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What is labor arbitrage?

By Scott Robinson

Labor arbitrage is the practice of searching for and then using the lowest-cost workforce to produce products or goods. The term labor arbitrage is limited in its daily use; it's more likely to be used in academic papers and business-consulting reports than in everyday business discussions, although the practice itself is widespread.

Applications of labor arbitrage

The term as it applies to labor specifically has become more common in staffing and workforce discussions during the past few decades. The practice has become more prevalent due to shifting government policies and societal expectations as well as new technologies that have enabled the practice to be more broadly applied.

Some experts limit the definition of labor arbitrage, saying it applies strictly to taking work from one location to another where there's the same skill set but at lower costs.

However, some experts use a broader definition and say labor arbitrage encompasses multiple corporate policies that result in lowest-cost labor. That lowest-cost labor can come in a variety of forms today, including the following:

• Remote workers. Remote workers currently make up a significant portion of the labor market and can indirectly increase operational efficiency by reducing the on-premises worker footprint. In addition to widening the potential talent pool and increasing diversity, organizations can often save money on office space. According to the Pew Research Center, roughly 22 million employed adults over age 18 in the U.S. work from home all the time.
• Off-shore workers. Companies can hire workers in a foreign country and pay less for wages, payroll taxes, benefits and overtime.
• Less expensive subcontractors. Organizations can hire subcontractors in a company's home country instead of staff employees.
• Outsourcing partners and providers. Outsourcing can be considered both a cost-effective and highly focused form of labor arbitrage, provided the quality of their work is sufficient. An organization can also select partners and providers based on proven expertise.
• Work-visa programs to import foreign workers. These workers are generally willing to take lower salaries. Companies that pressure existing workers to take lower wages to save their jobs are engaging in labor arbitrage, too.

Some experts also consider the use of undocumented immigrants who generally work for less and can't fight for their legal work rights as a form of labor arbitrage.

What are the benefits of labor arbitrage?

Labor arbitrage can benefit an enterprise in the following ways:

• Reduces costs. Outsourced labor is generally less expensive, offering both direct and indirect savings over in-house employees who require office space, equipment and other on-premises expenses.
• Enables specialization. Labor arbitrage accesses a global labor market of talent, much of it highly specialized. In India and other countries, numerous companies exist solely to provide talent pools with specific skill sets.
• Optimizes resources. When an organization uses labor arbitrage for non-core operations, it frees up resources that can be reallocated to other priorities, boosting overall operational efficiency.

What are the drawbacks of labor arbitrage?

Just as labor arbitrage has its upsides, it also has the following downsides:

• Language barriers. When using workers in foreign countries, it's often necessary for employees in the organization to work with people to whom English is a second language, sometimes making communication difficult.
• Time zone issues. Many of the countries where talented labor is plentiful are in different time zones, making it challenging to have real-time communication. India, for instance, is 9-12 hours offset from U.S. time.
• Security. There can be risk associated with systems and data access across international distances, when networking is more complex and there are more risky points of connection.

The ethical implications of labor arbitrage

There are several ethical considerations of labor arbitrage that must be considered. These include the following:

• Job displacement. This occurs when workers lose their jobs to outsourcing functions. The ethical response is to call for effective measures to assist displaced workers in transitioning to new opportunities.
• Compensation. Organizations that use labor arbitrage should ensure that workers are compensated on a fair scale commensurate with local cost of living.
• Exploitation. When labor arbitrage doesn't adhere to local labor laws, especially in countries and regions where those laws are weaker, worker exploitation can occur. A responsible organization ensures that overseas service providers conform to fair practices and provide safe working conditions.

The future of labor arbitrage

Companies throughout history have sought to keep labor costs in check, so in some regard the concept of labor arbitrage isn't new. Historically, companies were located near their workforce and stayed in those regions over the long term. For example, in the U.S., the textile industry was a New England industry through the early 20^th century but then moved all its operations to Southern states in part to capitalize on lower labor costs.

Moreover, companies today can more easily opt to engage in labor arbitrage for pieces of their production, engaging contingent workers and other kinds of workers for different components of their products or services.

Several factors have caused this shift in how companies now engage in labor arbitrage, a shift that started following World War II and has continued into this century. Lower national tariffs helped foster global workforce competition. At the same time new technologies broke down barriers that made shifting work away from central corporate facilities easier and more efficient. The internet and global communications technologies, for example, enable more outsourcing and offshoring, while still allowing corporate controls to be in place.

What's coming up next in labor arbitrage? How is the landscape changing today, and what will it look like, going forward?

While the global COVID-19 pandemic of 2020-2022 made clear that remote workers weren't only cost-effective but of potentially equal value to on-premises employees, the fact is that labor arbitrage is on the decline. Several factors have contributed to this decline, including rising wages overseas and the advent of artificial intelligence (AI)-driven automation. Call centers servicing U.S. companies, for instance, that are plentiful in India and other parts of the world, are increasingly being staffed by fewer human beings and more intelligent chatbots. This trend can only increase.

The rise of AI is also depressing the labor arbitrage market by shifting the emphasis of enterprise efficiency from lowering the cost of labor to increased productivity, where AI is offering optimization opportunities that yield greater long-run savings than labor arbitrage can offer. This trend, too, can only increase.

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