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 to go after the argument instead of the author?

It was a touch of, ummm, sarcasm.

[navyblue]

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.

Thank you for making that point. And of course, real wages are the only wages that matter.

[A. Pole]

Durn, I'm not a subscriber to WSJ. I was hoping they'd explain how Europe and Japan can outsource to us and do Okay but our corporations have to outsource to "developing nations'" cheap labor to survive. I real mystery to me. Durn.

There is no mystery. Follow the money - WSJ represents the interests of those who profit from out-sourcing. I would not put much value in WSJ assertions in those matters. But I grant that they have excellent spin doctors and they know on which side their bread is buttered.

Sooner you will get Osama to confess Jesus Christ then them to repent.

[edsheppa]

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

Yeah, him and Stockman. A couple of dopes if ever there were. As bad as O'Neill. Just goes to show how hard it is to pick good help. Thank God for Volcker and Greenspan.

[sarcasm]

You have yet to state your objections to what he wrote - are you incapable of doing so?

[EGPWS]

Economists are blind to the loss of American industries and occupations because they believe these results reflect the beneficial workings of free trade.

So who is it we should turn to as an alternative for infinite wisdom on the economy Mr. Roberts?

[sarcasm]

Perhaps the CIA?

[EGPWS]

Perhaps the CIA?

Perhaps, however the idea of dependency has been a topic of political rhetoric for decades and as long as we use the CIA and our other assets born out out of a free business society we will always be the entity that is enticing for others to be grasping for when it comes to improvement.

In other words, we have to offer what others don't have.

[sarcasm]

In other words, we have to offer what others don't have.

For the present - I'm not convinced that will be the case in the near future.

[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."

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

Average American Wages Increased After Inflation From 1959 Through 2002

[Southack]

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?"

You've missed the point, and no, it isn't true for several countries such as Cuba, North Korea, Zimbabwe, and Haiti, for instance which have all seen their overall infrastructure and standard of living decline over the last few decades.

[EGPWS]

For the present - I'm not convinced that will be the case in the near future.

There has been many in the last century who have taken your stance and have been proved wrong, so this being the case, our way of doing business has shown to be optimal in reference to other ways that have been promoted.

We are now the only standing "super power" left in the world, and obviously because of our standing we have performed properly however there are many who would give input as to the way we have achieved such a status.

IMHO, it's splitting hairs and that, my friend, can lead to whining...let alone terrorist attacks.

[sarcasm]

No, real wages in the U.S. have steadily increased even after inflation.

Using the Clinton Administration new and improved CPI calculation? The calculation which was manufactured in order to reduce the Social Security COLA?

[Tuco Ramirez]

The worst aspect of outsourcing, which is rarely addressed, is the fact as more US companies employ people in other countries, US troops will certainly be used to ensure that work flows uninterrupted.

If Microsoft had thousands of workers in Cuba in 1959 as a cost-cutting measure, Castro wouldn't have been in power for a week...

[Southack]

"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."

The U.S. produces more food than anyone else, not that you were actually referring to farming above. As for industry, in 1984 the U.S. was making 22% of every product made in the world. By 2004 that had risen to 30%.

What has happened is that companies have re-engineered themselves to take advantage of technology. Ten years ago General Motors, for instance, made 8 Million cars per year with slightly more than 500,000 employees. Today GM makes slightly more than 8 Million cars per year in the U.S. with only 180,000 employees and contractors. And wages for those 180,000 employees are up, too. They can afford to be up, after all.

[sarcasm]

There has been many in the last century who have taken your stance and have been proved wrong, so this being the case, our way of doing business has shown to be optimal in reference to other ways that have been promoted.

We haven't been doing business in the current fashion until recently.

[Luis Gonzalez]

You guys rock.

[Southack]

"Using the Clinton Administration new and improved CPI calculation? The calculation which was manufactured in order to reduce the Social Security COLA?"

The Clinton Calculation erred on your side by lowering present wages (to reduce the visible appearance of inflation for the current budget) and therefor OVERSTATED past wages from decades ago.

That I can show that U.S. wages increased steadily from 1959 through 2002 using government figures and the Clinton Calculation simply means that using older math would show even larger gains for U.S. wage earners.

...Also, arguing over data that one poster has gone to the trouble to link, without posting your own data that might contradict it and therefor form a legitimate point of debate...is bad form.

[Southack]

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

No, our wages are rising even AFTER inflation. See the link that I posted in message number 50.

...And anyone who claims that we are progressively impoverishing ourselves is also someone who has just paraphrased Marx's sum total point of his entire Das Capital book...a book that has been roundly refuted for Centuries both by Adam Smith's On Wealth of Nations as well as by the obviously increasing standards of living in capitalist nations.

Furthermore, anyone who doubts that Americans are financially impoverished today compared with those having no running water, electricity, or air conditioning back in 1920 is someone who has no real grasp on the world.

I'd suggest prompt treatment for Alzhiemer's for the old boy.

[sarcasm]

Real Hourly Wages, By Education* Level, All Workers 18-64, 1973-97
(1997 Dollars)

Year	Less Than High School	High School	Some College	College	College Plus	College/  High School
1973	11.22	12.82	14.16	18.60	22.66	1.45
1979	11.15	12.49	13.61	17.43	21.42	1.40
1989	9.38	11.36	13.20	17.88	23.24	1.57
1990
1991
1992	8.86	11.07	12.52	18.04	23.03	1.63
1993	8.72	11.02	12.47	17.97	23.22	1.63
1994	8.52	11.10	12.36	18.14	24.17	1.63
1995	8.25	10.90	12.20	18.13	23.90	1.66
1996	8.21	10.84	12.18	17.86	23.80	1.65
1997	8.22	11.02	12.43	18.38	24.07	1.67
Annualized Percent Change
1973-79	-0.1	-0.4	-0.7	-1.0	-0.9
1979-89	-1.6	-0.9	-0.3	0.3	0.9
1989-97	-1.5	-0.4	-0.7	0.3	0.4

*Education levels from 1992-1997 are estimates designed to be consistent with pre-1992 educational coding.

Source: Authors' analysis of CPS ORG data; inflation-adjusted using CPI-U-X1.  

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