absolute advantage redux

["Devine, James" <jdevine@xxxxxxx>]

[strange bedfellows department.]

MARCH 22, 2004

SPECIAL REPORT -- WHERE ARE THE JOBS?
By Paul Craig Roberts

Guest Commentary: The Harsh Truth About Outsourcing

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. [He's also a
pillar of so-called "supply-side economics."] 

------------------------
Jim Devine jdevine@xxxxxxx &  http://bellarmine.lmu.edu/~jdevine