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]

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).

You are again selectively reading the conclusion of the study. I dismiss the government propaganda.

[templar]

So. if I read the chart right (averages) then close to 1/2 of the wage earners are experiencing a decline in real dollars?

BTW, is the average a total average (all earnings divided by all earners) or a median average? I also notice it uses the CPI, which is not a cost of living (real inflation) indice. Basically, this chart just leaves me guessing about real wage increases or declines. Personally, I know as many people that have lost income over the last 10 years as have increased it.

[Nick Danger]

88% of all high-quality magnets used to make smart bombs are now made in Communist China. We no longer make these high-quality magnets at all

By "we" I presume you are referring to the Magnequench company of Valparaiso, Indiana. Under what Constitutional provision are you declaring public ownership of this company, and with it the right to tell the shareholders what they can and cannot do with their company? If it is public ownership of the means of production you are after, just say so. That way we can label you, correctly, as "socialist" and proceed apace.

I don't think you would really like the world you would create with this business of using political power to force private entities to bend to your will. It may not always be your will that gets forced.

Another specific example: Intel is building a $200 million dollar semiconductor plant in Communist China.

Are you proposing we stop them? Under what authority? Do you own Intel? If not, buy it and do what you want with it... or move to a socialist country where the government owns the industry and you get a vote. Advocating socialism here is not a good move. Americans have never really taken to the idea. Especially not after seeing how well it has "worked" everywhere it has been tried.

And no, I am not using "socialist" as an epithet. I am using it in its dictionary sense of "someone who advocates public ownership of the means of production." If you advocate using political force to make decisions on behalf of owners who are now to have no say in what is done with their property, then you are advocating socialism. You scare me more than the Chinese do. At least the Chinese are in China.

CEOs cannot hand it over to them fast enough

The class warfare hoo-hah adds another data point to the "socialist at work" hypothesis.

I do not mind you moaning and wringing your hands over this, because that might be the limit of what you can do. But if you're going to start building political support for socialism, or even "socialism lite," with the government telling Americans where they can and can't invest their money, all in the name of "the public good" as defined by you, you will not get me as an ally. Your way lies the "dictatorship of the proletariat," and I've seen how that movie ends. No thanks.

[Southack]

"Found this in the Economist"

So now you've cited a British graph of American wages that are supposedly "deflated by consumer prices" as well as a Canadian study.

And you've bashed my U.S. government study.

I'm seeing a pattern here from you. Do you have *any* American sources??

[sarcasm]

Do you have any American sources besides White House propaganda?

[Southack]

Salary Increases Fall For First Time In A Decade

Here's a question for you: If Salary increases "fall," have salaries still increased??

[sarcasm]

It doesn't give a breakout of the increases - not enough data for any conclusion to be drawn.

[Steve Eisenberg]

mi

The one in post 60 that broke out wages by education? It did show decline within educational categories, but Americans now have more education. The GED is so easy to get that most everyone who would have had less than high school education now has at least that. And large numbers now graduate from college who are in no way college material by older standards.

I am sure that free trade is good, but am not quite as sure on outsourcing. In as much as wages may have gone down in certain categories, I fear the real explanation would have been deterioration in how hard some Americans work, not anything international. Now, there are vast numbers engaged in non-productive work (lawsuits, for example, and keeping statistics for government regulations), and that stuff lowers everyone's wages.

[Southack]

"It doesn't give a breakout of the increases - not enough data for any conclusion to be drawn."

Hello! Is there anybody in there? Knock, knock, knock, knock.

That non-government link breaks out the salary increases as being in the 3.5 to 4% range, falling from earlier increases, but still increasing a full 1% faster than inflation.

Sheesh...

[MegaSilver]

Gotcha.

[MegaSilver]

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.

If I have to qualify for one of those, count me as the last.

I just don't see the point in allowing a nation like China to gain wealth.

[lelio]

but still increasing a full 1% faster than inflation.

Are taxes included in this salary wage increase?

[Southack]

"Are taxes included in this salary wage increase?"

Federal income taxes, thanks to GWB's two major income tax cuts, are now down to $45 per year for a family of four earning $40,000 annually.

That's less than $4 per month. How much do you think that $4 per month is going to change the *average* hourly wage for Americans?

[sarcasm]

Hello! Is there anybody in there? Knock, knock, knock, knock.

You're becoming arrogant again.

That non-government link breaks out the salary increases as being in the 3.5 to 4% range, falling from earlier increases, but still increasing a full 1% faster than inflation.

The Canadian study that you sometimes love and sometimes hate breaks down the increases based on education levels. Yours does not. Your "study" also does not indicate the number or nature of the businesses surveyed. Not enough data - please feel free to try again

[Hamza01]

This describes how the free trade theories of Ricardo (circa 1817) are now obsolete and destructive.

Perhaps not quite obselete. But getting there.

The central problem with applying Ricardo's free trade ideas in today's economy is that he assumes that certain factors of production are relatively immobile, specifically labor.

Post Internet, and the advent of large educated work forces in the 3rd world, that's just not true anymore. Labor has been commoditized and is now easily transferable across borders.

Free Trade is like any other widespread dogma, with all the usual divisions amongst its adherents. Some people cling to dogma for reasons of self-interest, others because of intellectual laziness and inertia, or as in this case-- blind quasi-religious faith.

Heck. The flat-earth theory worked fine for a while. Newtownian phsyics was once thought to be the final frontier. Then came Einstein and relativity. And even Einstein was uncomfortable with quantum physics.

Bottom line... people like to be comfortable in their delusions. That's the history of man.

[sarcasm]

Federal income taxes, thanks to GWB's two major income tax cuts, are now down to $45 per year for a family of four earning $40,000 annually.

You're neglecting the minor detail of state and local taxes. Please don't give us the bilge about property taxes in rural Alabama.

[Southack]

"I just don't see the point in allowing a nation like China to gain wealth."

One of the links that I posted early on to this thread shows that average wages in China have DECLINED for the past three years in a row. Chinese banks are technically insolvent, and more than half of all Chinese (government-owned) factories lose money each year.

The *myth* about China is that their low wages give them a competitive advantage, however.

The *reality* is that China is globally competitive only because they brutally punish their own citizens with a near worthless (officially) currency.

By undervaluing the Yuan versus the U.S. Dollar, China in effect props up the foreign exchange value of the Dollar. That "propped up" Dollar allows Americans to purchase far more Chinese goods and services than would otherwise be profitable to us here.

In other words, the Chinese government is subsidizing American consumer purchases at the expense of their own people (oil costs far more for them to import because of this, for instance).

And Americans are intuitively taking advantage of these deep discounts.

Whether that transfers net wealth to China or not is therefor somewhat debatable.

[junta]

Dell customer service IMHO sucks much rotten curry.

[Southack]

"The Canadian study that you sometimes love and sometimes hate breaks down the increases based on education levels."

Yes, but what your Canadian study doesn't point out is that more Americans obtain more education each year...making data on the educational level wages of 1960 meaningless compared to 2000 simply because so many more Americans fit into the "college" catagory now than back then.

Your Canadian study also uses a non-standard CPI calculation to adjust their wage data, and even then they conclude that American wages increased (albeit at a slower pace).

[lelio]

Federal income taxes, thanks to GWB's two major income tax cuts, are now down to $45 per year for a family of four earning $40,000 annually.

What about state, local, property, and sales taxes? Oddly those have gone up.