Outsourcing a plus for the US economy.?

[pdavidso <pdavidso@xxxxxxx>]

Will Free Trade and Outsourcing of US Jobs Inevitably Increase the
Wealth of All Nations?

              Paul Davidson, Editor, Journal of Post Keynesian Economics

Will outsourcing and the loss of US jobs ultimately lead to the benefit of all
nations as President Bush?s economic advisor, N. G. Mankiw has declared?
Mankiw is merely expressing the mainstream  economic theory that claims that,
over the long run, free trade in goods and services (including labor services)
results in more income and wealth for all nations. Even former US President
Bill Clinton at the recent Davos economic conference expressed this belief
when he stated that anti globalization activists want to ?take us back to a
time that never was, on a journey that cannot be effective.

The economic theory basis for statements such as Clinton?s and Mankiw?s is
what economists call ?the law of comparative advantage?. But what if this
comparative advantage theory that  a completely free trade global economy
results in income gains for all nations require logical conditions that makes
it inapplicable to the economic world in which we live?  It can be shown
that this law of comparative advantage theory has  severe logical weaknesses
that makes applying policies based on it misleading and dangerous to the US
economy.

A conventional textbook example will make the comparative advantage argument
readily comprehensible to the reader. In this example there are two economies,
the East [i.e., cheap labor countries like India and China] and the West [
high cost labor countries such as  the United States]. Assume there are a
million workers in the East and a hundred thousand workers in the West.  Each
economy produces  two possible tradeable products ? say bicycles (which uses
cheap unskilled labor) and computers (which requires skilled labor).  In the
absence of trade,  the global total of 1,100,000 workers  produce (and
presumably their employers could profitably  sell) a global total of 375,000
bicycles and 55,000 computers. After trade  each country specialises  in
producing the products it has a comparative advantage, and the result it is
assumed is that globally the 1,100,000 workers would  produce 400,000 bicycles
and 70,000 computers.

It therefore follows that while employing the same number of workers globally,
as a result of free trade, the world has gained a total of 25,000 additional
bicycles and 15,000 additional computers (even if the East has an absolute
advantage in having an almost unlimited inexpensive supply of both the
unskilled and skilled labor necessary for  producing bicycles and computers).
Consequently, the theory of comparative advantage ?proves? that the real
income of the global economy has increased, thereby providing more potential
income for every person in both East and West economies. In the face of this
textbook comparative advantage ?proof the anti-globalization advocates and
those who want the Bush Administration to take positive action against the
outsourcing of jobs to China and India appear to be either the roar of
ignorant fools who do not understand simple economics, or the voice of a
coddled, protected (from competition) unionized Western labor force.

 Unfortunately this comparative advantage analysis is based on unrealistic
assumptions, e.g., under free trade, the hypothesized additional supply of
25,000 bicycles and 55,000 computers automatically creates its own additional
demand. (Wouldn?t the multinational auto companies be glad to know that if
they increase global productive capacity by siting plants in countries that
have comparative advantage in auto assemblies, then they will sell (at a
profit) all the cars they can produce? There can never be surplus capacity--as
there seems to be today.)

This assertion that additional supply always creates its own additional market
demand is known as Say?s Law which, as the famous economist John Maynard
Keynes noted, assumes ?that there is no obstacle to full employment?. Keynes
demonstrated that Say?s Law could not be applied  to money-using
entrepreneurial economies and that full employment was not an automatic
outcome
of free market competition. Consequently, if there is anything  economists
should have learned since Keynes, it is that one cannot prove that there  will
be gains from free trade to be shared by all trading economies unless one can
be assured that there is full employment in all nations ? before and after
trade.

 That brings us to a second problem with applying this law of comparative
advantage to today?s global economy. Economic theory assumes that the gains
from trade due to comparative advantage occur only if neither capital nor
labour are mobile across national boundaries. If capital is internationally
mobile ? as is necessary if one is going to have business firms free to
produce
overseas (outsourcing) --, then the proof that  this ?law of comparative
advantage? assures there are gains from trade for all nations does not
logically follow.  If  capital is freely mobile, marketable goods and services
will be produced wherever geographically it is most profitable, i.e.,
where unit labour costs are lowest for producing bicycles and computers. In
such a world if foreigners have an ample supply of both unskilled and skilled
workers, outsourcing of all production of tradeable goods will be a readily
observable phenomenon.

For example, if  the East has an absolute advantage in that it possesses
unskilled and skilled workers whose unit labour costs are significantly lower
than labor costs of similar workers in the West, while the East has an ample
supply of workers to produce all  of the bicycles and computers that global
markets can absorb, then the East will attract sufficient foreign capital from
the West to hire domestic workers to produce all  the bicycles and computers
to meet demand in the global market. As a result, the East will experience a
tremendous surge in its growth in GDP. Production and employment in the West
will decline (or at best stagnate) and the West?s labor force will become
impoverished as either unemployment rates in the West rise dramatically, or
the
West?s workers are forced to accept a real wage that is competitive to wages
being paid to the abundant supply of unskilled and skilled workers in the
East.

Surely, politicians in the West should be more aware of what they are
advocating for their domestic labor force before blindly accepting the Clinton
?s ?inevitable journey? into an outsourcing free trade world. Instead these
politicians must recognize that indiscriminate application of the law of
comparative advantage can be dangerous to the health of the West and
perhaps even the global economy.

Paul Davidson
Editor, Journal of Post Keynesian Economics
University of Tennessee
SMC 503
Knoxville, Tennessee 37996-0550
office phone #;(865)974-3303; office fax#(865)974-4601
home phone and fax # (561)369-1951
email pdavidson@xxxxxxx
http://econ.bus.utk.edu/Davidson.html