Sunday, May 9, 2004

The Natural Law of Outsourcing

For this election year, offshore “outsourcing” of jobs has become the lightening rod for rants from politicians, labor leaders, pundits and TV personalities.

As rhetoric heats up and emotions overflow, the frustrated out-of-work individual becomes susceptible to suggestions for irrational behavior. Hate crimes spring from irresponsible and irrational exhortations by persons in positions of influence.

In 1982, Vincent Chin, a Chinese American, was beaten to death with a baseball bat in the hands of two laid off white autoworkers who blamed their misfortune on the success of Japanese cars. After September 11, a number of Sikh Americans were shot to death simply because their turbans and beards triggered the vigilante in some deranged minds.

No wonder when prominent figures in America express outrage at the seeming unstoppable flow of jobs to Asia, Asian Americans cower and fade into the background.

To the economists, outsourcing is as natural as the falling apple bopping Issac Newton on the head. The analogous law in economics to gravity is called the law of comparative advantage.

Simply stated, the law says jobs will naturally go to where the task can be done better for less. Or, the job may simply disappear because of technological advances.

When multinational corporations outsource offshore, of course they are driven to reduce cost or, as detractors say, driven by greed. But making money is not only their fiduciary duty, it also creates jobs.

By moving less demanding and lower skilled jobs to third parties offshore, the savings can be reinvested in research or product development, i.e., higher paying jobs.

Frequently in today’s world, cutting cost is the only way to stay in business and thus preserve other jobs. The alternative is to close the door altogether.

In some places, such as China, multinationals may find it necessary to locate some high paying jobs there in order to be closer to the market. Revenue from their offshore business benefits the health of the overall company.

Silicon Valley venture capitalists now favor business plans with an offshore component because these companies will have improved odds of survival. Offshore outsourcing makes it possible to start some businesses that otherwise could not be economically viable.

Goods made offshore keep the prices affordable for the general public and create a progression of jobs to support the movement of the goods. Stable and low prices keep the economy growing without inflation, which obviously is also good for job creation.

Offshore outsourcing also leads to insourcing of jobs. As the recipients of the offshore businesses grow, they begin to establish offices and operations in the U.S. Japanese carmakers in Tennessee and Mississippi and more recently China’s Haier in South Carolina are examples of the reverse flow in jobs.

Recent but unpublicized findings reveal that the difference between number of jobs outsourced and those insourced is actually getting smaller.

Many have observed that by far the bigger cause for job reduction is due to gains in productivity. Wall Street Journal concluded that the U.S. lost far fewer jobs due to automation and productivity gains than the more backward economies such as Brazil and China.

The advent of automation in self-operated elevators wiped out hundreds of thousands of jobs for elevator operators. No one would now argue that the loss of those jobs as a bad thing.

While personally tragic to the person displaced, the outsourcing trend is inevitable and is actually a positive sign that the economy is allocating resources efficiently.

Protecting jobs per se is self defeating. Had we insisted on keeping the elevator operators, our operating costs would be higher, our buildings would be less efficient and we would have fewer resources to deploy for more productive pursuits.

Some pundits are justifying protectionism by repudiating the validity of the law of comparative advantage—as if water can now flow uphill. The near term solution has to be in anticipating the economic transitions and provide training and assistance to those affected.

Longer term solution clearly rests with making sure that the U.S. continues to be the source of ideas and innovations. Commercialization of new ideas is the top of the economic pyramid beneath which a foundation of new jobs are created.

Historically no other country has captured the essence of this truth as well as the U.S. and no where in the U.S. epitomizes this better than Silicon Valley.

To maintain that trend and stay on top of the heap, the U.S. must improve the education opportunities for the young. To continue the generation of innovations, the U.S. must not let anti-terrorism interfere with her ability to attract the best and brightest from rest of the world.

Rather than lamenting the outflow of jobs, America’s leaders should be much more concerned about the indications that the U.S. is losing its leadership grip on science and technology.
Co-authored with Dennis Wu