NS3040 Fall Term 2014

Outsourcing/Globalization

Outsourcing/Globalization

• A recurring issue in international economics involves the effects of globalization on the U.S. economy, especially as it relates to jobs.

• Several articles explore the issue from different perspectives:

• Daniel Drezner, The Outsourcing Bogeyman – conservative view – outsourcing good – increases efficiency

• Alan Blinder, Offshoring: The Next Industrial Revolution? – liberal view – outsourcing a threat, but probably inevitable, big but not necessarily good, changes lie ahead

• Michael Spence, The Impact of Globalization on Income and Employment: The Downside of Integrating Markets – balanced view – globalization brings threats and opportunities

• While none advocate protectionism, each has a somewhat different set of policy recommendations.

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Drezner: Outsourcing I• Wants to make the point that:

• Outsourcing a variant of comparative advantage at work – increases efficiency and makes the country stronger

• Simply involves subcontracting a business function to outside supplier

• Claims critics of outsourcing/offshoring don’t have the big picture:

• “Believing that outsourcing causes unemployment the economic equivalent of believing that the sun revolves around the earth: Intuitively compelling, but clearly wrong.”

• Feels biggest problem with outsourcing is the political backlash that may result in protectionism or other government action reducing the competitiveness of American firms.

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Drezner: Outsourcing II• Main propositions:

• Many of the figures on job loss are exaggerated or seem dire, but when look at % of labor force, rather small

• While manufacturing jobs have fallen, pretty much a global phenomenon – can probably explain using models such as product cycle – shifting comparative advantage, not outsourcing per se.

• Many companies that outsource operations upgrade remaining workers to higher value jobs

• Need to look at insourcing. For each dollar spend on outsourcing to India the U.S. gains $1.12 to $1.14 in benefits

• Because companies are more efficient and have higher profitability with outsourcing, they actually expand jobs by increasing investment

• When job loss occurs, best to cushion process rather than resort to protectionism

• Because outsourcing companies actually expand, the normal worker protections not in place – need to develop job insurance 4

Blinder: Offshoring I

• Also looks at offshoring/outsourcing as changing comparative advantage

• Longer run view than Drezner, so sees greater impact from outsourcing/offshoring.

• Compares the current wave of IT innovation as eventually having the impact as the agricultural and industrial revolutions

• With industrial revolution, if you could put it in a box, your job was insecure and likely lost with time

• With the IT revolution and offshoring, if you can send it over a wire, your job is insecure and will be likely gone with time

• Sees the economy rapidly evolving to point where the best jobs will be in personal services – areas that the product can not be put in a box or the service delivered over a wire – still some problems.

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Blinder Offshoring II• Complicating factor is Baumol’s Law or the cost

disease of personal services• Stems from the fact that many personal services,

productivity improvements common in manufacturing or agriculture are either impossible or highly undesirable

• Not good to play Mozart faster, school bus drivers can’t speed – professors shouldn’t talk twice as fast or cram more students into a classroom

• Prediction of Baumol’s law – the prices of personal services will rise relative to the prices of manufactured goods and impersonal services because costs fall more rapidly in other sectors

• Constantly rising relative prices have predictable consequences

• Because demand curves slope downward, the demand for personal services will decline.

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Blinder Offshoring III• Should mean decreasing relative demand for many

personal services and increasing relative demand for many goods and impersonal services over time

• Main exceptions are personal services:

• that are strong “luxury goods” (people get richer then want more of them) and

• those few goods that are considered “inferior goods) – as people get richer whey want fewer of them

• With regard to offshoring changing trade patterns will keep most personal service jobs at home while many jobs producing goods and impersonal service migrate to the developing world.

• Given that the demand for many increasingly costly personal services is likely to shrink relative to demand for ever cheaper impersonal services and manufacturing goods – major changes in the economy

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Blinder Offshoring IV• One adjustment reallocating labor from one industry

to another• Another will show up in real wages• As more and more rich country workers seek employ

in personal services, real wages for those jobs are likely to decline unless offset from rising demand

• Thus wage prognosis is brighter for luxury personal service jobs – (plastic surgery and chauffeuring) than ordinary personal service jobs (cutting hair and teaching elementary school)

• One implication – historically have felt more education better than less – may no longer be the case for some personal services

• Will need to rethink our whole education system to make sure it is producing graduates for the jobs that are likely to be available.

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Future Jobs I

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Future Jobs II

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Spence: Impact of Globalization I

• Less concerned than Drezner and Blinder with offshoring and outsourcing per se. Focuses on broader impacts of globalization and shifting comparative advantage

• Expands on some themes we looked at in the income distribution paper – role of education and impact on income distribution

• Main points:• Until about a decade ago, effects of globalization on the

distribution of wealth and jobs were neutral• Advanced economies growing at rate of 2.5% and in most of

them the breadth and variety of employment opportunities at various levels of education seemed to be increasing

• As the developing countries became larger and richer

• economic structures changed in response to forces of comparative advantage

• they moved up the value change

• now developing countries increasingly produce kind of high value added component that 30 years ago were exclusive purview of advanced economies 11

Spence: Impact of Globalization II

• These trends are likely to continue with impacts on the advanced countries even more intense

• By relocating some parts of the international supply chains, globalization has been affecting the price of goods, job patterns, and wages almost everywhere

• In advanced economies it is redistributing employment opportunities and incomes

• For most of the postwar period U.S. policymakers assumed that growth and employment went hand in hand – largely the case

• But the structural changes in the global economy today and its effects on the U.S economy mean that for the first time, growth and employment in the U.S are starting to diverge

• Major emerging economies becoming more competitive in traditional U.S. areas

• Job opportunities in U.S. are shifting from sectors experiencing the most growth to those experiencing less

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Spence: Impact of Globalization III

• The result:• Growing disparities in income and employment

across U.S. economy

• Educated workers enjoying more opportunities

• Workers with less education facing declining employment prospects and stagnant income

• Spence argues the U.S. government must

• develop long term policy to address these distributional effects and their structural underpinnings and

• restore competitiveness and growth to the U.S. economy

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Spence: Impact of Globalization IV

More detailed patterns:•Between 1990 and 2008, number of employed workers in U.S. grew from 122 million to about 149 million•Of roughly 27 million jobs created during that period, 98 percent were in the non-traded sector – goods consumed domestically•Largest employers in the U.S. non-tradable goods were government (22 million jobs in 2008) and health care industry (16 million in 2008)•Together the two industries created ten million new jobs between 1990 and 2008 or just under 40% of the additions•Meanwhile employment barely grew in the tradable sector of the economy•Tradable goods accounted for more than 34 million jobs in 1990, but added only 600,000 jobs between 1990 and 2008 14

Spence: Impact of Globalization V

• Dramatic, new labor saving technologies in information services eliminated some jobs across

• But employment in U.S. has been affected even more by fact that many manufacturing activities, principally lower value added components have been moving to emerging economies

• Trend causing employment to fall in virtually all of manufacturing sector except at the high end of value added chain

• However, employment is growing in other parts of tradable sector – finance, computer design and engineering, and top management at multinational enterprises

• Like top end of manufacturing these expanding industries and positions:

• generally employ highly educated people and

• are in area where U.S has a comparative advantage and can compete in the global economy 15

Spence: Impact of Globalization VI

In sum:•The employment structure of the U.S economy has been

• shifting away from the tradable sector, except for the upper end of the value added chain

• shifting toward the non-tradable sector

•Problem because non tradable sector likely to generate fewer jobs than is expected of it in the future•Moreover the range of employment opportunities available in the tradable sector is declining which is limiting choices for U.S. workers in middle income bracket•Unlikely employment in the government and health care in the U.S. will continue to grow as it did before economic crisis•Actually remarkable the U.S. did not have much of an employment problem until the crisis•If non-tradable sector continues to lose its capacity to absorb labor and tradable sector does not become an employment engine, U.S. will have a long period of high unemployment 16

Spence: Impact of Globalization VII

Other Side of the employment trends•Unlike employment, value added in the tradable and non-tradable sectors has increased at a similar rate since 1990•In non-tradable sector which experienced rapid employment growth value added grew slightly faster than employment – value added per employment increased modestly – 0.7 percent since 1990•On tradable side where employment levels barely increase, value added per employee rose very swiftly•Whereas in non-tradable sector value added per employee grew from $72,000 to over $80,000 between 1990 and 2008, in tradable it grew from $79,000 to $120,000•VA grew by about 12 percent in non-tradable sector but close to 57% in tradable sector•VA translates into personable income, dividends for shareholders interest on investment

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Spence: Impact of Globalization VIII

Picture clear•Employment opportunities and incomes are high and rising for the highly educated people at upper end of tradable sector of U.S. economy•They are diminishing at the lower end•Every reason to believe these trends will continue•As emerging economies continue to move up value chain and they must in order to keep growing,

• the tradable sectors of advanced economies will require less labor and

• the more labor intensive tasks will shift to emerging economies

•Highly educated US workers already shifting toward high value added parts of U.S. economy – returns on education are rising

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Spence: Impact of Globalization IX

• Highly educated and only them are enjoying more job opportunities and higher incomes

• Competition for highly educated workers in tradable sector spills over to non-tradable sector

• Raises incomes in the high value added part of that sector as well

• But with fewer jobs in lower value added part of tradable sector, competition for similar jobs in the non-tradable sector is increasing

• This in turn further depresses income growth in the lower value added part of the non-tradable sector

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Spence Impact of Globalization X

• Implications:• Evolving structure of global economy has diverse

effects on different groups of people in US• Opportunities expanding for highly educated

throughout the economy

• In the tradable sector because global economy is growing

• In non-tradable sector because that job market must remain competitive with the tradable sector

• But opportunities shrinking for less well educated• Developments not a market failure – externalities• Not economically inefficient – more efficient• Problem – everyone benefits from lower priced goods• However people care greatly about chance to be

productively employed and the quality of their work

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Spence: Impact of Globalization XI

• Problems with globalization

• Ample labor available in various skill and educational categories throughout tradable sector globally

• Companies have little incentive to invest in technologies that save on labor or otherwise increase the competitiveness of the labor-intensive value-added activities in advanced economies

• In short, companies private interest (profit) and the public’s interest (employment) do not align perfectly

• Conditions not permanent if

• Growth continues to be high in emerging economies

• In two or three decades there will be less cheap labor available there

• Still two or three decades along time

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Spence: Impact of Globalization XII

• Spence feels even though public and private interests are not perfectly aligned today – not perfectly opposed either

• Relatively modest shifts at margin could bring them back in sync

• Would not require great changes to restore employment growth in tradable sector of U.S. economy

• Specifically

• Right combination of productivity-enhancing technology and completive wage levels could keep some manufacturing industries

• Or at least some value added piece of production chains in the U.S. and other advanced countries

• Involves more than market forces

• Most also involve labor, business government

• Germany good example of cooperation of these groups.22

Spence: Impact of Globalization XIII

• Germany managed to retain its advanced manufacturing activities in industrial machinery by removing rigidities in labor market

• Making a conscious effort to privilege employment over rapid rises in incomes

• Wages may have increased only modestly in Germany, but income inequality is markedly flatter there than US where it is higher than most other industrial countries.

• Combination of initiatives necessary:

• Education important, but can’t be the whole solution

• Need better infrastructure

• Tax structure needs to be reformed – simplified and reconfigured to promote competitiveness, investment and employment

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