The great hollowing-out myth

Outsourcing to other countries has become a hot political issue in America. Contrary to what John Edwards, John Kerry and George Bush seem to think, it actually sustains American jobs

EARLIER this month, President George Bush's chief economic adviser, Gregory Mankiw, once Harvard's youngest tenured professor, attracted a storm of abuse. He told Congress that if a thing or a service could be produced more cheaply abroad, then Americans were better off importing it than producing it at home. As an example, Mr Mankiw uses the case of radiologists in India analysing the X-rays, sent via the internet, of American patients.

Mr Mankiw's proposition, in essence, is the law of comparative advantage, first postulated by David Ricardo two centuries ago and demonstrated to astonishing effect since. Yet the Republican speaker of the House of Representatives, Dennis Hastert, joined Democrats in their rebuke of Mr Mankiw for approving of jobs going overseas; another Republican called for his resignation. The White House gave Mr Mankiw only lukewarm support—unsurprisingly, since Mr Bush recently signed a bill forbidding the outsourcing of federal contracts overseas. And the Democratic presidential contenders? Mr Mankiw had just written their attack ads.

The Bureau of Labour Statistics gives the latest unemployment figures and other economic statistics. See also the Department of Commerce and the Federal Reserve. The Institute for International Economics publishes a policy brief on “Globalization of IT Services and White Collar Jobs: The Next Wave of Productivity Growth”. The Federal Reserve Bank of New York posts a copy of “Has structural change contributed to a jobless recovery?” by Erica Groshen and Simon Potter.

As if to underline the point, this week's Wisconsin primary was dominated by the subject of jobs, and the failure of the Bush administration to do enough to protect them from going off to India. In John Edwards, who wants to rewrite the North American Free-Trade Agreement (NAFTA), the American left may have found its cuddliest protectionist yet; support for the southerner surged after he spent much of a debate drawing implicit comparisons between his own skills as a jobs-defender and those of John Kerry, who has stuck to free trade only a little more loyally. The Democratic front-runner defends NAFTA, but rants about “Benedict Arnold” bosses betraying American workers by moving jobs overseas (presumably to boost returns for fat-cat investors, like, er, Mr Kerry's family).

As for what might be called the business lobby, this is in disarray. “Tech jobs are fleeing to India faster than ever,” moans the cover of Wired. Watch “Lou Dobbs Tonight”, America's main business show, and every factory-closing is hailed as proof of America's relentless “hollowing-out” at the hands of dark forces in China, India and indeed the White House. Strangely, no mention is made of the fact that a pretty tiny proportion of all jobs lost actually go overseas.

•Although America's economy has, overall, lost jobs since the start of the decade, the vast majority of these job losses are cyclical in nature, not structural. Now that the economy is recovering after the recession of 2001, so will the job picture, perhaps dramatically, over the next year.

•Outsourcing (or “offshoring”) has been going on for centuries, but still accounts for a tiny proportion of the jobs constantly being created and destroyed within America's economy. Even at the best of times, the American economy has a tremendous rate of “churn”—over 2m jobs a month. In all, the process creates many more jobs than it destroys: 24m more during the 1990s. The process allocates resources—money and people—to where they can be most productive, helped by competition, including from outsourcing, that lowers prices. In the long run, higher productivity is the only way to create higher standards of living across an economy.

•Even though service-sector outsourcing is still modest, the growing globalisation of information-technology (IT) services should indeed have a big effect on service-sector productivity. During the 1990s, American factories became much more efficient by using IT; now shops, banks, hospitals and so on may learn the same lesson. This will have a beneficial effect that stretches beyond the IT firms. Even though some IT tasks will be done abroad, many more jobs will be created in America, and higher-paying ones to boot.

The “jobless recovery” first, then. Despite strong productivity growth and an accelerating recovery from the recession of 2001 (the economy grew by an annual 4% in the fourth quarter of last year), jobs are being created at a feeble rate of 100,000 or so a month. The jeremiahs point out that a net total of 2.3m jobs have been lost since Mr Bush came to office.

Although this date is often used as the starting-point from which to make a comparison, it is a silly one. In early 2001 the hangover effects from the investment boom of the late 1990s were only starting to be felt. Unemployment, at 4.2%, was unsustainably below the “natural” unemployment rate, consistent with stable inflation, that most economists put at around 5%. In other words, perhaps two-thirds of those 2.3m jobs were unsustainable “bubble” ones. Given the scale of job losses—along with the shocks of a stockmarket bust, corporate-governance scandals and terrorist attacks—it is a wonder that the recession was so mild. By the same token, a mild recession is now being followed by a commensurately mild recovery.

This week, the White House retreated from a claim that 2.6m new jobs would be created this year. But there are reasons to think that job growth will be more robust. In particular, the remarkably strong productivity growth, running at twice its long-run average of 2.1%, must slow down eventually. In the face of rising order books, businesses will have to hire more workers.

This may already be happening in some parts of the country. William Testa, director of regional research at the Federal Reserve Bank of Chicago, points out that the downturn began in the mid-west (because of its relative emphasis on manufacturing, notably business equipment, the mid-west was hit first by the slump in business investment) and then spread to the coasts. Now a recovery is spreading in the reverse direction—starting on the coasts and ending up, alas for Mr Bush, in the key electoral states of the industrial heartland.

In the absence of an obvious jobs recovery, it is perhaps not surprising that the myth arose that the American economy was being buffeted by structural, not cyclical, forces. Yet it nevertheless is a myth—as three notable economists, William Baumol, Alan Blinder and Edward Wolff, point out in a recent book.*

Churning, they point out, has being going on in the American jobs market for years, and “the creation of new jobs always overwhelms the destruction of old jobs by a huge margin.” Between 1980 and 2002, America's population grew by 23.9%. The number of employed Americans, on the other hand, grew by 37.4%. Today, 138.6m Americans are in work, a near-record, both in absolute terms and as a proportion of the population

Of course some firms wither—Reynolds Tobacco's workforce shrank by nine-tenths between 1980 and 2002—but others grow: Wal-Mart's by 4,700%. During the 1990s, about a quarter of all American businesses shed jobs in a typical three-month period, equivalent to 8m jobs. Yet jobs created greatly outnumbered these, to the tune of 24m over the decade.

The process leads to incremental shifts that can have profound cumulative consequences for some sectors of the economy. In 1960 only one in 25 workers was employed in the business-services and health-care industries. Today, one in six is. In terms of output, manufacturing has risen, but, thanks to that productivity spurt, these goods are produced by fewer people—12% of the workforce, less than half the proportion of three decades ago.

And what of China? Still piffling. Certainly, China competes with some labour-intensive American industries that have long been in decline, such as textiles and stuffed toys. In the mid-west, metal-furniture makers and small tool-and-die foundries face growing competition. Yet most Chinese imports are of consumer goods, competing with imports from other poor countries, whereas America's manufactures are chiefly capital goods. Even at their peak in 2001, the number of all “trade-related” layoffs represented a mere 0.6% of American unemployment.

As for the Indian threat, “offshoring” is certainly having an effect on some white-collar jobs that have hitherto been safe from foreign competition. But how big is it, really? The best-known report, by Forrester Research, a consultancy, guesses that 3.3m American service-industry jobs will have gone overseas by 2015—barely noticeable when you think about the 7m-8m lost every quarter through job-churning. And the bulk of these exports will not be the high-flying jobs of IT consultants, but the mind-numbing functions of code-writing.

“The creation of new jobs always overwhelms the destruction of old jobs by a huge margin”

Meanwhile, there is another side to the ledger. Instead of focusing on jobs lost to the globalisation of information technology, Catherine Mann of the Institute for International Economics in Washington looks at globalisation's power to reduce prices and so help spread new technology, new practices and job-creating investment through the economy.

She uses the example of cheaper IT hardware, one of the main aspects of globalisation in the 1990s. Most of the drop in prices for PCs, mainframes and so on was caused by the relentless advance of technology; but she still thinks that trade and globalised production—all those Dell Computer factories in China, for instance—was responsible for 10-30% of the fall in hardware prices. These lower prices led to higher American productivity growth and added $230 billion of extra GDP between 1995 and 2002, equivalent to an extra 0.3 percentage points of growth a year.

These days, software spending is increasing at twice the rate of hardware spending, as businesses struggle to make their new computers work better. The manufacturing sector is where such integration has gone furthest. In many other parts of the American economy, the process has barely begun—particularly among smaller- and medium-sized businesses. Mr Mankiw's example of the Indian radiologist shows how the internet could help lower costs and raise productivity in health care. Who would object to that?

Ms Mann concludes that if IT software sees falls in prices, thanks to globalisation, similar to those that IT hardware has seen, then the second wave of productivity gains—notably in the service sector—could be greater than the first, which was based mainly on manufacturing. Some service sectors, such as construction and health care, are ripe for gains, because their efficient use of IT is low.

Will the trend lead to jobs going overseas? You bet, but that is not a disaster. For a start, America runs a large and growing surplus in services with the rest of the world. The jobs lost will be low-paying ones, such as bank tellers and switchboard operators. Trade protection will not save such jobs: if they do not go overseas, they are still at risk from automation.

By contrast, jobs will be created that demand skills to handle the deeper incorporation of information technology, and the pay for these jobs will be high. The demand for computer-support specialists and software engineers, to take two examples, is expected by the Bureau of Labour Statistics (BLS) to double between 2000 and 2010. Demand for database administrators is expected to rise by three-fifths. Among the top score of occupations that the BLS reckons will see the highest growth, half will need IT skills. As it is, between 1999 and 2003 (that is, including during the recession) jobs were created, not lost, in a whole host of white-collar occupations said to be particularly susceptible to outsourcing.

Yes, individuals will be hurt in the process, and the focus of public policy should be directed towards providing a safety net for them, as well as ensuring that Americans have education to match the new jobs being created. By contrast, regarding globalisation as the enemy, as Mr Edwards does often and Messrs Kerry and Bush both do by default, is a much greater threat to America's economic health than any Indian software programmer.

If you were the CEO of Acme widgits, you WOULD -- get this -- YOU WOULD OUTSOURCE YOUR LABOR.

There are many CEO's who have not. The dichotomy between outsourcing and protectionism is false. The main reason to hire and buy American is patrioitism which does not require protectionism or pure profit motive. You may decide that it is more patriotic to outsource and reinvest the savings in America. That is fine and your choice. But it is certainly not partriotic to buy cheap crap from China and squander the savings on more cheap crap.

ROI is just one measure. Private companies often don't outsource even when it becomes economically painful to keep domestic employment. My own investment decisions are driven by technical and macroeconomic factors much more than company fundamentals. But mostly I was referring to consumption decisions. Those have a much greater potential for patriotism than investment.

Human nature.

People will "buy American" in the short run, but will not in any significant numbers, continue to do so when the dollars reach a certain threshold. Small private companies will pay higher wages to loyal employees for awhile, till their profit margin drops to a certain threshold. Both employment and consumption decisions will allow some room for salving the patriotic conscience UNTIL THE NUMBERS GET BIG ENOUGH, then your loyalty to your own family's budget supercedes your loyalty to what is relatively an abstraction.

Liberals build programs in their heads using denatured symbols of people, like pieces on a chessboard. Then, in practice, the symbols come to life like werewolves of self-interest.

Protectionists build "solutions" in their heads using denatured symbols ("executives" "consumers") then, in real life, the symbols stubbornly morph into selfish actors.

Nothing is more fundamental to economics than the assumption that all actors will pursue their rational self-interest.

Any other value injected into the system, unless it is a vivid and dramatic moral prohibition, is a local and transient island, soon to be overwhelmed by the profit motive.

Labor will be moved offshore to cheap markets. An apple, released from the tree, will drop to the ground.

Nothing is more fundamental to economics than the assumption that all actors will pursue their rational self-interest.

A much more pertinent corollary is that all actors must not be protected from the consequences of pursuing policies other than rational self-interest otherwise the economic system will break down. That's why I am against protectionism because it distorts and ultimately weakens the economy. On the other hand, self-interest is a broad measurement and depends on time scales. The short run Buy American policy will translate into economic growth in the longer run from the ripple effect of those purchases. Unless as you say, the numbers get big enough and foreign purchases result in more significant savings. But that same actor must then invest those savings and not be protected from lack of savings and debt by our government weakening the dollar.

So in my it boils down to a few simple principles: the government must stay out of the market (I wish!) and people need to take a broad and long-term view of their economic self-interest which means taking a serious look at how their (non-abstract) neighbors will make a living.

"So the shift of labor to cheap markets produces two deflationary pressures: one on American wages, the other on American prices. How these two will net out in the short run no-one knows."

You've essentially said the same as I, but in much better terms.

As I see it, when we're all forced to become biotechnicians, the demand for biotechnicians diminish along with the price of wages (probably much truer that wage price increases won't keep up with the normal pace of economic growth/inflation)...

John, Your ad hominems are significantly outnumbering your reasoned refutations. I suggest that you try again.

Whoaaa!!!!

I never claimed to be making a reasoned refutation. Why should I? It has already been done ad infinitum by far more able people than I.

Instead I just had a bit of a laugh. Lighten up. And, get that copy of Sowell's book I recommended.

What I find interesting are the people who say "sending our jobs to other countries is evil" and then argue that "illegal aliens are just doing work Americans won't." Illegals are just our way of outsourcing by bringing the foreigners to the jobs instead of sending the jobs to them. Same effect, except that when they're here we also get to educate their kids, and deal with their health problems.

As usual, the protectionist vision sees part of the economic system and thinks it is the whole picture.

Aren't the income tax and state and federal regulations essentially tariffs on American labor?
Doesn't the combination of these tariffs on American labor and international free trade amount to protectionism for foreign jobs?
Why aren't self-styled "free traders" interested in the free trade of American labor?

Revenue needs to be raised somehow. To suggest protectionism to offset some preceived tax benefit for imports is way off the mark in my opinion.

Raise the revenue through taxes, tariffs, and levies on the fruits of foreign labor, and abolish the income tax. As it stands, the tax disparity amounts to protectionism against American interests in favor of international ones, as it places an uncompetitive burden on American workers against their less taxed and less regulated foreign competitors.

Fair enough. You favor protectionism, through the use of the tax code, which of course is how protectionism is effected. It would be a total disaster long term, and of course would trigger trade wars. It won't happen as a result. Nobody in power is really going to go down that route, because the consequences are just too negative for America's economy, and its ability to finance a robust defence and foreign policy.

I will not vote for any Pubbie who supports a protectionist agenda, assuming the Dem is not worse, and maybe not even then. I will cross over, not to waste my vote on a third party, but to support the Dem. Well maybe not for the Senate, with the judge thingie.

Fair enough. You favor protectionism, through the use of the tax code, which of course is how protectionism is effected

You've begged the question, which is:
"Why aren't self-styled "free traders" interested in the free trade of American labor?"
How is it that free traders are not concerned about the lack of free trade in American labor, due to the anticompetitive burdens of excessive domestic taxation and regulations?
If anticompetitive burdens on foreign labor equal protectionism for American jobs, how is the corollary not also true?
If raising revenues on the fruits of foreign labor is economically destructive, why is that not also true of the raising revenue on the fruits of domestic labor?
That "revenue needs to be raised somehow" doesn't argue for a tax system that penalizes American labor at the expense of foreign labor.

If raising revenues on the fruits of foreign labor is economically destructive, why is that not also true of the raising revenue on the fruits of domestic labor?

An excellent point! As a lifelong believer in Free Trade, I find myself forced to make some exceptions today. First, we need to make certain that we have the means at home to sustain a possible war effort in the future--I mean a real war, with a formidable foe, not hit and run bandit fanatics, as are those with whom we are presently engaged. Second, there is a terrible social cost in this present farming out of jobs overseas. This was not possible in this form, historically, so it really is outside the human experience, and suggests all sorts of problems, not even yet addressed here.

We need a debate on just what are worthwhile personal choices, family goals and all sorts of other subjects, that usually have little role in debates on world trade. This is not just another business cycle, which can be expected to correct itself. Not where people who had to train for many years to obtain a highly skilled position, can be put out of business overnight, by companies willing to transfer information on the internet, 11,000 miles, to obtain the same service. That sort of change does not self-adjust in any manner of which we have any past experience. There are totally new factors thrown in, which might take generations, rather than months or years, to sort out.

William Flax Return Of The Gods Web Site

Whenever apologist for outsourcing start trying to impress with hi-speed flapping of the gums they never touch on the H1B and L1 visas which the republicans and democrats legislatively encourage and which take hundreds of thousands of Hitech jobs not outsourced.

They then say that the bulk of these exports will not be the high-flying jobs of IT consultants, but the mind-numbing functions of code-writing. Of course they fail to say that without the code-writing there is nothing. Like the engine of a car.
They claim proudly that - some firms wither—Reynolds Tobacco's workforce shrank by nine-tenths between 1980 and 2002—but others grow: Wal-Mart's by 4,700%. WALMART! So we are bragging about a supermarket now? Boy that is really cutting edge pushing the envelope stuff. A supermarket on steroids.

It is then said that some service sectors, such as construction and health care, are ripe for gains, because their efficient use of IT is low. Will this trend lead to jobs going overseas? You bet, but that is not a disaster. I tell you what it is though, it is a disaster for the election of 2004 because Bush 2 is making the exact same mistake Bush 1 made, trying to tell the American people that the economy is OK. Disaster is a democratic victory.

Some say trade protection will not save such jobs: if they do not go overseas, they are still at risk from automation.
True so let them be automated here in America. Let the automation industry grow here. Let the knowledge grow here.

Mr. President don't make the mistake your father made.

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