Outsourcing is a Red Herring

Now that Barack Obama’s India visit is over, he can get back to flaying outsourcing as the chief reason for job losses in the US. He had toned down the rhtetoric while in India, but he can raise the pitch again lest his critics stateside start accusing him of being insensitive to high unemployment at home.

But as he and his critics fully well know, outsourcing does not create job losses. If anything, it will sustain American jobs and improve productivity. Hard to believe? Yes. Counterinuitive? Yes. But, it is the truth.

A study by McKinsey Global Institute in 2006 confirms this. McKinsey researchers added up costs and benefits of outsourcing and found that for every $1.00 that was outsourced, $1.12 was returned. The source for this fact is Greg Mankiw’s blog. Greg Mankiw was the economic advisor to George W. Bush and was roasted alive by the media and political figures for  defending outsourcing in 2004.

Adam Smith first talked about why make when you can buy it cheap theory in his economic treatise, “Wealth of Nations”. It was further developed by David Ricardo in 1817 and named the “Law of Comparative Advantage“. In short, the law states that a country can gain by specializing in a good/service where it has a comparative advantage, and trading that good/service to other countries. Even modern economists such as Paul Krugman have made additions to this law by proving that transportation costs can actually make or break it. Over the last two hundred years or so, the law has proved accurate with an astonishing effect.

For example, textile production moved from India to England in the eighteenth century, and then to the US and now to China, despite attempted protectionism and xenophobia. It is now spreading further from China to Vietnam, Bangladesh and other low wage countries. This is actually great for the consumers as they spend a lot less buying clothes sourced from a low wage country, but not very good for mill workers. However, the mill workers were forced to improve productivity, innovate and eventually move on to jobs that required higher skill and paid better. Obviously, several people suffered on an individual basis and there is no denying that.

Moving onto modern times and looking at a different industry such as software, where higher skill jobs are being lost to lower wage coutries, the same principle applies. A US software engineer today is far more productive nad paid better than his counterpart in India or elsewhere. By the time the productivity of the Indian engineer reaches his level, he would have already moved on to a better paying job that requires a higher skill-set, perhaps managing several such Indian software engineers.

The logic is pure and simple: India today has a comparative advantage in producing software and the United States will gain from buying Indian made software. In return, products/services that the US has comparative advantage in producing must be sold to India. Both coutries stand to gain from this trade. As India sells its low cost software, legal and back-office services to the US, the US can sell its expertise in nuclear energy and cleantech, defence, hi-tech, space, and infrastructure to India. In fact, today, India is or will be the biggest consumer of US made internet products or services – Facebook, Twitter, Foursquare, etc., and that will sustain thousands of US jobs.

It is also clear that Obama and his economic advisors actually get it. Obama talked about trade when he was in India this week and it makes boatloads of sense. He announced deals worth $10B where Indian companies will buy products/services from US corporations. This in turn will create close to 60,000 new jobs in the US. So, why point to outsourcing as the cause of domestic job losses when the real reason is that the US has not been able to sell its goods and services to its traditional markets – the EU and Japan, as their economies are slowing down as well? Domestic investments in factories and infrastrcture have plummeted as a result and jobs have been lost.

The reason is that outsourcing provides a favorite whipping boy and a tool to energize the vote. It has an emotional quality to it and allows politicians to empathize with scores of unemployed, and it makes good TV. Who wouldn’t cry when CNN shows the heart rending story of a steel factory worker who lost his job, his house and everything because his job moved to China?

But, the truth is, that blaming outsourcing for job losses is like beating a dead horse. It is a practice that has withstood the test of time and will not go away because a few politicians wish for it. Rather than engage in false propaganda, US should work with emerging economies in Asia and Latin American to lower tariffs and increase trade allowing for greater domestic investments and more higher paying jobs to boot.

I leave you with this:

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One response to “Outsourcing is a Red Herring

  1. The problem with the US right now is that there are many “comparative advantage” industries to create the kind of mass employment needed to bring down the unemployment rate meaningfully from 9.6%. there aren’t that many high skilled jobs to go around. It works for Germany since their population is smaller so they only have to specialize in a few markets. For every job that Apple creates in the US there are probably 1000 jobs being created in Foxconn. The other issue is of living standards – there is a reason why $20/hour is a wage that is not sustainable in the US when his indian/chinese counterpart is more than happy with $2/hour. Living standards will have to fall in the US (or stagnate) while the other countries who’s workers live in 1 room hut can afford to trade up, there is nothing wrong with it…. I agree better to embrace outsourcing than try to put barriers to it….

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