a violation of GATS for a member state to impose any restriction on market access in any of the following forms:
- Number of Service Providers: limitations on the number of service providers (such as in the form of numerical quotas, monopolies, exclusive services providers or the requirement of a “economic needs” test as a condition of market access).
- Value of Service Transactions: limitations on the total value of service transactions or assets (in the form of numerical quotas or the requirement of an “economic needs” test).
- Quantity of Services Provided or Service Operations: limitations on the total number of service operations or on the total number quantity of service output expressed in terms of designated numerical units, in the form of quotas or the requirement of an “economic needs” test.
- Number of Employees: limitations on the total number of natural persons who may be employed in a particular service sector or that a service provider may employ and who are necessary for, and directly related to, the supply of a specific service in the form of numerical quotas or the requirement of an economic needs test.
- Type of Legal Entity or Joint Venture: measures that restrict or require specific types of legal entity or joint venture through which a service supplier may supply a service.
- limitations on the participation of foreign capital in terms of maximum percentage limit on foreign shareholdings or the total value of individual or aggregate foreign investment.
General Agreement on Trade in Services, Art. XVI(2), MTN/FA II-A1B, p.18.
Exceptions to GATS Protections.
Several exceptions expressly permit a member state to disregard its obligations on trade in services.
Services Supplied in the Exercise of Governmental Authority.
By definition, the GATS does not apply to “services supplied in the exercise of governmental authority.” General Agreement on Trade in Services, Art. I(3)(c), MTN/FA II-A1B, p.14). In some countries, “governmental authority” involves the performance of functions that are considered commercial or otherwise not “in the exercise of governmental authority.”
In the United States, for example, in November 2000, President George W. Bush’s administration adopted regulations requiring that all governmental functions be evaluated and classified as governmental or non-governmental, and non-governmental functions are to be contracted out to outsourcers (or possibly even privatized).
National Security.
National and international security considerations take precedence over trade in services under GATS. In particular, member states may take actions that they may deem necessary to protect “essential security interests” relating to services for provisioning military establishments, nuclear fuels or their materials, or any other action “taken in time of war or other emergency in international relation.” As a procedural matter, the member state must notify the WTO’s Council for Trade in Services when such “security exceptions” have been adopted and when they have been terminated. General Agreement on Trade in Services, Art. XIV bis, MTN/FA II-A1B, pp.16-17.
War.
As a “national security” measure, a member state might impose an embargo on trade in services with one or more other WTO member states during a time of war. The exception applies “in time of war.”
This “war” exception leaves open a number of vital questions about the legality and viability of discrimination, trade embargos and other acts normally prohibited by GATS. The “war” exception does not specify that the embargo must only apply to another member state that is at war with the buying member state. But it is not clear whether the right to impose an embargo applies to a country that is perennially in a “state of emergency” or has never entered into a formal cessation of armed hostilities with a particular other member.
In a sense, this exception could arguably serve as the basis for a member state’s attempt to circumvent the WTO principles of free trade in services. In our view, such an attempt could invite trade reprisals and dispute resolution before a WTO dispute tribunal.
Deceptive and Fraudulent Practices; Contract Default and Enforcement of Rights.
Under GATS, member states may adopt and enforce measures of a general, non-discriminatory nature relating to “the prevention of deceptive or fraudulent practices or to deal with the effects of a default on service contracts. Accordingly, laws governing enforcement of rights and remedies under contract breach are not subject to GATS rules, so long as the laws are “not applied in a manner that would constitute a means of arbitrary or unjustifiable discrimination between countries where like conditions prevail, or a disguised restriction on trade in services.” General Agreement on Trade in Services, Art. XIV(c)(i), MTN/FA II-A1B, p.15.
Data Protection.
Similarly, under GATS, member states may adopt and enforce non-discriminatory laws for “the protection of the privacy of individuals in relation to the processing and dissemination of personal data and the protection of the confidentiality of records and accounts.” General Agreement on Trade in Services, Art. XIV(c)(ii), MTN/FA II-A1B, p.15).
Safety.
Laws governing safety are also generally exempt from the rules of GATS, except if they are discriminatory or disguised trade restrictions. General Agreement on Trade in Services, Art. XIV(c)(iii), MTN/FA II-A1B, p.15.
Collection of Taxes.
Laws for the “equitable or effective imposition or collection of direct taxes,” or for the avoidance of double taxation under a tax treaty, may be somewhat discriminatory against foreign service providers. General Agreement on Trade in Services, Art. XIV(d) and (e), MTN/FA II-A1B, p.15).
Government Procurement.
Exceptionally, under GATS, the WTO principles of most-favored-nation treatment, market access and national treatment do not apply for governmental procurement of services. General Agreement on Trade in Services, Art. XIII(1), MTN/FA II-A1B, p.14). (The other principles, such as the “transparency” duty to publish applicable laws and regulations, remain unaffected.) The Government Procurement Code, adopted prior to the GATS, relates to trade in goods and does not require any treatment different from GATS.
Safeguard the Balance of Payments.
This exception allows a government to escape from GATS requirements to open its economy to free trade in services in order to safeguard the country’s balance of payments “in the event of serious balance-of-payments and external financial difficulties or threat thereof.” General Agreement on Trade in Services, Art. XII(1), MTN/FA II-A1B, p.12). This exception is not directed at measuring bilateral trade imbalance between two countries that are trading partners. Rather it focuses on multilateral trade and generalized imbalances in the balance of payments.
Conclusions for Outsourcing Services Providers.
If you are promoting the sale of your services from a foreign country, you should focus on the practical economic benefits of your service. This may include:
- abundant labor supply.
- rapid deployment of a large pool of skilled workers for early completion of a complex project.
- high quality standards, such as the Software Engineering Institute Capability Maturity Models for both software and services.
- low cost to the taxpayers whose governments are acting as purchasing agents.
- local presence in the host country, and the role of the host country employee pool for the service provider.
Conclusions for Purchasers of Transborder Services.
There are undoubtedly substantial risks of force majeure in outsourcing. But the WTO principles of national treatment for private-sector transactions and other fundamental protections of international trade in services are well established. Legislation by state legislators is not likely to have any impact on your ability to procure services at low cost under a clear outsourcing contract. Despite the risks and problems, using technological methods as well as legal contracts, you can protect your investment in foreign services.
Conclusions for National Governments.
The opening of borders to “free trade” under WTO principles leaves everyone exposed to the risk of loss of value of their knowledge in a rapidly changing information economy. Governments should focus on building a workforce that is skilled in knowledge tools.