Outsourcing and the Global Optimum

The last week has seen the ‘great US ousourcing debate’ hit both new highs, and new lows. On the plus side would be the declarations of the oft maligned Greg Mankiw to the effect that the “outsourcing” of jobs is beneficial to the United States economy (even with the qualification ‘perhaps’ this has merit – since despite the fact that the suggestion may not be as well-founded as Mankiw imagines, it is at least courageous in a situation where the President he is advising doesn’t appear any too clear on the question himself). Among the more evident examples of the low points would be the statement from the Democratic Presidential aspirant John Kerry to the effect that company leaders who promote business process outsourcing are ‘Benedict Arnold CEO’s’.

Benedict Arnold, for those of us not steeped in US folklore was, well, a very different kind of American military leader:

a military hero for both sides in the same war………..Arnold served the Patriot side with distinction in one battle after another, including a dangerous assault against the center of the British line at Saratoga, where he was again wounded in the leg. No general was more imaginative than Arnold, no field officer more daring, no soldier more courageous………… Yet Arnold has gone down in history not as a hero but as a villain, a military traitor who, as commander of the American fort at West Point, New York, in 1780, schemed to hand it over to the British.

Of his role in this conspiracy there is no doubt………….Why did Arnold desert the cause for which he had fought so gallantly and twice been wounded? Was there any justification for his conduct?

Now of course the target Kerry has been keeping his powder dry for here is a very specific one: the US Multinational Corporation. The MNC is itself an entity which like Arnold, may be thought through its tenacity and imagination to have ably served its country of origin in one moment, only to be seen as conniving treacherously to bring about its demise in another.

Now this judgement of Arnold may be merited or otherwise, and I for one would not deign to offer an opinion. What may be more to the point would be whether his purported modern equivalent, the corporate CEO, is deserving of such comparison.

Clearly Jagdish Bhagwati thinks he (or she) isn’t, and it might be that this rather more considered opinion offers a better starting point for approaching the problem. According to Bhagwati:

“Senator Kerry is wrong on two counts. First, his economics is faulty: the practice only adds to the overall economic pie and improves the competitiveness of American companies. In a world economy, firms that forgo cheaper supplies of services are doomed to lose markets, and hence production. And companies that die out, of course, do not employ people.”

Now as an economist who knows more or less what he is talking about, Bhagwati is obviously right over Kerry. But we might like to note that the point that he is making is interesting in its choice of wording: the practice of outsourcing jobs is beneficial to American companies, and those firms who in a world economy don’t avail themselves of the cheapest sources of supply and most efficient systems are doomed to die out. But maybe this wasn’t Kerry’s point, maybe Kerry’s point is that for once, US corporations, acting in the interests of their own survival, may make for a globally more efficient and equitable market, but the impact of this activity on the US economy itself may not be quite the one which was anticipated.

In other words as economist qua economist what Bhagwati is saying makes perfect sense, this will produce a better global product, and a more efficient distribution of resources (after all putting all those third world brains to better use can hardly be described as a bad thing economically).

To understand where the problem might lie in all this reasoning, let’s try and think about an internal US distribution question, a drift of IT jobs say, out of Silicon Valley and into Washington and New York (An IEE paper by Jack Kiekegaard talks about precisely this process). This job drift may well be good for the US as a whole, it is certainly good for Washington and New York: but is it good for Silicon Valley? Well it depends, it depends of the quality of the response. It is an open, empirical question.

Big dislocations are evident between states, and big changes are occurring within states. While Ohio lost 20,000 jobs in sales and related occupations between 2000 and 2002, Texas gained 41,000. On the other hand, Texas lost 55,000 jobs in management occupations, while other states gained a limited number of managerial positions. California was the largest job loser in computer and mathematical occupations and legal occupations but the largest job gainer in business and financial operations occupations and arts, design, entertainment, sports, and media occupations. Are computer and mathematical occupations going offshore? Not so in New Jersey, which added nearly 10,000 such jobs in 2000?02, but definitely so, if you?re from California, which lost 44,000 of these positions.

Now transfer this point from jobs moving out of state to jobs migrating out of the US and into the global arena: the answer again will be: it depends. It depends on the nature of the internal response inside the US, and on the technological constraints on the possibilities of job creation. It depends, in other words, on what technological innovations lie waiting just round the corner. The ones we can’t quite see right now.

Are there grounds for thinking the US economy will find a solution, of course there are. But are there also grounds for thinking that this time things are different, well this too. We have never had such globally equal competition up towards the top end of the value chain.

The second, newer type of outsourcing involves American companies that do highly skilled research and development work abroad. Craig Barrett, chief executive of Intel, has said that American workers face the prospect of 300 million well-educated people in India, China and Russia who can “do effectively any job that can be done in the United States.” But such concerns seem exaggerated. There is little evidence of a major push by American companies to set up research operations in the developing world. I have taught hundreds of fine foreign students in the last few years, but only a small fraction are at the level of proficiency that Intel looks for in its research programs. And a cursory look at American immigration shows that the best students in high-tech fields come from just a handful of world-class institutions in those countries.

Here we move from the realm of analysis to that of opinion. The opinion of Craig Barrett appears exaggerated: perhaps. But Bhagwati himself hardly seems convincing. Those near to the cutting edge seem to be taking a different view. Nandan Nilekani, chief executive of Infosys Technologies, an Indian outsourcing company, declared, for example, at the World Economic Forum last month that “Everything you can send down a wire is up for grabs.” That everything seems to include quite a lot.

What we are talking about here is not a small number of elite scientists, but large numbers of highly educated people. Put it this way, it may be that the US education system still produces a top 1% which is above and beyond what any other country can produce, but if we back downstream to the next 20% the situation doesn’t seem to be so unequal, and it is here that the competition for work may be most intense.

There is another side detail here worthy of comment. Bhagwati has himself in the past drawn attention to the way the research levels of the US university, and the research departments of the top US global companies have benefited from a steady supply of the best brains on the planet. This supply may well now reduce significantly, as the prospects of lucrative work nearer home make the migration appear to be less attractive.

The fact is, when jobs disappear in America it is usually because technical change has destroyed them, not because they have gone anywhere. In the end, Americans’ increasing dependence on an ever-widening array of technology will create a flood of high-paying jobs requiring hands-on technicians, not disembodied voices from the other side of the world

I think this is an oversimplification. Jobs do in fact migrate: they migrate economically. I think denying this is silly. What is technologically redundant is itself an economic question. Cheap able labour pools in some parts of the world may well alter the global pace of technological change for a significant time. A job which is now economically difficult to justify in a comparatively prosperous Spain, may well relocate to Morocco. I don’t see the problem.

To say jobs don’t move just flies in the face of history and reality. Just look at the Uk and its history for a moment. Pre WWI something over 80% of the world’s ships were built there, after 1918 the percentage and the numbers employed simply went down and down. But this didn’t mean that ships had become technologically redundant, just that the UK could no longer compete, and certainly not with the rising young star: the United States.

The rise of the US changed many things for the UK, and arguably the UK economy spent from 1920 to 1990 adjusting to the change. But does anyone really want to seriously argue that the world as a whole isn’t better off despite the UK’s ‘relative’ demise.

So the bottom line in all this is that we are moving to a better global optimum, in terms of the use of resources and the distribution of the global product. Economic theory should tell us this. What economic theory won’t tell us is whether any particular region or nation will find itself worse or better off in the process, this is a purely contingent historical question.

I mean if nuclear fushion were just around the corner, or the fuel cell car, this would certainly ease energy constraints and make growth easier (just look at the rumpus the OPEC output reduction is causing this week). It may also provide a rationale for all that extra education which is being recommended as the global solution.

One key question here would be: are there ‘waves of innovation’? If there are, then whether we have another spurt or a contraction in growth rates may in part depend on whether we have another wave just over the horizon. Is the ICT/web browser fusion simply a one off from which most of the benefit has already been extracted, or at we only at the begining?This is what I mean by a contingent question, and this is something which it is difficult to know in advance whatever reading the stock markets may give.

The pharmaceutical industry is a case in point here. The last decade has been pretty much a failure in terms of path-breaking innovation, a lot of high cost research, but little to show in the way of really high cash-in value intellectual property. But maybe there is a big ‘breakthrough’ just looming out there. If there were this would change a lot of things.

Of course the big, big question would still be whether the ‘breakthrough’ comes from a core US or European team, or a group of researchers outsourced in China or India or, why not, elsewhere.

So our job as economists is not to deny the possibility of any given eventuality, but to explain why dramatic changes can and at times will happen, why believing in competition and market solutions isn’t simply a matter of convenience (when your part of the globe seems to be winning out), and why there is no ‘god given’ right to be up at the top: if you want to stay there then you need to earn by your own creativity and initiative the right to do so.

16 thoughts on “Outsourcing and the Global Optimum

  1. Like it or not, outsourcing will be verging on impossible to control short of introducing draconian restrictions on ebusiness with repercussions for the present WTO rules-based framework for international trade. The potential downstream consequences are unforeseeable. Unilateralism has its limitations in a world where business is driven by the perspectives of globalisation and where loan facilities, software and information can be traded online.

    An instructive lesson can be drawn from an experience of the early 1990s. At the tail end of the previous Bush administration in late 1991, the US imposed steep, supposedly anti-dumping duties on American imports of flat-screens for the local assembly of the rather chunky notebook computers of those times. Presumably, the intended rationale for the duties was to promote manufacture of flat screens in America of which there was verging on none. After all, Caspar Weinberger, Reagan’s Defense Secretary, had launched SEMATECH in 1987 with support from federal funding.

    SEMATECH was a rather traditional programme of national industrial policy intended to promote collaborative industrial research among American companies so as to revive the business prospects of American companies engaged in designing and making the equipment to make semiconductors – and the flat screens for computers and TVs are realy one huge semiconductor. The declared ostensible purpose of the programme was to protect American strategic interests in frontier technologies with defense applications, which is why the policy initiative came from the US Department of Defense and not the Department of Commerce. However, retrospective evaluations of the effectiveness of SEMATECH have been mixed – see: Scott Callon: Divided Sun; Stanford UP (1995) and Richard Lester: The Productive Edge; Norton (1998).

    One early action of the incoming Clinton administration in 1993 was to rescind the anti-dumping duties on imports of flat screens. An unforeseen and unintended consequence of the duties had been that local assembly of notebook computers moved off-shore to relocate in Asian countries with local manufacture of flat screens or few, if any, trade restrictions on their import, thereby losing moderately skilled assembly-line jobs in America.

    Curious that Republican administrations in America have aplied very traditional national strategic trade and industrial policies but then as Jeffrey Frankel of KSG has remarked, the political parties have switched places, with Democrats becoming the party of fiscal responsibility, free trade, competitive markets, and minimal government, while the Republicans have become the party of trade restriction, big government, and interventionist economics: http://ksghome.harvard.edu/~.jfrankel.academic.ksg/Republicans%20and%20Democrats%20Have%20Switched.PDF

  2. Good points Bob, on two counts. Really, I think digital products are going to present a much more diificult target for any kind of protectionism.

    Secondly, yes, this tendency towards Republican protectionism is noteworthy. India’s Arun Jaitley is taking Zoellick to task for this right now:

    “Prospects for the Doha world trade round risk being set back by a proposal in the US Senate to ban outsourcing to developing countries of some types of federal government work, India warned the US on Monday.

    Arun Jaitley, India’s commerce minister, said he supported a recent US call for resumption of the round, but the Senate bill could make it difficult for New Delhi to sell free trade to the Indian electorate.

    For the WTO talks as a whole, an adverse environment has been created in this country since an erstwhile open market is now being closed,” Mr Jaitley said after meeting Robert Zoellick, the US trade representative.

    But Mr Zoellick defended the proposed Senate legislation – even though he had assured India a year ago that he would oppose federal government moves to adopt similar measures tabled by several US state legislatures.

    Financial Times
    http://news.ft.com/servlet/ContentServer?pagename=FT.com/StoryFT/FullStory&c=StoryFT&cid=1075982580282

  3. I agree that American complaining (and especially both Republicans complaining and tech workers complaining) about jobs moving abroad is more than a bit hypocritical. Unfortunately the history of free trade has always been one of fair-weather friends. Free trade is something supported when it is politically convenient, and makes an easy target as soon as the economy turns south because there’s always pressure to do something and foreigners don’t vote. It was that way already in the 1870′s.

    Good jobs go to India. I’m okay with that. My job disappears. That poses real problems for people unless someone can clearly explain to them how they, in the time frame that they have to pay their bills in, will gain from it.

  4. Scott: “My job disappears. That poses real problems for people unless someone can clearly explain to them how they, in the time frame that they have to pay their bills in, will gain from it.”

    Free traders among economists have long understood that they appear complacent or hard-hearted when confronted with the realities of what free trading threatens to bring in its wake. But look at it this way:

    Britain’s first population census was in 1801. Suppose that some demographer of genius had then predicted correctly that over the next hundred years Britain’s population would treble, as it did. Indeed, the populations of some cities doubled and more over the next 50 years. The obvious question is then where will all the extra jobs come from to provide a living for all those extra folk?

    Who could have said? In 1801 there were no railways, steam ships made of iron or steel, not much of a chemicals industry to speak of and certainly no gas or electricity piped to homes or factories, let alone telecommunications, plastics, cars, or bulk production of pharmaceuticals that were actually effective. All that was to come.

    The next thing to be said is that as with the real example above of steep anti-dumping duties on flat screens for notebook computers introduced in late 1991, the effect of bringing in trade restrictions is often to destroy jobs in downstream industries. All the studies I’ve come across of the costs of maintaining jobs by trade restrictions or subsidies show the costs per job saved, which fall on buyers or taxpayers collectively, to be extraordinarily high. Britain has a long track record of recording opposition to a long series of anti-dumping restrictions and trade protection measures introduced by the EU – usually ineffectively as Britain just gets out-voted. With the Common Agricultural Policy, every cow in the EU attracts a subsidy of $2 a day. The outcome is that Britain has a current unemployment rate of 4.9% as compared with 8.8% in the Eurozone – figures from the stats annex in The Economist.

    The best safeguard against staying jobless is to have a good range of adaptable skills or else highly specific skills in almost permanently scarce supply. From many accounts and personal experience, it is very difficult to get skilled plumbers anywhere in Britain. There’s a continuing demand for good computer related skills – heaven knows, successive British governments have wasted literally Billions on failed computer projects, for the best of all possible reasons, naturally.

  5. “The best safeguard against staying jobless is to have a good range of adaptable skills…..”

    Or maybe Bob the best safeguard against staying jobless is to drop your price a bit, or have your government do it by letting your currency fall.

    Now here in Europe……….oops!!

    Incidentally in this environment of an excess of emminentally educated cheap global minds, education may not be the breadspinner it once was, now plumbing…………

  6. “Britain’s first population census was in 1801. Suppose that some demographer of genius had then predicted correctly that over the next hundred years Britain’s population would treble, as it did. Indeed, the populations of some cities doubled and more over the next 50 years. The obvious question is then where will all the extra jobs come from to provide a living for all those extra folk?”

    Would this be the same England that was deporting to Australia for the most trivial infractions ? Or was that to come a bit later ?

  7. Patrick,

    “Would this be the same England that was deporting to Australia for the most trivial infractions ? Or was that to come a bit later ?”

    1787 to 1853, if I am not mistaken. But the total number transported amounted to 123,000 males and 25,000 females over that whole period, or an insignificant drop in the bucket as compared to the level and natural rate of population growth on the home islands. A moot point, in other words.

    Bernard Guerrero

  8. Bob,

    “but then as Jeffrey Frankel of KSG has remarked, the political parties have switched places, with Democrats becoming the party of fiscal responsibility, free trade, competitive markets, and minimal government, while the Republicans have become the party of trade restriction, big government, and interventionist economics”

    This is a shallow understanding of the situation, as I see it. The fact is that, based on rhetoric, one would have to conclude that both parties are drifting towards protectionism, larger government and massive spending. A race to the bottom, as both sides compete to out-pander each other. Mankiw speaks the truth concerning the aggregate effects of trade, and it’s a contest to see whether the Democratic contestants or his own President can repudiate him first. Etc, etc.

    Bernard Guerrero

  9. I’d suggest that the question of “outsourcing” needs clarification. The private use of IT service companies outside the US isn’t “exporting” US jobs, and although D.C. has the legal authority to regulate it if the customer is in the States, they’ve generally stayed away from doing so (there’s been call centers in Ireland for a decade).

    This is a completely different animal from India’s claim that it’s companies should be able to bid for US State and Federal government outsourcing contracts as a matter of “free trade”. The State and Federal government’s have legal obligations to ensure labor standards and civil protections are practiced by private contractors working for them, and there’s no possible way this would happen if State or Federal services were undertaken in another Nations legal jourisdiction. If it were a matter between US States, there wouldn’t be a fight in the Senate. But the obligation the State and Federal governments have to ensure Contractors adhere to US legal standards takes priority over a desire to cut costs. (It’s also a bit of amazing cheek from India, which has one of the most closed economies in the universe).

  10. Bernard,
    I’ll cede the point abut forced deportations if you cede that Emigration was occuring on a massive scale in 19th century Britain.

    From my cursory search
    In 1824 the law prohibiting emigration of workmen was repealed. Between 1830 and 1839 about 668,000 emigrated and this rose to about 1,495,000 between 1840 and 1849. See also Irish Potato Famine below.
    and
    Between 1815 and 1914 about 16.4 million emigrated from Britain. About 11 million went to the USA, 2.55 million to Canada, 2 million to Australia and New Zealand, and 850,000 to South Africa. Of these 16.4 million about 4 million were from Ireland. (See Irish Potato Famine of 1840s)

    This doesn’t seem particularly indicative of a balanced economy that organically grew to meet the demands of a growing population.

  11. “But the obligation the State and Federal governments have to ensure Contractors adhere to US legal standards takes priority over a desire to cut costs.”

    Believe me, most governments are subject to lobbies urging that government procurement should be restricted to national suppliers on grounds of “national interest” or “national security”. With Britain being an island and the hazards to sea transport in times of war, I’ve even seen it claimed that the sourcing of underwear amounts to a vital national interest. Protectionist lobbies are seldom inhibited by lack of inventive faculties for devising imaginative rationales for trade restrictions.

    If successful, the pay-offs are that a few gain a lot at a small cost each to many. From time to time, I’ve suggested the urgent need for an Act of Parliament requiring every adult in Britain, of which there are some 44 million, to each pay me just one penny a year. That’s all – a penny a year each. Unfortunately for me, the government and public at large remain unconvinced of the obvious merits of my helpful suggestion.

  12. Patrick,

    “I’ll cede the point about forced deportations if you cede that Emigration was occuring on a massive scale in 19th century Britain.”

    Fair enough. The key question then becomes, though, just what the rate of growth looked like as compared to the rate of emigration and the rate of unemployment. It’s worth looking at, but I won’t be able to get figures until tomorrow. It’s 9PM and I gotta get home for dinner. If you’ve got the time-series handy, please feel free to beat me to the punch.

    Bernard

  13. Scott,

    “Good jobs go to India. I’m okay with that. My job disappears. That poses real problems for people unless someone can clearly explain to them how they, in the time frame that they have to pay their bills in, will gain from it.”

    Short-term answer is, many of the bills they have to pay (the kids’ sneakers, the replacement for the busted VCR) will fall, so even a lower-paying job may leave them with the same standard of living in PPP terms (if not in self-respect terms, but the heck with psychobabble, eh?) Outcomes will vary, of course.

    More deeply, in the short-term I don’t _have_ to explain it to them. I just have to calculate if the majority who will retain their jobs (and most do) will in aggregate gain more in utility terms than the minority who get canned lose. You can’t deny that the shift will produce better _aggregate_ results, but there will almost certainly be winners and losers even under strongly redistributionist schemes. All that really matters is the utility math, and how it translates into electoral math.

    In the medium-to-long-term, of course, everybody has the potential for gain out of the situation. The short-term winners will do _something_ with their gains, after all. Buy more goods & services, save more and drive down interest rates, etc. The short-term losers may still win after having repositioned themselves. Or their kids, naturally enough, which is why you never hear anybody ask John Edwards why he didn’t feel like staying down at the low end of the value-added chain like his dad, the unemployed mill-worker.

    Bernard Guerrero

  14. Bob,

    Obviously the US Fed and State governments are subject to lobbyist pressure in any number of things. But there’s a pretty massive difference between buying a stapler and hiring someone to do a service job for you. I conceed that product of the service workers labor has the same class of value as the stapler. But Public institutions in the US have a legal obligation that forces the direct human role to be taken into account. Citizens of India have already brought suits against US companies for actions that occurred in India due to neglegence by the Indian Citizen who held the license on behalf of the US Company. It is certain that the justice dept will point out the likelyhood that the ILO or Legal Aid or whomever will file suit over conditions in India as a harrassment technique.

    (and There’s no need for lobbyists when one is confronted with the reps. for the largest union in the US that want to know why the jobs are being outsourced at all. That’s why there’s not many defenders of extra-national outsourcing on the Hill).

  15. Alexander,

    So if in a decade or so, the governments of India and a few other countries got together and decided that because of their increasing humanitarian conern over the growing obesity problem in America they are going restrict imports of American products and services then that would be fine?

  16. Bob,

    First, I’m not claiming public contracting is rational economics! heh.

    Second, There’s a legal difference between “products” and “services” in the US. Especially “professional” services.

    Third. Yes. Theoretically India could decide that Americans are too fat to be allowed to participate in bids for public contracts. Stranger things have happened.