Academia
Some Background Information:
When I wrote this class paper in April 2007 one could hardly see the dark clouds of the economic storm that would hit us
one year later. Today I am facing significantly rising unemployment rates and tough
economic conditions anything else but helpful in my current job hunt. Nevertheless basic positions stated in this article haven't change.
Protectionism will not save jobs but diminish the potential to create new ones.And the last issue analyzed in this article is more relevant (and dangerous) than ever: the exploding national debt exceeding in the meantime more than 10 trillion US dollars.
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Stephan Kroker-Bode
Some Lessons to learn about Trade (April 2007)
Task: Analyze free trade, fair trade, outsourcing and the future of (types of and well-paid) employment in the United States. Can America sustain economic leadership without maintaining a critical mass of manufacturing employment, producing 'real' things?
190 years ago David Ricardo formally developed the theory of comparative advantage [Kennedy/Koehn 1996]. The theory was finalized four decades after Adam Smith's "An Inquiry into the Nature and Causes of the Wealth of Nations". His book was an attack on the most contemporary economic theory of its time - mercantilism - that emphasized export promotion, import substitution and the accumulation of national gold reserves. Smith argued that specialization increases productivity, that exchange allows the benefits of specialization to be realized, and that the gains from specialization and exchange apply to both individuals and to nations.
This set the stage for Ricardo's model, published 1817 in the "Principles of Political Economy and Taxation" - an idea which should become the foundation of modern trade theory: The comparative advantage of nations.
Ricardo proved in his model - based on only two countries with two different products - that with specialization and free trade the partners would be better of than producing a reduced amount of both products for domestic consumption only. Even if one country would have higher production rates with both products (called an absolute advantage) it would still be able to consume more goods with trade.
Another important element of this theory is the fact that gains from trade do not depend on one's trading partner being 'fair'. Even with one country imposing tariffs on foreign products, the trading partner would benefit from trade as long as the tariffs are smaller than the difference in relative prices. It would reduce the gains for this country - but would not leave it worse off than autarky.
But what exactly is 'Free' Trade?
It is an economic term which combines the following criteria:
Traditionally there have been some objections to the above theory that free trade leads to a better situation for all participants:
1.) Although nations benefit from free trade in the aggregate, these gains are often unevenly distributed: "For example, China may possess a comparative advantage in producing labor-intensive textiles while the United States has an advantage in agricultural products. Trade would make both countries better off in the aggregate, but American textile workers and Chinese farmers would bear losses as specialization and trade increase." Even as minorities both groups have a much greater incentive to organize politically than the vast majority receiving only a small individual benefit (lower prices on textiles and agricultural products).
2.) The second objection referred to as the infant industry argument. It asserts that a new industry which has the potential to become the nation's comparative advantage may not get started unless it is given temporary protection against foreign competition. Kennedy/Koehn identify three conditions which can justify related trade/import barriers:
3.) The third traditional objection is that some industries have to be protected for national security reasons.There are several alternative models to 'Free Trade' which - with one acceptation - can not be discussed in details here. These include:
The idea of 'Fair Trade' is not really an alternative to 'Free Trade' but more of a potential 'enhancement'. Worldwide, 'fair trade' sales total $400 millions each year. That is a drop in the bucket (0.01% of the global goods exchange of roughly $3.5 trillion). 'Fair Trade' Organizations differentiate each other from commercial importers through a commitment to the following principles:
Why Free Trade is good for developing countries
In his excellent article "The Eight Losers of Globalization" economist Guy Pfefferman is asking the question: "Who benefits from the free movement of ideas, goods, people and capital? The answer is: The vast majority of the world's population. Yet, it is nearly impossible to show this in a photograph." [Pfefferman 2002].
While pictures of starving children instantly attract our attention (and they should do that - there are still 30,000 of them dying because of malnutrition each day!) facts related to positive developments in underdeveloped countries are easily overseen.
The amount of goods traded around the world has grown by 16 times since 1950 (reflecting the lowering of tariff barriers) - and the growth of trade in services is even larger. The countries that never developed or even got poorer within this time are those that are not open to world trade, notably many nations in Africa.
Many studies and cross-country analysis have shown that the integration into the global trading system leads to faster economic growth and rapid poverty reduction everywhere around the globe. The study of Jeffrey Sachs and Andrew Warner ("Economic Reform and the Process of Global Integration", 1995) for example found that open economies grow between 2% and 2.5% per year more rapidly than closed ones.
Better trade policies help to increase economic freedom globally - thus reinforcing the rule of law and fostering economic development in poor countries. According to the World Bank, per-capita real income grew three times faster in developing countries that lowered trade barriers than in those who did not. Over the past 25 years, roughly 500 million people have been lifted from poverty, largely as a result of freer trade and market reforms [Markheim/Kim-2007]. Countries that have successfully integrated into the global trading system enjoy faster growth, better living standards, easier access to capital and technology, higher productivity and lower prices than countries with closed economies.
And at least the overall development related to poverty and starvation is not such a bad one. The economists Surjit Bhalla and Arne Melchior estimate that the proportion of people in the world living on less than a dollar per day (a measurement to define the poverty line) has fallen from 30% in 1987 to 13.1% in 2000. In Asia, more than 650 million people were lifted out of poverty between 1970 and 2000.
According to the Australian Department of Foreign Affairs and Trade, the number of undernourished people in the world has been reduced from 920 million in 1970 to 810 million in 2003 [ICC].
But there are still these 30,000 children who will die today because they don't have enough to eat, enough water or enough medicine. The miracles of free trade and all World Bank or IMF Poverty Reduction Strategy Papers were not able to solve this problem. Could one solution be an increase of financial aid? Jeffry Sachs, Director of the Earth Institute at Columbia University and author of the 2006 bestseller "The End of Poverty" would answer this question with a clear Yes! In a frequently quoted article - published 2005 in The Globalist - he mentions an important document: The 'Budget Request for the FY2006 International Affairs Account'. There President Bush's National Security Strategy is linked for the first time directly to poor nation's development "as the third component of U.S. national security - alongside defense and diplomacy". But soon after this document was released in 2005 the development assistance budget was cut by $345 million. In this budget the 'generous' sum of $25 million was reserved for five key regional countries - Djibouti, Ethiopia, Kenya, Nigeria and South Africa - with a population of 275 million people. That equals 9 cents per person [Sachs].
Sachs questions the sincerity of the government's new policy of monetary support of poor nations as one of the three equal U.S. National Security pillars. One pillar - the U.S. military - enjoys roughly $500 billion of support, while the development pillar receives $16 billion.
"Discouragingly, of that $16 billion we direct most toward strategic states, such as Afghanistan, Colombia, Iraq and Pakistan. Afghanistan alone will receive more development assistance than will all of sub-Saharan Africa in FY 2006 budget. We do not need a single new promise, a single new commitment, or even one new program. The rich countries first committed to giving 0.7% of GDP to development assistance as early as 1970. […] The United States stands at 0.15% of GDP - the lowest share of income given by any rich country."
We shouldn't forget that even 0.15% of the highest GDP worldwide is still a very respectable sum - but the basic idea is undeniable: The economically most powerful country in the world is showing its meanest face when it comes to support the very poor worldwide. We should direct our view for a moment to the roughly $420 billion which has been spent for a disastrous war in the Middle East up to now - or the $2 trillion it could cost in the end according to 2001 Nobel prize economist Joseph Stieglitz. Besides the financial burden we have to recognize also the horrendous toll of victims. No one really knows how many civilian Iraqis died since the war started 4 years ago (the official 30,000 or the more realistic number of more than 60,000). And without doubt each of the 3324 dead U.S. Soldiers (as of April 23, 2007) is an individual loss.
So we can't 'balance' one avoidable death against another we have to remember again a number already mentioned in the text, a number which best reflects the ongoing tragedy of poverty in the world. A group of people - roughly 10 times the number of all U.S. soldiers dying overseas in the last 4 years - will die today, in a single 24 hours; not because of a bullet or a bomb but the lack of food.
And so it will be tomorrow and next Sunday.
For William Easterly, this is only the first tragedy. Nearly 2 million annual child deaths from diarrhea could be easily prevented with 10-cent doses of oral rehydration therapy. With all the aid of the last decades this medicine is still not delivered in sufficient amounts.
"The data show that there is a correlation between aid and growth, but unfortunately, it's negative. Sophisticated econometric analysis finds no evidence that aid raises growth. What does raise growth is markets, so the citizens of India and China, by shifting to more market-oriented economic systems and creating new opportunities for millions of local entrepreneurs to get rich by their own efforts, increased their incomes by $715 billion last year while we were agonizing about whether to give $10 billion more here or there for foreign aid."
A wider gap
'Anti-Globalists' claim that the gap between rich and poor has been widening over the last decades and that the living conditions in severely underdeveloped countries have deteriorated as a result of globalization. In their opinion rising inequality is the inevitable result of market forces. Without restrictions - so they say - pure market forces just give the rich the power to add further to their wealth.
Large Corporations invest in poor countries only because they can make greater profits from low wage levels or they can get access to their natural resources. Free market forces do nothing to address re-distribution of wealth - except the assumption that wealth will 'trickle down' to the poor.
Figures used most frequently are those from the UNDP (United Nations Development Program). The 1999 Development Report finds that over the past 10 years, the number of people earning $1 a day or less has remained static at 1.2 billion while the number of those earning less than $2 a day has increased from 2.55 billion to 2.8 billion people.
"Gaps in income between the poorest and richest people and countries have continued to widen. In 1960 the 20% of the world's people in the richest countries had 30 times the income of the poorest 20% - in 1997, 74 times as much."
By the late 1990s the worlds 5 percent of people living in the highest-income countries had:
New research indicates severe shortcomings in the UNPD report. It considers each country as a point of comparison regardless of its population
size (giving equal weight to China compared to a country in Africa while all 35 African states together have only half the population of China).Additionally UNPD's poverty ratios were computed by simply comparing unadjusted incomes while ignoring the fact that the cost of living in developing countries is lower. According to researcher Xavier Sala-i-Martin, once adjusted for purchasing power parity, the poverty ratio of the richest 20% to the poorest 20% has actually started to diminish over the last two decades. "Rather than rising from 20 to 74, the ratio increases from 11.3 in 1960 to 15.9 in 1980, but then declines slowly to 15.09 in 1998." [ICC]
The fact which was overlooked here is: The decline in global inequalities results mainly from massive poverty reduction in countries such as India and China, which account for 38% of the world's population. More than 40% of Africans still live on less than a dollar a day - a proportion that has been steadily increasing all over the continent since the 1970s.
One big problem: Agriculture Subsidies
Countries that lower trade barriers concentrate their energies in industries where they are more efficient and where there is an international advantage. Import barriers encourage countries to focus efforts in industries where they do not have any advantage; leads to wasteful and inefficient investment.
"Openness promotes economic efficiency by allowing countries to specialize in what they do best rather than produce everything on their own. In an open world economy, countries tend to export what they produce efficiently and to import what they produce relatively less efficiently. This allows a more effective allocation of resources both within and between countries, thereby increasing the overall economic pie." [ICC]
One major reason for the ongoing stagnation especially in Africa is the fact that industrialized countries (especially some European nations and the United States) continue to impose high tariffs and other trade barriers on labor-intensive products (textile, clothing or agricultural products) - in which developing countries have a competitive advantage. Three quarters of the world's poorest people live in rural areas, with the majority making their living from agricultural production.
Agriculture plays a vital role in the economies of developing countries, including those that are already well advanced in the industrialization process. Research by the International Food Policy Research Institute shows that in sub-Saharan Africa, each additional dollar of income from agriculture generates two to three dollars of growth in the overall economy.
But according to the UNCTAD (United Nations Conference on Trade and Development) the share of developing countries in world agriculture exports has dropped from 31.7% in the early 1970s to 26.4% in the late 1990s (3.5% to 1.0% in the least developed countries). This was partially related to dramatic falls in world prices of commodities such as milk, sugar and cotton.
There are massive agriculture-related subsidies given worldwide to a very small - but very powerful - group of people. WTO members report average subsidies totaling more than $221 billion per year. That is more than 18 percent of global agricultural value added. Based on World Bank and WTO data, the EU and the U.S. each contributed a little more than a third of the total subsidies in 2001. A 2005 Gato Institute study indicates that farmers in OECD countries received $279 billion in some form of protection support (or 30 percent of total farm income) - U.S. farmers received $46.5 billion from the American government (18 percent of total U.S. farm income).
Nearly 90 percent of all subsidies go to growers of just five crops (wheat, cotton, corn, soybeans and rice) - while the vast majority of farmers specializing in livestock, fruits, vegetables and other crops flourish in a (subsidies-) free market.
Most importantly - it is not small family farms or poor cash-strapped farmers who get the bulk of subsidies (the average farm household now earns $79,961, which is 26 percent above the national average) - but big agribusiness. Two-thirds of subsidies are distributed to the wealthiest 10 percent of farmers. A recent U.S. Department of Agriculture report found that both the number and market dominance of large farms (those with sales of more than $500,000) grew significantly between 1989 and 2003 while the number of small farms fell from 40% to 26% in the same timeframe. Especially large farming cooperations are the key drivers of overproduction (with an unprecedented yearly destruction of food) and drive world prizes down to levels where farmers in developing countries cannot compete.
Additionally, tariffs in the 'rich world' are even higher for processed food, discouraging developing countries from upgrading their food industry.
There are lots of losers - including small operation farmers in the Triad (Europe, Japan, US). Citizens there loose money as taxpayers (financing these costly subsidies) and as consumers. According to a 2004 OECD study, U.S. farm programs resulted in higher food prices and had the effect of transferring more than $16 billion from American households to domestic (not foreign) farmers. The Office of Management and Budget estimates that American taxpayers paid over $20 billion in agricultural subsidies in 2006 [Markheim 2007]. The only winners are large-scale farming corporations - and these, while carry a significant political weight and lobbying power - fiercely oppose any reforms.
It's no question that this has to stop! Reforms are overdue - and they would result in an overwhelming relief for developing countries also.
"The World Bank estimates that the liberalization of agricultural trade (with a repeal of all rich-country trade barriers and subsidies to agriculture) would improve global welfare by about US $250 billion by 2015, of which almost US $150 billion would accrue to developing countries. A rise of only 1% in Africa's share of world exports would amount to US $70billion a year." [ICC (3), P.10]
It is not only a matter of numbers and dollar signs - but very essential political talks which include much more than monetary gains only. Western trade subsidies are the most important stumbling block for the Doha Development Round. Unfortunately these trade talks came to an end last summer. The big losers are Developing Countries. According to Oxfam, a 5% increase of the share of developing countries in world exports would generate $350 billion - seven times as much as they receive in aid [Oxfam].
World Bank calculations show that gains from multilateral trade liberalization under the WTO Doha Development Agenda could amount to more than $800 billion a year by 2015 - with more than half going to developing countries.
Why Free trade is good for America
The Institute for International Economics estimates that over the past 50 years, trade liberalization has brought an additional $9,000 per year to the typical American household. The North American Free Trade Agreement (NAFTA) and the WTO Uruguay Round - the two major agreements of the 1990s - generate annual benefits of $1,300 to $2,000 for the average American family of four [Markheim 2007]. The research institute has also calculated that moving from today's trade environment to one characterized by a 'perfectly' free trade and investment would generate an additional $500 billion ($5,000 per household) in annual income. And a University of Michigan study concluded that with a reduction of agriculture, manufacturing, and service trade barriers by just one-third another $164 billion ($1,377 per household) could flow to the U.S. economy - it would be an annual additional income of $497 billion if all trade barriers would be completely eliminated [Markheim 2006].
Daniella Markheim presented this data in several publications published by the conservative 'Heritage Foundation'. It might be overoptimistic and guaranteed politically biased - but her personal 'State of the Union' summary is nevertheless worth quoting.
She writes: "The gains from freer trade are substantial. Today, the $12 trillion U.S. economy is bolstered by free trade, a pillar of America's vitality. American exports support one in five U.S. manufacturing jobs. Jobs directly linked to the export of goods pay 13 to 18 percent more than other U.S. jobs. Moreover, agricultural exports hit a record high in 2005 and now account for 926,000 jobs. The service factor accounts for roughly 79 percent of the U.S. economy and 30 percent of the value of American exports. Service industries account for eight out of every 10 jobs in the U.S. and provide more jobs than the rest of the economy combined. Over the past 20 years, service industries have contributed about 40 million new jobs across America." [Markheim 2006-6]
Whenever the subject of trade is discussed is doesn't take long before three major counter-arguments are put on the table to discredit the idea of a tariff and subsidy free world. It is the little Halloween round of the dark U.S. Manufacturing Death; the Demon of Outsourcing and the nasty Budget Bitch. To be precise - it is Ms. Trade Budget. Only a few recognize her twin sister - who is the only really dangerous person lurking in the shadow (that will be the last topic in this paper). Let's briefly discuss these three 'riders of the apocalypse'.
Deindustrialization and the 'Death of Manufacturing' are a myth
Drezner writes in his most cited "Outsourcing Bogeyman" about the fact that the number of manufacturing jobs has fallen dramatically in recent years. Fortunately he doesn't wait very long to explain that this has very little do with outsourcing and almost everything to do with technological innovation. If outsourcing would be relevant one would expect some corresponding increase of manufacturing employment in developing countries. But an Alliance Capital Management study of global manufacturing trends shows that while the U.S. saw an 11 percent decrease in manufacturing employment from 1995 to 2002, China saw a 15 percent decrease and Brazil a 20 percent decrease. In that same time period global manufacturing output increased by 30 percent [Drezner].
Linsey describes major events which have increased the supply of labor during the last half-century (the baby-boom, a significantly higher work force participation of women and rising rates of immigration) while other key developments have slashed demand of certain kinds of labor.
Among these are the growing competitiveness of foreign producers, falling U.S. import barriers, a shift toward globally integrated production and relocation of some operation overseas as well as the deregulation of 'commanding heights' industries like transportation, energy and telecommunications.
We clearly see significant job reductions in the manufacturing industry. But historically it is not the first economic sector with a drastic decline. In 1900, 41% of the U.S. labor force was employed in agriculture - today it's only 2%.
In 1970 the telecommunications industry employed 421,000 workers in good-paying jobs as switchboard operators - today this industry has only 78,000 operators (an 80% job loss). But in 1970 these almost half a million switchboard operators could handle 9.8 billion long-distance calls. The much smaller number today accounts for 100 billion long-distance calls - and the cost to make one of these calls is only a fraction of what it was in 1970 [Williams 2006-2].
Did all jobs go to China - or have they already been "sucked" to Mexico (one might wonder if Ross Perot still hears that sound, this poor guy with tinnitus). Nonsense! Since 2000, China lost 4.5 million manufacturing jobs, compared with the loss of 3.1 million in the United States.
Interestingly U.S. manufacturers are producing and exporting more goods than ever before. Between 1980 and 2003 American manufacturing output climbed an amazing 93 percent. But -while manufacturing output easily outpaces the larger U.S. economy - manufacturing employment is with 14.2 million nevertheless at its lowest level in more than 50 years. What caused that? The superior productivity of American manufacturers!
Between 1980 and 2002 output per hour in the overall non-farm business rose 50% - but it was 103% in the manufacturing sector [Lindsey].
International trade might have at best only a modest effect on manufacturing's declining share of the economy. In the three years between July 2000 and October 2003 manufacturing jobs had fallen by 16% - from 17.32 million to 14.56 million. But it was not foreign competition which eliminated these jobs. In the relevant time frame manufacturing imports rose only 0.9 percent - but manufacturing exports drop by 9.6%.
Additionally a worsening domestic market for manufacturers during the recession in the first years of the 21st century led to a big drop in business investment. David Huether, chief economist of the National Association of Manufacturers, describes the situation in a refreshing short and precise way: "We're making more stuff with fewer people." [Williams 2006-2]
Today manufacturing represents a small part of the U.S. economy (17% of GDP compared with China's 41%). But the United States is still by far the world's largest manufacturer measured in the raw value of goods produced. It was worth $1.79 trillion in 2005 - nearly twice as the closest rival Japan ($0.99 trillion), followed by China ($0.78 trillion) and Germany ($0.5 trillion). All other countries together amount of $2.97 trillion [Aeppel].
Every manufacturing job lost is a personal tragedy (as long as it is not compensated through finding a better job somewhere else). But can it be considered to be a real threat for U.S. employment generally? Similar anxieties have surfaced before:
During the Great Depression supporters of the theory of 'secular stagnation' argued that declining population growth and the 'maturity' of the industrial economy would lead to failing private-sector job creation.
The return of higher unemployment in the early 1960s with an ongoing progress of factory automation and more and more electronic computers fueled fears of an 'Automation Crisis'.
In the early 1980s the success of Japanese producers sparked predictions of an imminent 'deindustrialization' of the American economy.
Ten years later Ross Perot won 19 percent of the presidential vote with his 'giant sucking sound' metaphor of jobs lost to Mexico. But U.S. employment continued to increase and the sky was never falling.
Without doubt the last five decades saw significant shifts in labor supply and demand. But jobs churn constantly. Large numbers are shed even in good times - while and even larger number is created elsewhere in the country. According to data out of a labor statistic of the Department of Labor's Bureau, total private-sector employment rose by 17.8 million between 1993 and 2002. This was a healthy net increase. It masks the fact that an enormous amount of 309.9 million jobs was lost in this time - and a total of 327.7 million new ones created.
The Scope is: Technology - not trade - is the basic explanation for the decline in manufacturing employment in industrialized countries. Automation and the IT revolution have boosted productivity - reducing demand for low-skilled labor. It's once again a question of optimizing competitive advantage: Manufacturing in industrialized countries has continue to shift to higher value-added products - and while doing this it might very well create better-paid jobs with better working conditions. Despite ongoing outsourcing activities, the Bureau of Labor Statistics in the US predicts a net creation of 22 million new jobs over the next decade - mostly in business services, health care, social services, transportation (including logistics) and communications.
One should not forget that the rising development of some eastern countries not only leads to more western production facilities there but also increases the domestic market capacity for western products. China's imports for example have risen by 70% since it joined the World Trade Organization in 2001 - making it the world's third largest importing country and the fastest growing export market for EU, US and Japanese companies [Institute for International Economics, ICC, see also Pfeffermann].
The only crisp argument is a strategic one. We have to be careful not to loose the ability to produce important goods. Even if trade might flourish for a long time - it is not a natural law. In fact it is still something very fragile. We should never forget that economic liberalism and the free flow of global goods, services or capital was better developed one hundred years ago (the increase in world trade as a proportion of world GDP was proportionately greater between 1870 and 1914 than it has been since 1975). It 'only' took one horrible war to push the world back into a time of stagnation, fear, protectionism and depression.
Outsourcing is overstated
There is clearly a rise in emerging countries' skill levels. Especially China and India have invested heavily in education in recent years - which allows them to start competing in more sophisticated markets. More engineers and scientists graduate from Chinese and Indian universities as in America, the European Union and Japan combined - and three times the number 10 years ago. According to data from the National Science Foundation, 1.2 million of the world's 2.8 million university degrees in science and engineering in 2000 were earned by Asian students in Asian universities, with only 400,000 granted in the United States [ZDNet Research, 6-20-05]. India for example produces 3 million college graduates every year, including nearly 400,000 engineers [ZDNet Research 03-29-06].
A large share of these engineering graduates in China and India are needed for the booming domestic construction. Both countries have not yet enough capacity to produce high-tech goods similar to US - but is has to be noted that (according to the OECD) China overtook in 2004 America as the worlds leading exporter of information-technology goods. Rich countries have lost their monopoly on high-tech capital and know-how - and the faster spread of technology to poor countries is continuously weakening the rich world's comparative advantage in high-tech sectors.
Low-skilled manufacturing workers are no longer seen as being challenged most - there are rising fears that white-collar staff might also lose their jobs related to a competition from developing countries. Information Technology makes it possible to outsource services that were once non-tradable; now the 'global labor arbitrage' (Morgan Stanley) is moving rapidly to better jobs. America's service sector - now accounting for about 85% of the United States work force - will be increasingly vulnerable to competition. It's no longer just basic data processing and call centers which can be outsourced but also software programming, medical diagnostics, CAD, law, accounting, finance and business consulting.
If you monitored research studies related to outsourcing over the last few years you could easily get the impression that the end for the U.S. Service industry is coming closer. Here is a small selection of these 'Fear Facts':
With all these numbers - especially when professionally home in the IT business - the credo for me personally seems to be: Look for the exit
door; rethink the MBA and go back to healthcare; stop working on the American citizenship (and go for an Indian visa instead) - but most
of all, follow the back cover advice of 'The Hitchhikers Guide to the Galaxy': "Don't panic!"
And indeed - this advice is the right one, but with another focus: The real numbers and especially their impact are much smaller. Porter Eduardo is right when he writes: "The threat of global outsourcing is easily overstated." [Porter]
Let's look for example at the study done by the McKinsey Global Institute, well known for its favorable view of globalization, in 2005. 160 million service jobs - about 10 percent of total worldwide employment - could be moved to remote sites because these job functions don't require customer contact, local knowledge or complex interactions with the rest of the business. This sounds almost as frightening as the results from a study done at the Organization for Economic Cooperation and Development in Brussels, also published in 2005, stating that 20% of the developed world's employment might be "potentially affected" by global outsourcing. This could include all American librarians, statisticians, chemical engineers and air traffic controllers - but they forget to explain what "potentially affected" means.
The McKinsey study - after surveying dozens of companies in eight sectors from pharmaceutical to insurers - comes to the conclusion that only a small fraction of these jobs will actually be sent away. The report estimates that by 2008, multinational companies in the entire developed world will have located only 4.1 million service jobs in low-wage countries, up from about 1.5 million in 2003. That is equivalent to only 1 percent of the total number of service jobs in developed countries!
Most jobs will remain unaffected altogether: close to 90 percent of jobs in USA require geographic proximity - services that have to be produced and consumed locally. Today outsourcing affects less than 0.2 % of employed Americans. [Lindsey].
Another important reason: Many business processes are difficult to separate into discrete chunks that can be sent away. Additionally there aren't that many suitable cheap workers available because of issues ranging from poor language skills to second-rate education systems - only 13% of the young, college-educated professionals in the big developing countries are suitable to work for multinationals (which have to compete with local companies).
We should keep the perspective right: So far fewer than 1 million American service jobs have been lost to offshoring. The Forrester Research 2015 forecast of 3.4 million jobs lost in services due to outsourcing is not much compared to the 30 million jobs destroyed and created in America every year.
As Lindsey points out, IT employment indeed experienced a significant decline after 2000. Some jobs were lost because of offshoring - but the more important reason was the slowdown in demand for IT services after a dramatic buildup in the late 1990s (Internet boom and Y2K computer fixing) followed by the dot-com collapse and a broader recession. Despite the offshore trend IT-related employment is expected to see a healthy increase in the years to come. The Department of Labor projects that the number of IT-related jobs will jump from 3.02 million in 2002 to 4.07 million in 2012 - a 35% increase [Lindsey]. Other studies expect that the number will grow 43 percent by 2010.
It is especially important not to overlook that there are also significant gains from outsourcing. The Information Technology Association of America says global outsourcing generated a net increase of US jobs in 2005 of 257,042, and is expected to create a net number of 337,625 new jobs by 2010. According to the ITAA the US economy benefits from global outsourcing - it helped to increase the U.S. Gross Domestic Product by $68.7 million in 2005. In 2010, outsourcing is expected to increase the U.S. GDP by $147.4 million [ZDNet Research, 5-22-06].
The Mc Kinsey Global Institute is often cited with this estimation: For every dollar spent on outsourcing to India, the United States reaps between $1.12 and $1.14 in benefits. But it gives another interesting one too: For every dollar invested offshore, American companies save 58 cents - 4 or 5 percent of these savings could pay for a theoretical wage insurance program that would cover 70% of the income lost between an old job and a new one as well as subsidized health care coverage [Lohr].
As Lindsey points out, the U.S. runs a trade surplus exactly in these IT services most directly affected by offshoring. The same is true for all kind of services like banking, accounting, legal assistance, engineering or medicine. The United States is not only a major exporter of services generally but runs a sizable trade surplus in services. Gross job losses due to offshore outsourcing have been minimal when compared to the size of U.S. economy: creation of new jobs overseas will eventually lead to more jobs and higher incomes in the United States. High-quality jobs will continue to grow in the years to come.
Finally- The impression that the majority of U.S. companies are deeply involved in outsourcing is only partially true. Today 19% of businesse in the United States have an offshore outsourcing strategy - according to a study by Ventoro (however, the percentage skyrockets to 95% if exclusively Fortune 1000 companies are considered) [ZDNet Research, 10-3-05]. The survey also found that only 9% of any cost savings from offshore outsourcing was the result of lower overseas labor costs. The cost savings from offshore outsourcing was not in the 35-40% range that many corporations assumed they would gain when they decided to go overseas. Savings averaged slightly less than 10% for all the offshore outsourcing projects that Ventoro reviewed [ZDNet Research, 7-15-05].
Similar results come from TPI. In their study outsourcing of IT and business services delivered average cost savings of 15%, disproving also claims that outsourcing can reduce costs by over 60% [ZDNet Research, 4-13-06].
InfoWorld TechWatch points to a Deloitte & Touche study of current outsourcing where an overwhelming number of respondents had negative experience with outsourcing and half of the respondents faced hidden costs. 70% of participants have had negative experiences with outsourcing. 25% of respondents realized that they could handle certain functions better in-house, and revised their outsourcing contracts. 44% did not see cost-savings from outsourcing. 57% ended up absorbing costs that they believed were included in the contracts with vendors. Nearly 50% cited hidden costs as the biggest problem [ZDNet Research, 5-22-06].
With no doubt the outsourcing industries in India and China will continue to flourish for the next years - despite a lot of problems especially India has right now. A lot of Indian companies have trouble to get qualified personnel [Rai]. Despite a high nominal 'output' of college students only 10% of the graduates with non-specialized degrees (and 25% of engineers) were considered employable by leading companies [Giridharadas]. Security breaches are shaking Indian outsourcing companies. In some industries wages are rising significantly (more than 25% a year) and especially real estate is driving prices. Both India and China find their economies "on the verge of overheating" [Bradsher]. With all the options of going overseas - the best one might still be around the corner [Chiium].
The 'Twin Deficits' - only one is really dangerous
In 2005, the U.S. trade deficit with China grew by 25 percent to $202 billion. That amounts to nearly twice the $130 billion bilateral deficit in 2002. The ratio of imports to exports with China is now 5 to 1 - which is perfect for a 'Chinese invasion' storyline. But when analyzing the 'Twin Deficits' - the Trade and Budget Deficit - the first one deserves less attention and is by far the smaller problem. Why?
Trade flows are balanced by investment flows. The bigger the trade deficit, the more capital is flowing into the United States. Chinese and other foreign investors still prefer to trade their goods for America's equity and debt. It's seen as the safest, surest investment bet in the world. And - empirically - record trade deficits have coincided with positive economic news in the United States.
Much of the trade deficit with China represents re-importation by U.S. firms with factories overseas (General Motors, Motorola or Boing). Parts leave the United States and come back as more valuable assembled products.
"A 2005 National Bureau of Economic Research study reported that 90 percent of U.S. exports and imports flow through U.S. multi-national companies, with 50 percent flowing within a single firm. The lesson for Congress is that American companies, not just China, will be injured by protectionism." [Kane/Miles/Kim]
Pat Buchanan once called the trade deficit a "malignant tumor in the intestines of the U.S. economy". But it is actually a good thing. John Stossel explains this very well in his Capitalism Magazine article "Loosing Sleep over the Trade Deficit?":
"Foreigners trade cool products (and capital goods) for paper money. They can do only three things with our dollars: buy American goods and services, save them, or invest in the United States (including buying U.S. government debt). In other words, most of what foreigners don't spend here, they invest here. The trade deficit is mirrored by the capital-account surplus. […] They trust America's future enough to invest in it. Investment creates new products and better jobs." [Stossel]
But there is one big problem:
In February 2007 President Bush unveiled his new $2.9 trillion budget [Stolberg]. In four volumes and 2,500 pages of text, charts and tables he explained his plan which he considered to be 'realistic' and 'achievable'. The budget is based on a lot of economic assumptions of which the most important one is that the costs of the war will soon drop sharply and then go away in the coming years. This would bring the deficit down from a projected level of $244 billion this year to $239 billion next year; in 2012 there would be a surplus of $61 billion. Bush proudly declared that under his leadership the deficit "was cut in half" from 2004 to 2006 (in fact the deficit declined from $412 billion to $248 billion). For the very first second - but not much longer - this sounds like a great achievement. But what exactly does it mean?
A 'deficit' is an annual addition to national debt - so what President Bush stated was that the national debt is not going up as fast as it had been in the past years. He is not talking about the annual gross (total) budget deficit - the total deficit has hardly decreased at all. Additionally Bush's deficit (let's call it a 'deficit lite') counts borrowing from the 'public' (financial markets) - but does not count borrowing from Social Security - which is huge. To make this clear: Bush took every single cent out of the Social Security Fund!
Social Security is not part of the Federal Budget General fund - it is a separate account and has its own source of income. Social Security payments go in the Social Security trust fund and should not be counted as general revenue. The trust fund is supposed to be used to pay future benefits. Currently there is more being paid into the Social Security Trust Fund than is being paid out to beneficiaries. What's left over is routinely being 'borrowed' and used as if it were general budget revenue (for his defense, President Bush didn't start this dangerous procedure, it was actually President Johnson in 1968).
But 'borrowing' from Social Security are obligations which must be repaid; in fact - those funds should be helping to increase savings and investments on order to provide for the coming retirement of the large 'baby-boom' generation. They should not be used for current government expenses!
So here is what's happening now: The gross deficit is about $550 billion - when you subtract $300 billion coming from Social Security you get the $250 billion 'deficit lite' - and this is nothing else but a very bad charade. It is a cover-up of the most dangerous economic problem the United States are facing today: Our inflationary national debt.
In 1835, under President Andrew Jackson, the US Federal Budget was balanced and the National Debt was paid in full. This has never happened since. During the economic boom if the 'Roaring'20s' the Federal budget ran surpluses for ten consecutive years - that also has never happened since. Recessions and wars in the 1930s and 1940s initiated a half-century of chronic budget deficits steadily increasing the National Debt.
During the 1970s and 1980s the US Federal Budget ran deficits for twenty straight years - another economic boom in the 1990s enabled 4 years of budget surpluses (1998-2001, the best in 2000 with a surplus of $236 billion). Unfortunately that was the last time we saw some black numbers.
As of April 15, 2007, the national debt of the United States is roughly $8.8 Trillion! In Fiscal Year 2006, the U.S Government spent $406 Billion on interest payments alone - compared to less than $4 Billion to the National Science Foundation, $6 Billion to the Environmental Protection Agency and $95 Billion for Education (see a good overview at http://www.federabudget.com). The economic implications of this gigantic debt are very well explained in Robert Freeman's article "The Bush Budget Deficit Death Spiral", published October 22, 2004; in the Common Dreams NewsCenter, (online at: http://www.commondreams.org).
Lenders talk about a 'debtor's death spiral' when borrowers get so far in over their heads they begin borrowing money just to cover the interest payments on past borrowings. They can no longer pay down the principal - and as new debt compounds the old, bankruptcy becomes imminent.
The United States are not only running large and growing deficits - these trends are becoming irreversible, a structural part of the U.S. economy.
Most of it began under the economic stewardship of Ronald Reagan. He cut the marginal tax rate on the wealthiest of Americans from 70% to 38%. When Reagan took office in 1981, the national debt stood at $995 billion; by the end of George H.W. Bush presidency 12 years later the budget deficit had exploded to $4 trillion. Bill Clinton reversed the course, raising taxes on the wealthy and lowering them for the working and middle class. This was followed by the longest sustained economic expansion in US history - and produced budgetary surpluses which helped to reduce the debt. In 2000, the surplus amounted to $236 billion. The forecast ten year surpluses stood at $5.6 trillion.
Then George W. Bush reduced taxes again - especially some $630 billion in tax cuts to the top 1% of income earners (Freeman doesn't forget to mention that this preferred group returned the favor by investing over $200 million to ensure Bush's re-election). In 2004 the deficit had reached $415 billion. Its real size was masked by the same trick Bush used in 2007 - shifting $150 billion from the Social Security trust fund in order to make the shortfall look smaller. Freeman describes the situation in 2004 with the following words:
"Add it all together - the 'nominal' deficit, the stealth siphoning from Social Security, and the permanent effects of Bush's tax cuts - and the 10 year deficit explodes to a mind-boggling $7.9 trillion. Within ten years, the government will owe more than $15 trillion. And this, at precisely the time the government needs fiscal solvency to begin paying the Baby Boomers their Social Security. The run-up in debt represents the most rapid, predatory looting of public wealth in the history of the world. The interest costs alone will consume the government and soon, the entire economy. In fiscal 2004, interest costs came to $321 billion against a deficit of $415 billion. So three quarters of all the current year borrowing is spent paying interest on past borrowing. This is the most immediate symptom of the deficit death spiral.
And the situation will only get worse when interest rates rise, as they must. The U.S. has enjoyed an unprecedented period of low rates, the lowest in 50 years. The only direction they can go is up. And they will rise quickly once foreigners, who are more and more the buyers of U.S. debt, become saturated with dollars and begin to eschew additional lending."
Freeman points to past examples: In the early 1970s Arab oil sheikdoms realized that Nixon had decoupled the dollar from gold redemption but was still paying for oil in dollars (essentially paper). They tripled their oil prize in 1973 and again in 1978 - the OPEC 'oil shocks' plunged the US economy into an ongoing recession. Japanese did something similar in 1987, when the dollar was loosing 15% a year in value - more than wiping out the 5% return they were receiving on their treasuries. They stopped buying in October 1987 - causing the greatest one-day U.S. stock market collapse since the Great Depression.
"No one knows when the world will say, 'enough'. Japan holds a reported $1 trillion supply of dollars, China more than half a trillion; both have bought dollars (loans to the US government) in order to keep the value of their own currencies low and therefore make their own goods cheaper in American markets."
There is an ongoing hope that both countries will continue to buy dollars so that their currencies will not rise. But if one of the partners declares to stop this, the United States may be in big trouble. "Demand for dollars, and with it, the dollar price, will plummet. The last player holding dollars will be stuck with the bag, a multi-trillion dollar stash of dollar holdings that are worth only a fraction of what they were just a month before." Up to now the dollar decline is being managed by the U.S. Treasury. Foreign central banks now hold some 40% of total U.S. government debt. According to Freeman the only way to prevent a stampede is to raise interest rates (the return for holding dollars). "But this, of course, increases the carrying costs of the national debt. As if a $7 trillion national debt funded at 4% isn't bad enough, envision a $15 trillion debt at 10%. Instead of $300 billion a year in interest costs, think of $1.5 trillion. Instead of interest amounting to 3% of GDP, imagine the carnage as it approaches 10%." Raising prices and increasing interest rates forcing private borrowers to pay ever more for scarce capital. Investment - the foundation of future growth - will be savaged [...]"
"This is the perverse, inescapable cycle-the death spiral-that comes part and parcel with too much debt. Its relentlessly rising carrying costs steadily erode the possibility of getting out from underneath it. Higher debt loads lead to higher interest rates, which lead to lower investment which leads to slower growth and, ultimately, diminished prosperity. And it develops a runaway, recycling dynamic all its own."
Undoubtfully Freeman's analysis is politically biased - this is more than obvious when he goes into details how to fix the problem (basically rolling back the tax cuts for the very wealthy). And again the presented data has to be put into a worldwide comparison. Williams for example points to the fact that the U.S. 10-year government bonds yield 4.6 percent per year compared with Japan's 1.6 percent. The government debt is 38 percent of GDP versus 86 percent in Japan; and while Europe's debt to GDP ratio is not as extreme as Japan's it's not nearly as favorable as the numbers for the United States [Williams 2007].
America still has the strongest economy in the world. Our GDP was $13.980 trillion in 2007 (followed by Japan with $5,290 trillion, Germany with $3.280 trillion, China with $3.010 trillion and The UK with $2.570 trillion). With 5.83% of world's population the U.S. economy produces 28.12% of world's GDP. The United States have the highest GDP per capita ($41,800, followed by Japan with $33,100).
There is a good reason that foreigners (especially China) continue to invest heavily in the United States' economy. Both countries are deeply clued together in a system of mutual dependency. China needs us as its most important foreign market - and we need China for ongoing investment. But if we don't find a way to reduce our Federal Deficit, the consequences can be very painful some day. It is still time to work on a 'soft landing' - it doesn't have to be a crash.
Free Trade has helped all countries participating to gain a lot. But there are problems unsolved while others are clearly overstated (basically to undermine the very idea of Free Trade). The discussion of the decline of manufacturing or the threat of outsourcing is used by influential lobbyists to impose tariffs and subsidies - which only help a few, but hurt many.
There is still a lot of work to do. But only the continuous path on the way to improved flows of gods, services and capital will help to get underdeveloped countries (especially in Africa) out of poverty. The United States have to be a leader on this path - not a brakeman.
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