Trade debunking

[Dave Mahadevan <mahadevan@xxxxxxxx>]

Folks:

You know they keep saying outsourcing increases trade and so forth.  The 
economic theory this is based on is called "comparative advantage".   
Any  beginning book on economics will have this in the  first couple of 
chapters.  On March  22, 2004, Paul Craig Roberts (former Assistant 
Treasury Secretary in the Reagan Administration) wrote a guest column in 
Business Week titled "The Harsh Truth About Outsourcing" where he 
debunks the "comparative advantage" myth.  Read below for his commentary.

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.




--
Thank You
Regards.
Dave Mahadevan.. mailto:mahadevan@xxxxxxxx
1:56 PM, Thursday, 1 April 2004 
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Only through hard work and perseverance can one truly suffer.
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