Remote Work and the Globalization of Services
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Globalization has fueled the world’s economic growth for more than 200 years. It began in the 1800s when the steam engine made it possible to produce goods in one location and transport them to another—almost anywhere in the world. Globalization 2.0 and 3.0 followed over the next 100 years as advances in manufacturing and transportation made trade faster and cheaper.
While the first three waves of globalization represented the trade of goods, there’s another important component in our economy: the services sector. Until recently, the services sector—including knowledge industries like software development, consulting, design, and marketing—did not experience globalization.
Today, however, the digital economy and the ability of companies to hire remote workers have ushered in Globalization 4.0. This wave—for the first time—has moved beyond the buying and selling of goods to include the services industry.
Why Trade of Services Lagged Behind
Since the steam engine, globalization has continued to expand. Exports of goods and services have grown from 6% of global Gross Domestic Product (GDP) in the 1850s to 30% in 2018.
Services are the largest contributor to the economy, at 63% of total global wealth. However, the export of services lags far behind the export of goods. (Goods represent 75% of total global exports, while services represent only 25%.)
Why do services represent only a quarter of all global exports?
Several differences between goods and services account for this disparity.
- The majority of services require on-site delivery. For example, goods can be produced in Indonesia and then transported and sold in the US. Services, however, until recently, haven’t been easily transported. Traditionally, the service provider and consumer had to be in the same location. This is still true for some service industries—customers must be on-site to experience the services of restaurants and hotels. Other knowledge-based services, such as communications and software, which make up 45% of the world’s service exports, attempted to solve this problem by having service providers travel to the customer. Unfortunately, this adds a significant cost to the basic services, making them less competitive.
Imagine a company in the United States hires IT consulting services based in Russia requiring 160 hours of work (20 days). Eighteen days of work can be done in Russia, but two days must be on-site in the US. If the IT specialist makes $20 per hour, they will make $3,200 (160 x $20) for the project. However, travel to the US, including transportation and lodging, will cost $1,600. The job now has a 50 % surcharge, so the effective hourly rate is $30.
Before Globalization 4.0, such remote work was too expensive. Remote work today, enabled by digital technology, is not only possible, it’s cost-effective. In addition, remote work provides access to talent around the world, addressing the shortage of skilled knowledge workers.
- Service businesses require high-skill labor. The manufacturing of goods during the earlier industrial revolutions primarily needed low-skill, low-cost labor. The factories that produced these goods moved to countries with this labor force. The services sector, however, requires mid- to high-skill labor. Until recently, knowledge-based industries had to be located in wealthier, more expensive countries like the US because of a shortage of high-skill labor in developing countries.
- Service characteristics are not observable before purchase. Unlike goods that have a definitive value and quality, the value and quality of services are more subjective. When someone seeks a well-made garment, they know to look at the material, stitching, cost, and delivery. On the other hand, a photograph of an IT consultant can’t demonstrate value and quality. Without the opportunity to interact with that IT consultant, the buyer may not trust the service. This problem is challenging to overcome. Some freelance talent platforms, like Toptal, address this problem with rigorous talent screening and a white-glove matching process for clients.
Today, the service sector is growing at a faster rate than the goods sector. Service trade still lags behind goods overall, but the gap is closing quickly. Between 2008 and 2018, the export of services grew nearly 48%, a higher rate than the export of goods, which only grew 30% in that same decade.
Remote Work Could Become the Main Driver of Globalization
Remote work can be the catalyst that unlocks the globalization of services. As professional services are delivered remotely, costs will go down.
The following levers contribute to the growth of remote work, and therefore of the services industry:
Broadband internet and tools. With the advances of technology such as 5G broadband internet, video conferencing, augmented reality, virtual reality, and instant messaging, many jobs can be delivered remotely in a way that rivals the quality of on-site jobs. When remote jobs are at the same quality level as on-site jobs, there is a huge competitive advantage to buy these services from lower-cost countries.
Global culture. The first three waves of globalization have made the world much smaller. We are now interconnected, our cultures are intermixed, and we have more in common. Today, thanks to travel, product globalization, and even Hollywood movies, Eastern European countries, for example, are far more aware of American culture than ever before. Americans are also more aware of cultures around the world. As cultural differences lessen, communication barriers will diminish and remote work can flourish.
The globalization of entertainment and goods results in a global culture that removes those trust barriers. Remote work is all about trust. The barriers to trust working with someone unknown and unproven are much higher than for a person you see each day. We tend to trust those that share our values and culture.
Foreign languages. Finally, speaking English is becoming far more common. There are currently 1.5 billion English speakers worldwide, or 20% of the world’s population. English is used not only when living in an English-speaking country but also as the common language between nations to conduct business. Having a common code of communication is the number one prerequisite for remote work.
How the Rise of Remote Work Will Change the World
Remote work and the accelerating export of services will bring tectonic changes to the world economy in the following ways.
Remote Work Will Stop Brain Drain
Developing markets often experience brain drain, also known as human capital flight. This is the physical migration of skilled individuals from a less developed area to a more developed area. When this occurs, a city or a country loses its most talented and educated workers, to the detriment of the entire country.
- The country experiences a shortage of skilled workers.
- The loss of skilled labor makes the country less able to attract businesses, which reinforces the flight of talent.
- The highly skilled people who leave are also potential entrepreneurs and innovators who might create new businesses and bring prosperity to the country. Without these people, the country experiences limited growth and development.
- Losing skilled workers results in a loss of tax revenue.
- The country also loses its investment in education. People educated at the country’s expense leave the area without paying back this investment.
Remote work, however, solves these problems. It allows those who might leave the area to stay and work remotely for companies in more developed markets. The effect is not entirely the same as if they were working for local companies, but the country can still benefit from their presence—they pay taxes, they are part of the local community, and they can contribute to the local entrepreneurial ecosystem. In addition, they export their services and bring money back into their country, positively contributing to the country’s trade balance.
Remote Work Will Intensify the Competition for Talent in Developing Markets
In the past, talent in developing markets had only one real option if they wanted higher compensation: emigration to a more developed market. Unfortunately, emigration comes with its own set of political, legal, cultural, and economic challenges. As a result, only a fraction of those who want to move to another country are capable of doing so.
With remote work, however, anyone with the right skill set can find a job. Remote work allows high-skilled labor to remain in their home country.
When companies from developed countries hire remote talent, they compete with local businesses for that talent. This has two effects in the local markets:
- Wages are pushed higher. Remote jobs typically pay better than local jobs. Therefore, if local companies want to keep local talent, they will have to pay higher wages. Higher wages may drive up the price of that company’s goods and services, making them less competitive.
- Talent shortages. If local businesses can’t pay the higher rates, they will lose high-skill talent.
Remote Work Will Disrupt Existing Business Models in Developing Markets
In offshore destinations, the service business model is simple: providing services at a lower cost than developed markets.
Let’s take, for example, the software industry. The majority of companies in Eastern Europe or India build software for Western clients at a low cost. They don’t innovate. In fact, they play the same role manufacturers in China and Southeast Asia play when it comes to goods. All of these countries offer access to the right talent at lower costs.
Remote work removes geographical barriers. Western companies can easily access the workforce of these developing countries, without a physical presence. The competitive advantage of local companies in developing countries disappears. In the past, a large US-based client might outsource specific projects to software agencies in India. Now, with the option of remote work, they can hire the best Indian-based developers remotely, which will eventually push these local companies out of business.
The only way for local companies to survive is to become value-producers instead of cost-cutters. To do so, they will have to invest in innovation and become more competitive.
Remote Work Will Bridge the Pay Gap
In a free market, talent rates are determined by the laws of supply and demand. An engineer in San Francisco might make four times that of an equally talented engineer in Bulgaria. Why? In San Francisco, there is more demand than talent supply and a higher cost of living, which pushes the rates up. In Bulgaria, the opposite is true, with far more supply than demand.
Let’s assume that the fair market rate for the Bulgarian developer is $25 per hour and that the San Francisco-based developer’s rate is $50 per hour. Because of high demand, San Francisco companies might have to pay that developer perhaps $100 or more per hour, putting a $50 premium on that rate.
The gap between $25 and $50 might be justified by the fact that the San Francisco developer has better training and education, more community support, and more experience in cutting-edge technologies or large-scale projects. The additional gap, from a $50 rate to a $100 rate, is just a premium based on high demand and cost of living in San Francisco. It’s highly doubtful the San Francisco developer offers value four times greater than the Bulgarian.
The discrepancy between the real value and the market value is simply a by-product of high demand and low supply and a difference in the cost of living.
Although this is an oversimplification, it illustrates the point. If success were as simple as hiring remote workers, there would be no San Francisco-based companies. They would have all been overthrown by Bulgarian companies. There are many other factors that explain why the biggest tech companies in the world are based in San Francisco and can still dominate the rest of the world. However, this traditional paradigm can be disrupted when remote work comes into play. With remote work, San Francisco-based clients have access to a larger talent pool, thus increasing the supply.
When supply and demand equalize, two things happen:
- The fees for talent in developed countries will go down.
- The fees for talent in emerging countries will go up.
Although the rates are not likely to become the same, the premium will become smaller, and market rates will converge to fair rates. This means that with remote work, companies will be able to pay talent their fair rate based on the actual value they bring. A developer living in San Francisco who makes four times more than one based in Bulgaria will have to produce four times the value.
Winners and Losers
The transformation of the world economy is not something new. We saw the same story with the globalization of products. Many companies moved their production to cheap labor countries causing many positions to disappear. Of course, for each job lost, there were multiple new jobs born. In these developed markets, talent doesn’t produce “stuff.” Instead, they perform higher-value jobs like management, design, and IT services.
Who will benefit from remote work?
- Companies in developed markets: They will now be able to get the same quality talent for a fraction of their current cost. This will improve the firms’ competitiveness.
- Talent in developing markets: They will now have access to fair market rates.
- Society as a whole: Society benefits when there are more services, greater economies of scale, and better resource allocation.
Who will lose? Talent in developed markets who now enjoy exceptionally high rates will eventually see these rates go down due to global competition.
Remote Work Can Democratize Opportunity
Remote work can create a consummate free market and democratize opportunity for both talent and clients.
- For talent: Talent should get paid based purely on merit, regardless of where they live. In theory, remote work will level the supply and demand outliers. Supply-constrained markets will see part of their demand filled in over-supply markets, helping the supply and demand balance of each market converge. As a result, the premiums and discounts applied to talent rates will also decrease, putting a talent’s earnings much closer to their fair value.
- For clients: Clients and companies will also have equal opportunities. Most San Francisco-based companies today can’t compete with Google and Facebook when it comes to accessing the local talent. However, with remote work, they can access an entire global pool of high-quality talent, thus having the ability to compete with much larger corporations.
Remote work will be the great equalizer of the 21st century. With the COVID-19 pandemic forcing remote work across the globe, such equalization may be coming sooner than imagined.
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