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.

[edsheppa]

For comparative advantage to work, a country's labor, capital, and technology must not move offshore.

This fellow must have got his econ degree in a box of Cracker Jack.

[Batrachian]

Do you think America became an economic powerhouse by farming out all of our industry to other countries? I assure you that's not how it happened.

[Mel Gibson]

Our wages are not rising. Paul Craig Roberts is a Reagan era supply side economist and not a Marxist (ad hominem attacks).

[WilliamofCarmichael]

RE: "How many jobs do we Americans enjoy now due to foreign "outsourcing" to the US? 6.4 million of us work for foreign automakers. . . ."

How do they do it when many free traders say our guys have to offshore to "developing countires'" cheaper labor and fewer government obstacles to stay in business. I am not being facetious I really would like to know.

[Nick Danger]

I wouldn't agree that someone who's leery of letting our capital leak out to a country run by a crazed Communist Party is a communist.

Anyone who thinks that privately-owned capital is "ours" is a communist, or a socialist, or someone who has not really thought through what he just said.

[LibLieSlayer]

"How do they do it when many free traders say our guys have to offshore to "developing countries'" cheaper labor and fewer government obstacles to stay in business. I am not being facetious I really would like to know".

Pardon my redundancy:

"This is directly due to productivity levels of the US worker (in comparison to their domestic force), coupled with savings from the elimination of shipping product via sea-lanes". (Build it here, sell it here).

Here is an example as far as tech-outsourcing i.e. Dell Computer. Lets say Dell pays $17.50 and hour to "customer service reps", plus health benefits, FICA, Workman's Comp etc...$17.50 a day for a worker in Bombay (doing the same job, trouble-shooting using a tech manual) looks enticing. No retirement plan, no health care costs, and far less government red tape.

Building electronics, assembling automobiles, and other "skilled" positions are better filled workers of the quality of those in the US work force.

BTW, a friend of mine works in marketing for Dell. He said that Dell is reconsidering its outsourcing due to complaints both in principle, and in service.



LLS

[lelio]

care to compare the U.S. living conditions in 1920 with half of our country not even having running water or electricity to today, for example

Isn't that true for any country?

[WFTR]

First, it should be noted that economists don't really produce anything. Economists are mostly college professors who spin theories and bore students.

Secondly, the winning country in almost every major war in the past 150 years has been the country with the greater industrial strength. Keeping production in the United States is a matter of national security.

Thirdly, we should be concerned when productivity moves to other nations. People can say that other jobs will replace those that are lost, but we need to question whether those jobs are really productive. Shuffling paper for a bureaucracy may be a job, but often bureaucracies are just a means of bleeding the productivity from companies that are actually making something. If the companies that are actually making things eventually disappear completely, there won't be any productivity for the bureaucracies to bleed. Then both the bureaucrats and the workers will be without means of financial support.

Fourth, I think things will get better only after we begin outsourcing lawyers, bureaucrats, and TV personalities. I vote that this process begin at FOX News with Fred Barnes. He's just not that appealing, and his commentary could be just as easily outsourced to some guy sitting in India and reading into a TV camera. They could put a screen in Fred's chair and get the same quality of commentary at a much lower cost.

Ready for a Repeat
Bill

[dennisw]

Paul Craig Roberts must be a communist.........


I saw him on Lou Dobbs and he was great. A great American telling the truth while bought and paid for economists and free trade cultists are busy drinking their PURPLE KOOLAID

[WilliamofCarmichael]

I was remiss in not stating my inquiry was more general than just Indian call center and IT jobs. To wit, China gets many of our electronics and other manufacturing jobs.

What you say about the American worker is absolutely true.

BTW, the "productivity levels of the US worker" and "the quality of those in the US work force" extend to IT, engineering, and back office jobs as well. And that is not just my opinion.

Still though even manufacturing jobs -- offshored here or not -- have costs that you mentioned and for government red tape. If it's still cheaper for Japanese and European folks then that makes sense.

"Cheap labor" is relative and our guys are sending jobs chasing after "cheap labor" in India and China and elsewhere. I just hate it when they call it "free" trade for the reasons Mr. Roberts listed.

Thanks for your reply and I do not wish to appear contentious but there is something I'm missing if it's not just "cheap labor."

[1rudeboy]

BTW, real wages are falling.

Sure they are. And the Earth is warming.

[Charles H. (The_r0nin)]

Do you think America became an economic powerhouse by farming out all of our industry to other countries? I assure you that's not how it happened.

Please describe the manufacturing capabilities of the United States during the first one hundred years of its existence in comparison to those of Britain, etc.

The US shipped its raw goods across the Atlantic to be processed into salable goods long after the Revolutionary War, and up until the Civil War (when the North imposed high import duties to try and force Southern raw materials to be shipped North instead of overseas). So what you claim was not how it happened is exactly how it happened. That's how emerging markets mature...

[LibLieSlayer]

Thanks for your reply and I do not wish to appear contentious but there is something I'm missing if it's not just "cheap labor"."

You are welcome. I enjoyed your post. The one thing I think that you overlooked is the prime motivator of Capitalism.....increased profits, followed by higher stock yields, increased net worth, higher market share/ratings, and a stronger position with which to raise capital for expansion or acquisition.

Thanks for the chat!

LLS

[Batrachian]

America wasn't an economic powerhouse in the first hundred years of it's existence. It only became so after the industrial revolution, and it became so by building factories.

[sarcasm]

There you go again.

[sarcasm]

This fellow must have got his econ degree in a box of Cracker Jack.

I'm sure that's why Reagan hired him.

[sarcasm]

A great American telling the truth while bought and paid for economists and free trade cultists are busy drinking their PURPLE KOOLAID

I'm waiting for someone to call him a socialist.

[1rudeboy]

C'mon, post that Canadian study. Or have you found another one yet?

[navyblue]

Paul Craig Roberts must be a communist. Little Ad Hominem there Sarcasm?

Why don't to go after the argument instead of the author?

[sarcasm]

Are you denying that real wages are lower now than they were in 1975?