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.

[Southack]

"Another tactic of failed argumentation is to change definitions, such as "wealthier" can mean a 50 cent/per hour real wage increase after 45 years."

That's just silly to say. What, did the average RAISE in U.S. wages make us poor?!
< /MOCKING! >

We were already rich. We got a 50 cent inflation-adjusted hourly raise over nearly half a century. Rich + raise = richer.

Sheesh...

[Southack]

"The statistic is still meaningless, especially since it's an "average."

Rubbish. The very point of contention was whether or not the *average* U.S. wage increased or decreased. The statistics show that such wages increased. That's hardly "meaningless" as you opine above.

[Nick Danger]

In the current academic year, 229 sophomores selected his department as their major, down from 282 in 2002 and 342 in 2001.

That trend has been seen in engineering schools across the board for years. It's not just computer science, they were actually among the last hit. Marine, naval, and ocean engineering... down 31%. Nuclear engineering, down 45%. Ceramic engineering, down 30%. Over that period, computer science was up 87%. Their day had to come. Other than Pakistan, who is outsourcing Nuclear Engineering? Are high tech ceramics the latest thing being designed in India? I don't think "outsourcing" is what's causing this; it's a general trend away from engineering.

The single biggest thing that correlates with choosing engineering is the amount of math and science taken in high school. People who do not do that tend not to go into engineering, as you might expect. The problem is starting there. The U.S. has slipped horribly in the international rankings as far as how our students do in math and science. Our best students are now middle-of-the-road compared to other countries. "...by Grade 12 U.S. math achievement was lower than 70% of the participating nations (Mullis et al., 1997)... it appears that the performance of American students relative to the countries participating in TIMSS declines as they progress through school." And yes, that is crazy feminists at work. There is no longer an "achievement gap" in math and science between boys and girls in the U.S. That was accomplished by lowering the achievement of both sexes until they were equal. Now we get to pay the piper for that.

[Southack]

"My statement, of course, was that real wages are lower today than they were in the mid 1970's."

Ha! You wish that's what you had said. That would let you cherry pick the data to compare the abnormal spike in average U.S. wages caused by the stagflation and high UNemployment of the 1970's (which impacts what the remaining employed average workers earn) to today.

But what you actually said was simply that U.S. wages were really declining, which is false.

Here's your post #20 to confirm:

To: Southack

All it means is that the world is awash in surplus labor - expect more offshoring to take advantage of the wage differential and a concomitant decline in American real wages. BTW, real wages are falling.

20 posted on 03/20/2004 4:04:14 PM CST by sarcasm (Tancredo 2004)

All it means is that the world is awash in surplus labor - expect more offshoring to take advantage of the wage differential and a concomitant decline in American real wages. BTW, real wages are falling.

[sarcasm]

I see that you are now admitting that there has been a decline in real wages since the 1970's. I also stand by my comment about wages being in decline right now - I simply do not believe that CPI reflects the cost of living since Clinton era changes in the way it is computed. I fully expect that you will now be defending Clinton and his regime.

BTW, you still haven't answered my question: please explain how we are so much "richer" when real wages are lower.

[Southack]

"BTW, you still haven't answered my question: please explain how we are so much "richer" when real wages are lower."

You seem to be having difficulty comprehending what your own Canadian study said (i.e. that U.S. average are still INCREASING, though at a slower pace) as well as having difficulty accepting the U.S. government study that I posted that shows that average U.S. wages have INCREASED even after inflation since the 1950's.

And yes, a wealthy people who get an INCREASE in their wages is a wealthier nation. I realize that's a difficult fact to comprehend, but I'm going to be spanking you with it for how ever many hundred more posts you wind up making on this thread (until we get into the inevitable "I'm bored" or "I don't have time" or other excuses that you will trot out when you finally decide to flee).

So get used to it. U.S. wages are up. We are now richer than we were half a century ago.

[sarcasm]

Spin, spin spin. Too bad that there isn't award for intellectual dishonesty around here - you would win hands down.

[Southack]

Rubbish. You are the one trying to claim that average U.S. wages are down even though no fewer than 3 different studies (including your own Canadian one) posted on this thread show our rates to have increased EVEN AFTER INFLATION!

Talk about projectionism. You are the spinMASTER!

[sarcasm]

They are also lower than they were in the 1970's - per the Bureau of Labor statistics.

[Nick Danger]

You are very naive if you think that corporations are passing on even half of the savings from foreign labor to the shareholders.

OK, I'm naive. Tell me how how higher earnings cause lower stock prices.

Like many free traitors, you

Argumentum ad hominem is not especially effective. Try something else.

you are concerned about consumers, not citizens.

Whereas you don't eat. And you're concerned about "workers." Workers of the world, unite! Where have I heard that before?

Our gigantic trade deficit with Communist China is evidence enough. They devalue the yuan 40%, use forced prison labor, have high tariffs, are dumping goods to drive many small to mid-sized American firms out of business, steal our technology, make their own versions of our products and will never buy much from American corporations.

What are they gonna do with all the dollars they are collecting? Eat them? Good. In that case, we will have taken their stuff and given them little pieces of green paper in return. If they ever want any value out of those little pieces of green paper, they are going to have to buy stuff with them. In the end, there's only one place to redeem dollars in real stuff.

For the first 200 years America engaged in protectionist policies, and these policies overall helped us grow enormously.

Yeah, and we've been going down the tubes every since those wonderful Smoot-Hawley tariffs were repealed.

I suspect that the fall of America is a goal of yours.

I was hoping you wouldn't go there again. If this is your style of argument, I have no use for it. I suppose I could suspect that you are a homosexual pedophile, but is that really helpful? Probably not.

[LibertyAndJusticeForAll]

That you refuse to acknowledge the danger of giving away vital technology to a Communist government is what a traitor would do.

Your suggesting that I am "homosexual pedaphile" has nothing to do with the argument or topic at hand. This is the kind of personal attack that liberals engage in when they refuse to follow logical arguments.

[Nick Danger]

In an effort to stop this nonsense, I went out and got time-series data for "average weekly earnings of production workers," and inflation rates. I combined those in a spreadsheet and out popped this:

It looks to me like there was a decline in real wages, and that most of it took place between the "oil shocks" of 1972 and the arrival of Ronald Reagan. It's been virtually flat since, but I wouldn't call that a Good Thing.

I think the fair thing to say is that real wages are headed back up again. Sarcasm says, "I simply do not believe that CPI reflects the cost of living since Clinton era changes in the way it is computed," but once we allow that, anybody can say, "Well, I don't believe that the average earnings are right either," or that "I say that the CPI was understating inflation in the 1960's." (There is probably a lot of truth in that, because the CPI does not include taxes, which rose very rapidly from 1957 until the Reagan tax cuts in 1981. By the same token, Bush's tax cuts would tend to make the CPI overstate inflation currently.)

In any case, if everybody gets to redefine the data on his say-so, then it makes no sense to discuss any of it.

[sarcasm]

Do you approve of the Clinton redefinition of the CPI?

[Starwind]

So get used to it. U.S. wages are up.

Clearly a false over-generalization which you keep repeating, and not your original claim in post #50 that "real wages in the U.S. have steadily increased even after inflation."

2004 real wages are up compared to '64-'68; down compared to '68-'80, and up again compared to '80 forward, but they never recovered to their pre-'73 oil shock levels.

Average hourly real wages 1964-2004:

the abnormal spike in average U.S. wages caused by the stagflation and high UNemployment of the 1970's (which impacts what the remaining employed average workers earn)

Clearly false. Real hourly wages (your preferred metric) were rising prior and upto the oil-shock of 1973, at which time unemployment (either the rate or level) rose. The 'abnormal spike' in wages as you call it was normal prosperity and preceded the unemployment spikes of '73 & '83, and consequently the wage increases upto '73 was not caused by the unemployment which actually followed later.

Unemployment Level 1964-2004:

Unemployment Rate 1964-2004:

We are now richer than we were half a century ago.

Not hardly. "Rich" people have large increased disposable incomes, and whatever they buy is paid with cash or their payments are a small portion of their disposable income.

The data shows that debt service takes an increasingly larger portion of disposable income, i.e., disposable income is not keeping pace with new debt obligations - debt is overtaking income - wealth is shrinking. Stock market equity losses estimated at $5-6T from 2000-2002, and bankrupt pension plan losses further exacerbate this decline in wealth.

We were already rich. We got a 50 cent inflation-adjusted hourly raise over nearly half a century. Rich + raise = richer.

As shown, you persist in a false over-generalization, wages were growing with the economy prior to '73 but never recovered to those levels since, nor are people richer, and a 50 cent/hour raise after 45 years doesn't change any of that.

[Nick Danger]

Your suggesting that I am "homosexual pedaphile" has nothing to do with the argument or topic at hand.

No, it has to do with your style of argumentation, which consists of calling people names instead of answering their points. That's exactly what you did here... again. If that's what passes for discussion on your planet, good for you.

[Starwind]

Nice work on your weekly earnings analysis.

(There is probably a lot of truth in that, because the CPI does not include taxes, which rose very rapidly from 1957 until the Reagan tax cuts in 1981. By the same token, Bush's tax cuts would tend to make the CPI overstate inflation currently.)

FYI, see the anchor comment in Pricing and Valuing Financial Assets - It's a great time to sell! for the BLS definition of CPI components. The article (and thread) offers additional descriptions.

[LibertyAndJusticeForAll]

Why would I bother having a discussion with anyone who refuses to acknowledge that we are giving away critical technologies, vital to our national defense, to a hostile communist government?

Every other so-called "free trade" proponent I have discussed this issue with for the past year here on FR has at least acknowledged that there are serious national security problems involved. Your lack of honesty on this point leads me to the conclusion I drew, that you are just a traitor.

You have no logical reason to call me a "homosexual pedophile" except that you cannot refute my logical conclusion that you must be a traitor and so have resorted to totally unrelated name-calling that makes no sense or logic whatsoever. Why should I discuss anything further with such an individual?

[Nick Danger]

Do you approve of the Clinton redefinition of the CPI?

1) I don't think it's relevant to the debate here. The rise in real wages, as adjusted by the CPI, started in 1996. But no changes were made to the CPI until 1999. So it cannot be that "Clinton's changes in the CPI" accounted for the rise in measured real wages that began in 1996.

2) The main change was 'geometric weighting,' which was not exactly Clinton's idea. This article talks about all the people who were screaming one way or the other about this. Basically it comes down to...

A nonpartisan panel headed by economist Michael Boskin of Stanford University issued a report in December, 1996, concluding the CPI overestimated inflation by 1.1% annually, an error that would cost the federal government about $1 trillion over the next 12 years. Most business groups strongly advocate CPI changes. But unions and elderly Americans are vigorously resisting a revised CPI calculation, arguing that they are victims of a political plot to help balance the budget on the backs of the old and the working class.

So this is one of those "angels on the head of a pin" arguments among economists, with political forces on either side trotting out whichever "experts" will say what they want said.

To label these changes as "Clinton's" as a way of denigrating them is more rhetorical than useful. There were plenty of people with excellent credentials saying that the changes were warranted.

3) I don't think it makes much difference. The CPI in the post-change world is but half a point away from where it would have been under the old scheme. My view of all these things is that if humans get within one percentage point of the truth, it's a miracle. Any slop that's less than a whole point is probably swamped by other effects that are inherent in human fallibility.

[sarcasm]

The rise in real wages, as adjusted by the CPI, started in 1996. But no changes were made to the CPI until 1999.

Wouldn't it also exaggerate any current increase in real wages? Would there be any increase in real wages in the past year if the CPI was computed under the old system?

[Ronzo]

The very point of contention was whether or not the *average* U.S. wage increased or decreased. The statistics show that such wages increased. That's hardly "meaningless" as you opine above.

Rubbish. The bone of contention is whether or not capitalists are behaving in the way Karl Marx predicted. You are using average wages to *prove* that Marx was an idiot. Well, Marx was an idiot but the average wage does not prove it, as a matter of fact, it is ammunition for the Marxists. Why so? Because the data shows very clearly that there has been only a *slight* positive change in the average wage over the course of 40+ years. But unlike the total employment graph, which has been steadily going up until 2001, the average wage graph tracks with inflation, which means, for all practical purposes that wages are stagnant.

So why does this help the Marxists? Because they have said all along that the capitalists are more than willing to pay a "subsistence wage" to their workers, but not much more than than that, ON AVERAGE. That's exactly what the data is showing.

They also said that the goal of capitalism is maximum profit with minimum employees. If people can be replaced by machines and technology, thereby lowering costs (and maximizing profits) for the capitalists, then they will do so, and in fact they have, many times over. However, we are now in a situation where employees are not being replaced with machines and technology, but by employees in other nations --non-capitalist communist and socialist nations at that... Our communist frieneds, like Red China, are doing what they can for their Democrat Party friends here in the USA to increase the distance between the "haves" and the "have nots" by eliminating the middle-class, thereby helping to foster that good, old class warefare that they've been longing for. Since it isn't coming about on it's own, they just want to lend us a helping hand. Generous, aren't they?

Marx also stated that it was very important for the capitalist to always have the unemployed "in reserve" to help keep those subsistence wages at subsistence levels. We now have a situtation where the economy is growing, and no new jobs are being created (at least not here in the USA...) However, the population of working adults keeps increasing over the same period of time, so even if job creation is stagnant, it still represents a bad situation because there are more people looking for the same amount of non-existant jobs.

Thanks to a whole bunch of things; techonology, unfair trade, and just blatant stupidity; there really isn't a limit to what can be outsourced to other countries. Hence, there's no real need to to employ people here in the USA, especially at their high cost, unless they can provide something the overseas firms can't. Over time, those things will become fewer and fewer, as in fact they have been.

So, wages here in the USA should go down right? No, because people won't work if they don't make a subsistence wage. Since the cost of living continues to increase, wages must continue to increase, even as fewer people are actually working. So instead of lowering wages, companies just "outsource" to save money and increase profits. It reduces the number of employees they have to take care of, and it increases profits, just as Marx predicted. The only thing is that he did not forese was how "outsourcing" would be able to advance his cause, nor could he have. This is especially ironic considering it's Marxist nations who are helping the capitalists dig themselves into their grave.

Once again, I think Marx was an idiot. But there are still a lot of people here on planet earth who think he was the greatest thing since sliced bread, and they haven't given up on him yet...

Nothing you have done disproves Marx's critique of capitalism, rather you are, in a strange and bizzare fashion, proving him right. None of the statistics you cite are meaningful in the regard of disproving Marx, hence my use of the term "meaningless."

As a matter of fact, the ecomonic conditions that now exist here in the USA are the best ammunition the Marxists have ever had in modern times.