Labor Arbitrage: What It Is & How You Can Benefit

Labor Arbitrage: What It Is & How You Can Benefit
Image Credit: Early Office Museum

In 2022, the war for talent was more competitive than ever. By some estimates, 96% of companies worldwide increased their salaries, and the average salary bump was 4.9%. While many companies did what they had to attract and retain their employees, for some companies, this level of salary growth is not sustainable.

As remote work continues gaining traction, some companies are looking to lower their expenses through labor arbitrage. By seeking out the best talent for the lowest cost, companies can hire the most qualified people for their open roles without hurting the bottom line.

What Is Labor Arbitrage?

While there are many ways to define labor arbitrage, the main definition is that it’s the “practice of searching for and hiring the lowest cost labor (typically in a different state or country).”

To some, “labor arbitrage” (or labor cost arbitrage) means “offshore,” but a company doesn’t have to send jobs overseas to lower its costs. There are many types of labor arbitrage, and some keep the jobs local.

See Also: How To Geoarbitrage

Global Labor Arbitrage

Global labor arbitrage is when a company sends jobs to a location where labor and raw materials cost less. This is often found in the manufacturing industry. A business in a wealthy country has high labor costs. They have to pay staff a reasonable wage and cover things like social security taxes. The company may also incur higher manufacturing costs to import materials to build the product.

To lower their overall costs, the company moves the manufacturing process to a less-wealthy country. They hire people at a salary that pays well (relative to other local jobs) but is less than what they would pay in a wealthy country. Likewise, by moving production where the raw materials are (or closer), the company reduces shipping costs.

Domestic Labor Arbitrage

Through domestic labor arbitrage (also called onshoring or nearshoring), a company keeps jobs in a wealthy country but moves them to an area with a lower cost of living, reducing their costs.

For example, a call center located in a rural part of the U.S. means the company likely doesn’t have to pay as high of a wage to those working in a call center in a major city. Likewise, the company’s costs may decrease since the cost of running the customer service center may be less (like cheaper electricity or internet).

Using Independent Contractors

Hiring independent contractors is another way companies use labor arbitrage. In this scenario, the employer may seem to pay more, but in reality, they are often saving money.

When a company hires a regular employee, they pay additional “fees” beyond the employee’s base salary. This includes things like health insurance and vacation, as well as social security taxes and unemployment insurance. However, the company may also have additional expenses, like paying an accountant to calculate the taxes or the payroll processor for the additional paperwork.

But with independent contractors, employers are freed from many of those additional expenses. For example, the payroll processor may still charge a fee for cutting the contractor’s check, but the employer doesn’t pay social security or unemployment taxes. So, while the company pays a contractor more per hour (say $25 instead of $15), they are no longer responsible for the taxes, thus reducing the overall cost of that employee.

Importing Labor

Finally, employers can import labor instead of products. When companies have difficulty finding qualified people to fill their roles, they may turn to visa programs to hire talented individuals from other countries.

Some new hires are willing to accept a lower salary in exchange for the opportunity to live and work in a different country. And if the company needs to import more skilled labor, there’s more competition for the open roles, driving down the salary.

How Labor Arbitrage Is Impacting Work

Though labor arbitrage has long been used in manufacturing, call centers, and tech support, the pandemic caused a massive upheaval in how employers and employees think about where, when, and how they work.

Many businesses had no choice but to allow remote work. As a result, job postings for knowledge workers specified that they no longer had to be in the office. As the pandemic dragged on, people experienced the benefits of remote work, which opened up a whole new way of thinking.

Employees realized that in addition to reducing their exposure to illness, they were less distracted, better focused, and had a better work-life balance. And as more employers allowed remote work, employees moved to less expensive cities to lower their cost of living.

Employers learned their remote employees were just as productive as in the office, sometimes even more so. What’s more, they realized that remote work expanded the talent pool. It wasn’t just limited to people who lived within a reasonable commuting distance. Then employers started thinking, We could hire an extremely talented person who lives in Nebraska, and that would cost us less money.

Once employers see how well their remote employees perform and how much money they save, companies will take their labor arbitrage to the next level. They’ll think: We could deliver the same product using a contractor in the Philippines and push to deliver work through independent contractors and foreign workers.

While this would seem to benefit only the employer, statistics show workers want to continue with some form of remote work going forward and are less likely to accept a job that doesn’t let them work from home part of the time. As a result, it’s estimated that by 2028, 73% of all teams will include some remote employees. And by 2035, there could be as many as 1 billion location independent workers.

Employers that don’t allow some remote work are likely to lose out on top-talent knowledge workers. As part of the battle, companies may have to increase salaries to unsustainable levels. To lower their costs, these companies may hire contractors living in other countries.

The end result would be more global teams that fiercely compete for the best talent. This could create downward pressure on wages in less-wealthy countries. Companies that allow remote work and use labor arbitrage will have more access to top-tier talent but won’t have to pay the costs of hiring talent in a high-cost area.

How Labor Arbitrage Can Benefit Your Company

No matter what kind of company you have, you can take advantage of labor arbitrage to lower your costs and improve your company’s bottom line.

Consider hiring independent contractors. Upwork is a great way to connect with talented individuals with the specialized skills you need. We use it to hire editors, writers, designers, researchers, and developers, allowing us to connect with people who know what they’re doing while lowering our costs.

Also, think about the benefits of sending some of your jobs to a different state or even country. For example, an overseas call center lets you provide live customer support representatives at odd hours when U.S. employees might not want to work or demand more pay for working second or third shift. This expanded customer service could help you retain existing customers and attract new ones.

Finally, labor arbitrage expands your talent pool to anywhere in the world. When you hire from other countries (or even other parts of your country), you’re expanding the skill level at your company.

About the author

Henry OLoughlin

Hi, I'm the founder of Buildremote. I have worked from home for a decade and run a fully remote, four-day work week company for eight years. I've made all of the mistakes running a remote company. I hope if you read my site, you'll be spared.

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