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.

[Starwind]

I am having trouble finding the humor.

Agreed. There is no humor in re-defining "wealth" to be a 50 cent/hour raise after 45 years of work.

I have been following the thread and it seems that Southack has made his case.

Only if you, like he, redefines "wealth" to be a few extra inflation adjusted pennies per year and cherry picks the data to find it.

A stunning testimony to your econmic acumen.

[Texasforever]

A stunning testimony to your econmic acumen.

Why thank you. Now what do you think about outsourcing?

[Southack]

"Only if you, like he, redefines "wealth" to be a few extra inflation adjusted pennies per year and cherry picks the data to find it."

Such a tragic analysis...

All three sources show a GAIN in wealth even after adjusting for inflation. That's hardly cherry picking.

Your analysis also ignores the starting point of "wealth."

It's not that we *became* wealthy after 1959 by 1 inflation-adjusted penny at a time. It is that we were *already* wealthy as a nation and as a people.

And we've become even richer, albeit at a seemingly slow pace.

This is *important* because it refutes Karl Marx and his Communist Manifesto. It refutes his claims in Das Kapital.

And refuting Marx is important because every so often new useful idiots get tricked into parroting Marx's long discredited drivel about capitalist societies *always* impoverishing themselves and *always* leading to revolutions against their mythical ruling classes.

You'll find at least one such poster early on in this thread. People really fall for that tired old nonsense.

[Starwind]

Now what do you think about outsourcing?

It happens due to global labor arbitrage, an absolute advantage held by countires like India and China and to a lesser extent Mexico.

It is irreversible until the cost of living for US workers becomes comparable to that of India, China, etc - theirs will rise, ours will fall until an equilibrium is reached.

They have an absolute cost advantage because they have not inflated their cost of living and their currency for 30 years like we have.

The new laws being discussed to prevent outsourcing will fail and only add to the US workers overhead. The solution lies is removing the costs - inflation, excessive taxation, over-regulation.

[jpsb]

Soon, the Chicoms will use all the technology and know how American companies are providing them to kill the Democratic Republic of Taiwan. Should the US come to the aid of Taiwan as promised this same technology will be used to kill US sailors and Marines.

Now what are you going to say then? Are you going to be honest and say "I did all I could to help arm and built the Chinese communist super state." I'll bet you will hiding under a rock.

Yall are proving Marx correct when he said "A capitalist well sell you the rope to hang him with." Cause that is exactly what you and your kind are doing.

By the way, GE is moving to China too, I'll bet the PLA fighter jets get a lot better.

[Texasforever]

A stunning testimony to your econmic acumen.

Let me ask you a question. How much should real wages rise for a person that has been in the same job 30 years?

[Texasforever]

They have an absolute cost advantage because they have not inflated their cost of living and their currency for 30 years like we have.

So in your opinion, labor rate is the absolute in competitive advantage?

[jpsb]

"Not in Texas,"

Bull Sh*t!!!! Property taxes are going thru the roof in Texas.

[Southack]

"It happens due to global labor arbitrage, an absolute advantage held by countires like India and China and to a lesser extent Mexico."

That sort of weakly researched answer can't explain why Nigeria (where 47% of their working population of millions earn less than $100 per year) isn't overtaking China and India in new outsourcing contracts.

Until you understand that China (whose average wages amount to $1,000 per year) and India are propping up the U.S. Dollar (versus the Yuan and Rupee), you won't be able to grasp their key competitive advantage over Nigeria.

HINT: It ain't the cost of their labor (Nigeria $100 per year versus China $1,000 per year per person).

[lelio]

And refuting Marx is important because every so often new useful idiots get tricked into parroting Marx's long discredited drivel

You're refuting Marx by showing a less than 50 cent an hour raise in a half century?

It refutes his claims in Das Kapital.

An extra cup of coffee a day refutes Das Kapital? You're going to have to come up with a better argument as that's not going to convince anyone.

I'm sure by bringing up this I'll be labeled a Marxist.

[Southack]

"They have an absolute cost advantage because they have not inflated their cost of living and their currency for 30 years like we have."

That's completely backwards. The Chinese Yuan and the Indian Rupee are just about worthless.

China and India deliberately undervalue their currencies versus the U.S. Dollar in order to make their largest customer (that's us) able to buy more of their goods and services.

In fact, the lower that the Dollar drops, the more it hurts China and India while in turn HELPING U.S. exports.

[Texasforever]

Now you are going to make heads explode. They are getting their "tariffs" and don't even know it.

[Southack]

"An extra cup of coffee a day refutes Das Kapital? ...

I'm sure by bringing up this I'll be labeled a Marxist."

Yes, and yes.

[Starwind]

labor rate is the absolute in competitive advantage?

No. More precisely, low cost is the reason China and India have an absolute as opposed to a comparative advantage.

Other factors would normally figure into competitive advantage, such as intellectual property. But we have lowered their IP costs (lowered their barriers to entry) as well.

We have tranferred to them the know how of what to do and whom to do it for, and provided them a ready made market for their output. We have put them in modernized business at a fraction of the cost we spent to develop entire industries. We have essential given them the intellectual capital free (or they stole what we didn't give them) and are helping them replace our industries with theirs.

They got all that virtually free relative to what we spent/invested to create it.

But we have also made the cost to live and work in the US exhorbitant by their standards, and because they can do what we used to do cheaper and can learn to do cheaper anything we can learn to do, they will always have that cost advantage, until their costs rise and ours fall.

[Ronzo]

I've been watching this idiotic debate about "real wages" for some time, but the statistic is MEANINGLESS. Why? There is no breakdown of who exactly is getting a wage "increase," even if it's .50 over 46 years. In other words, the statistic that would REALLY be interesting is the old stock market "gainer vs losers." Sarcasm's posts showing wages decreasing for those w/o a college education compared to those who do comes close, but doesn't quite hit the nail on the head.... (but better than a stupid "one size fits all" number like "real wage for EVERYONE...") We don't even have to know anything about statistics or graphs to know that NOT EVERYONE is experiencing a growth in real, imaginery, or even psuedo wages. As a matter of fact, many have experienced quite a drop in their own personal income as of late...even those with a college education...

If you want to see a really scary table from BLS, look at CES0500000001 (Total Private Employment) over a period from 1939 to 2004. That table simply shows the total number of people employed in the USA. No breakdowns, no nonsense. We see this nice little peak around 2001, then a nice drop-off that is still dropping...

I seriously doubt that we would see, if a chart were available, a mass exodus of people from the USA to other countries in that same time period, which would explain why fewer people are employed at this time than there were just a mere two years ago. As a matter of fact, I would wager their has been a net increase in the size of the population of people who are willing and able to work over that same two year period. So if total employment in the private sector has gone down, and the total population has increased, then what's really happening to wages and wealth???

If a person were making 50K a year as an employee of some business, then gets laid-off, his REAL wages go from 50K a year to zero overnight.

But let's say he finds a job where he now makes 20K a year...is that going to be reflected in the REAL WAGE statistics? No, because the point of reference is what ALL companies are paying ALL their EMPLOYEES. It doesnt' care if YOUR REAL WAGE took a 30K a year hit, nor is there any way to reflect that in those type of stats... (And it REALLY doesnt' care if YOUR REAL WAGE has gone down to zero...) On the other hand, if you were making a mere 20K last year, and now you're in a job making 50K, the stat's are unable to show that as well. The sword does cut both ways, but HUGE jumps in salary like that usually only happen to those just graduating from college. (Although I hear that really isn't the case anymore for many graduates)

Not only are there a LOT of people making a LOT less money that their were two years ago, amd there's a LOT of people making ZERO dollars that were at least making something two years ago. Unemployment and "real wage" statistics have no way of showing this, hence they are useless, except in government propaganda. Real wages have risen since 2000, but there are less people working, a LOT less people working than in 2000. More wealth in the hands of fewer people???

The bottom line: America NEEDS to create jobs HERE in AMERICA, not India, China, and the rest of the world. If we continue down this path of less & less jobs, (and the CES0500000001 chart is showing EXACTLY that...) then we are not, in fact, creating "wealth." We are exporting it.

Hopefully, those who are increasing in their personal wealth at this time will start spreading some of their good fortune within the friendly confines of the USA and then job growth and real wages will begin to rise. So far, that's not happening.

[Southack]

"because they can do what we used to do cheaper and can learn to do cheaper anything we can learn to do, they will always have that cost advantage"

That's a popular theory, but it doesn't explain why Nigeria isn't beating even China in the outsourcing world.

Nigerian labor rates, after all, can be as little as 10% of Chinese labor rates.

Hmmmm...methinks there is more to business than mere labor rates (see post #13).

[Nick Danger]

So the recent 33% drop in application to MIT's comp sci department is due to ... crazy lesbians?

What is your source for that statement? I ask because MIT does not have a computer science department per se, and applicants to MIT do not specify a major on their applications. Instead, they are first admitted to MIT and then, after the freshman year, may select any major.

[Southack]

"I've been watching this idiotic debate about "real wages" for some time, but the statistic is MEANINGLESS. Why? There is no breakdown of who exactly is getting a wage "increase"...

Ummmm, you do realize that we were debating the national American *average* wage, yes?!

HINT: you don't break down *average* wages.

[Texasforever]

You left out the most important. Quality and time to market. I am not talking IT here because most IT functions being outsourced are overhead functions and cheap labor is the driving force. Overhead jobs are gone for good and that is a good thing. If an American workforce is in the revenue stream of a corporation then the focus has to be on faster and better quality throughput than can be achieved in a foreign location.

[jpsb]

"China and India deliberately undervalue their currencies versus the U.S. Dollar in order to make their largest customer (that's us) able to buy more of their goods and services."

The purpose of Chinese trade policy is to strengthen the Chinese industrial base and technology base so that the PLA will be able to fight and beat US forces for control of the Pacific Rim.