The Harsh Truth About Outsourcing

Business Week ^ | March 22, 2004 | Paul Craig Roberts

[sarcasm]

It's not a mutually beneficial trade practice -- it's outright labor arbitrage

Economists are blind to the loss of American industries and occupations because they believe these results reflect the beneficial workings of free trade. Whatever is being lost, they think, is being replaced by something as good or better. This thinking is rooted in the doctrine of comparative advantage put forth by economist David Ricardo in 1817.

It states that, even if a country is a high-cost producer of most things, it can still enjoy an advantage, since it will produce some goods at lower relative cost than its trading partners.

Today's economists can't identify what the new industries and occupations might be that will replace those that are lost, but they're certain that those jobs and sectors are out there somewhere. What does not occur to them is that the same incentive that causes the loss of one tradable good or service -- cheap, skilled foreign labor -- applies to all tradable goods and services. There is no reason that the "replacement" industry or job, if it exists, won't follow its predecessor offshore.

For comparative advantage to work, a country's labor, capital, and technology must not move offshore. This international immobility is necessary to prevent a business from seeking an absolute advantage by going abroad. The internal cost ratios that determine comparative advantage reflect the quantity and quality of the country's technology and capital. If these factors move abroad to where cheap labor makes them more productive, absolute advantage takes over from comparative advantage.

This is what is wrong with today's debate about outsourcing and offshore production. It's not really about trade but about labor arbitrage. Companies producing for U.S. markets are substituting cheap labor for expensive U.S. labor. The U.S. loses jobs and also the capital and technology that move offshore to employ the cheaper foreign labor. Economists argue that this loss of capital does not result in unemployment but rather a reduction in wages. The remaining capital is spread more thinly among workers, while the foreign workers whose country gains the money become more productive and are better paid.

Economists call this wrenching adjustment "short-run friction." But when the loss of jobs leaves people with less income but the same mortgages and debts, upward mobility collapses. Income distribution becomes more polarized, the tax base is lost, and the ability to maintain infrastructure, entitlements, and public commitments is reduced. Nor is this adjustment just short-run. The huge excess supplies of labor in India and China mean that American wages will fall a lot faster than Asian wages will rise for a long time.

Until recently, First World countries retained their capital, labor, and technology. Foreign investment occurred, but it worked differently from outsourcing. Foreign investment was confined mainly to the First World. Its purpose was to avoid shipping costs, tariffs, and quotas, and thus sell more cheaply in the foreign market. The purpose of foreign investment was not offshore production with cheap foreign labor for the home market.

When Ricardo developed the doctrine of comparative advantage, climate and geography were important variables in the economy. The assumption that factors of production were immobile internationally was realistic. Since there were inherent differences in climate and geography, the assumption that different countries would have different relative costs of producing tradable goods was also realistic.

Today, acquired knowledge is the basis for most tradable goods and services, making the Ricardian assumptions unrealistic. Indeed, it is not clear where there is a basis for comparative advantage when production rests on acquired knowledge. Modern production functions operate the same way regardless of their locations. There is no necessary reason for the relative costs of producing manufactured goods to vary from one country to another. Yet without different internal cost ratios, there is no basis for comparative advantage.

Outsourcing is driven by absolute advantage. Asia has an absolute advantage because of its vast excess supply of skilled and educated labor. With First World capital, technology, and business knowhow, this labor can be just as productive as First World labor, but workers can be hired for much less money. Thus, the capitalist incentive to seek the lowest cost and most profit will seek to substitute cheap labor for expensive labor. India and China are gaining, and the First World is losing.

Paul Craig Roberts is a former Assistant Treasury Secretary in the Reagan Administration and a former BusinessWeek columnist.

[sarcasm]

Why don't we discuss the entire conclusion:

Nevertheless, large problems remain and some have even grown worse in the 1990s. Wages in the middle and top of the wage distribution have grown more slowly over the current cycle than they did in the 1970s or 1980s. The distribution of family income, at least through 1996, has grown more unequal, with the bottom four fifths of the distribution experiencing stagnant or declining real incomes over the period. Not surprisingly, given the family income trends, the poverty rate rose from 12.8% to 13.7% between 1989 and 1996. Finally, the already highly unequal distribution of wealth grew even more unequal between 1989 and 1997, in part, as a function of a stock market boom, whose benefits are still rather narrowly confined.

[Southack]

We shouldn't discuss the entire conclusion because it gives you too much room to wiggle and squirm.

The single sentence that I pulled out of the conclusion is all that is necessary to pin you down, which is something that you decidedly don't want to happen.

You don't want to answer that even your own Canadian study concludes that wages here in the U.S. did indeed grow, albeit more slowly.

[Sybeck1]

I would personally rather send some menial lower income jobs to a developing country, instead of a blank check of foreign aid to its despot leader.

[Southack]

"Wages in the middle and top of the wage distribution have grown more slowly over the current cycle than they did in the 1970s or 1980s."

Hey, that's from your own Canadian study's conclusion!

Tell me again, did wages GROW or shrink?!

[sarcasm]

From the study you've grown to love:

The distribution of family income, at least through 1996, has grown more unequal, with the bottom four fifths of the distribution experiencing stagnant or declining real incomes over the period.

[sarcasm]

We shouldn't discuss the entire conclusion because it gives you too much room to wiggle and squirm.

Au Contraire - I wish to discuss the entire conclusion - especially the part that you don't want to discuss.

[Southack]

"The distribution of family income, at least through 1996, has grown more unequal, with the bottom four fifths of the distribution experiencing stagnant or declining real incomes over the period..."

...if one chooses to use the CPI-U-X1 index instead of the standard U.S. government CPI index.

Now tell me again what your Canadian study concluded. Did wages GROW or shrink?!

[Southack]

We shouldn't discuss the entire conclusion because it gives you too much room to wiggle and squirm.

"I wish to discuss the entire conclusion"

Of course. You need the wiggle room.

[neutrino]

Any argument which attempts to transfer that same quality to the manufacture of household toasters deserves to be dismissed as frivolous.

With regard to toasters, true enough. But with regard to AI, computer chip manufacture, and that sort of thing - the argument ceases to be frivolous.

It must also be remembered that the Chinese will graduate 350,000 engineers this year to our 90,000. Given those numbers, it seems most imprudent to continue transferring technology to them - whether for toasters, or otherwise.

[sarcasm]

Now tell me again what your Canadian study concluded. Did wages GROW or shrink?!

Says it right here:

The distribution of family income, at least through 1996, has grown more unequal, with the bottom four fifths of the distribution experiencing stagnant or declining real incomes over the period.

[sarcasm]

Of course. You need the wiggle room.

You want to control the terms of the debate - not gonna happen.

[Southack]

Now tell me again what your Canadian study concluded. Did wages GROW or shrink?!

"Says it right here:"

It actually says it HERE:
"Wages in the middle and top of the wage distribution have grown more slowly over the current cycle than they did in the 1970s or 1980s."

[templar]

...whereas the wages in the U.S. have continued to rise.

What percentage of the population in the US has experienced a wage increase, both in dollars and inflation adjusted dollars, what percentage has stayed the same, and what percentage has declined??

[sarcasm]

You, of course, don't wish to discuss what happened to the wages of those not in the middle or the top - it doesn't fit your agenda.

[Southack]

See the link in Post #50.

[Southack]

"You, of course, don't wish to discuss what happened to the wages of those not in the middle or the top - it doesn't fit your agenda."

No, it doesn't fit with the point under discussion, which is the *average* wage of Americans...which has gone up since 1959 (again, see the link in post #50 as well as the conclusion to your own Canadian study).

[lelio]

"Wages in the middle and top of the wage distribution have grown more slowly over the current cycle than they did in the 1970s or 1980s."

How is wage defined? IE Steve Jobs has a $1/year wage for the past couple of years. Is there anything in there that states what wage means?

[sarcasm]

Found this in the Economist:

</HTML

They seem to agree with the Canadians.

[Victoria_R]

No, real wages in the U.S. have steadily increased even after inflation. Wages in China and Mexico, however, have declined.

Actually, I once figured real wages for 1970 to 2000 for the Western U.S. by state and found out the government numbers didn't include taxes (income, sales, gas, etc.) and a few other items. The average wage looked like it was increasing until I put the taxes and other stuff back in, then it was a steady decrease except for a short period in the mid to late 80's (Reagan tax cut).

And when you consider personal debt, it gets really ugly...

[HitmanLV]

Not so. I picked up a decent and cheap hawaian style polo shirt at Walmart the other day for $11, not made in the USA.

If it was made here, it would almost certainly cost more than $1.

I benefitted.