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ABSOLUTE LABOR DISADVANTAGE

One must be naïve or foolish or a basic simpleton to believe the rationalization behind job outsourcing. We are told of net job growth from the savings enjoyed by corporations. Cost savings from export of jobs to Asia permit a reprieve from business closure, since competition has become enormously difficult and rising costs force relentless cost cutting. Unless vast new businesses are spawned, no comparative advantage is gained. Officials like White House economic advisor Mankiw seem like street corner magicians working a shell game, when they claim net jobs are created from outsourcing. Instead, old jobs are preserved and new ones are created, just not in our country. The cost cutting advantage cuts across the entire service spectrum where the delivered product is based upon information and data. Output can be software, accounting ledgers, medical reviews, legal briefs, product design, or responses to questions, all lacking the personal physical touch, all delivered over networks. A tremendous slice of the US Economy is at risk of outsourcing. For a single company, the benefit is clear on the margin with cost savings. For the entire economy, we suffer from massive income loss, which is the essence of the Fallacy of Decomposition. The great majority of economists miss this critical distinction!!!

The work of David Ricardo on labor dynamics will be reviewed. He is being misquoted, just like Keynes has been. Capital investment is occurring in Asia by US firms. Our key advantage is technology, which we are transferring freely to Asia. We give away our only advantage, technology, while we build engines of wealth abroad. We talk about comparative advantage, when it aids the movement. We possess a crippling absolute labor disadvantage. We violate all of Ricardo’s guidelines, but boast of advantage.

Recently, global software giant Oracle announced plans to hire 250 engineers every month from India. Their outsourcing hub in Bangalore employs 6000 people to develop software in a truly complementary fashion, since the Asian region contributes 15% of the total revenue for the company. In the past, 10 to 15 years ago, Oracle would hire well-trained workers in US locations, our citizens. Now they expand Indian operations, because they cost 25% as much in salary expense. Charles Schwab recently moved part of its information technology division to a contractor in Bangalore.

THE POLITICS OF JOBS

The Asian labor pay scale is one to two orders of magnitude lower than that inside the USA. Job growth is the big story nowadays. However, the reality is that within the US Economy, jobs are produced by statistical models far more than from employers. Over 1.1 million new jobs show up on the Birth-Death model from the Bureau of Labor Statistics, which accounts for over 75% of claimed job growth. On the news, one can see proud claims of job growth, when they are mere estimates from questionable sources. This essay will not examine the fallacious grounds for that B-D model. Leave it that the model depends on data from an era long gone, before China was granted the Most Favored Nation in 1999, before worldwide connectivity and high-speed data transfer, before globalization had taken root. The B-D model probably is worthless; it is surely indefensible. Rather, a discussion follows on the complexity of the labor outsourcing initiative, which has accelerated in recent quarters.

Three principal issues define the public perception of the economy. Price inflation, aggregate economic growth, and job creation dominate their view. The issue of price inflation is offset in a huge way by home ownership, an asset which more than keeps pace with the price trend. Renters simply struggle. Economic growth, via the GDP, is a murky issue. The public has no idea of inventory buildup, or downward revisions from trade deficits, or the inter-relationship with productivity. Some of claimed GDP growth is merely unadjusted price inflation, kept low intentionally. They do understand job creation, especially when it applies to themselves, their family, and their close friends. It is doubtful that mainstream observers take the published 5.6% unemployment rate seriously. They know people who have lost jobs, whose work sites have announced layoffs, and those who no longer seek employment, the dropoffs who have exhausted benefits.

As a nation, whether leaders or citizens, we are incompetent in properly assessing the extreme threat to the US Economy from the trade gap, let alone Asian outsourcing. Critical to job creation is the location of business capital investment, where companies spend money to build big mfg plants with real output and paying jobs. A nation which depends upon foreign imports sends vast amounts of money abroad, a given percentage of which is devoted to investment in new equipment, new buildings, and new consulting to refine the mfg processes. That is not happening inside the USA, but rather in Asia. The side effect is that quality of US jobs has deteriorated, pay scales have worsened, as fringe benefits fall by the wayside. The great shortfall of job creation during this recovery is abysmal, millions below anything in past cycles.

The news is full of stories of job outsourcing, plant closing, and mass layoffs. The public hears of occasional propaganda that outsourcing creates net positive jobs, which is a cold heartless deception. The sponsors of such reports are US Mfg organizations who benefit from the lower costs and significant savings. How about a retort from the AFL-CIO? On their face, claims of net job growth are utterly ridiculous and laughable. Corporations continue to stand on the back of productivity claims, but in recent months have quieted such talk. It has become widely understood that productivity gains coincide with job layoffs, the two intimately connected. What began with increased output from new equipment brought online, and worker layoffs, has recently extended to increased output from Asian contributors. Clearly, and oddly, the US Economy has imported productivity from Asia. This viewpoint explains why productivity has failed to increase wages or generate much GDP growth at all.

The backlash has been an urgent plea to politicians to do something. Response from the party in opposition is for removal of tax incentives which support both outsourcing and migration of headquarters to foreign locations. Isolation and barriers have never worked to develop prosperity. Now is no different. What starts as protectionist policies disguised as tax measures can very easily shift to direct trade protection in the form of tariffs and restricted access to markets (whether supplies or finished products). Pressure will eventually grow beyond the threshold necessary to protect jobs in more direct forceful fashion. Friction with foreign rivals, even our friendly competitors in Europe and Asia, has escalated in the past year. The world courts have been quite active is ruling against one side or the other. The USA is a frequent violator of free trade laws and guidelines. We are more vulnerable.

Competition for scarce resources is here. Steel, reinforcement rods, copper, cement, and plywood lumber are in short supply. Two projects in growth centers dominate in demand. China is building roadways like there is no tomorrow. Greece is building Olympic venue facilities at breakneck speed. Their combined demand has led to stalled construction projects in Florida from cement shortage. If the trend continues, we will have heightened resentment for both job loss and material unavailability. The USA is slowly moving to second-tier priority. Politics, in such situations, responds to angry voters, anxious employees, and puzzled members from the business community. Pressure is put on politicians to act, often with grand errors the result.

It is my full expectation that two seminal events are on the horizon. First is inevitable trade protection, whose final form is in doubt. What begins as tax measures to thwart the flow of jobs to Asia, is likely to mushroom into tariffs on Asian imported finished products, and restricted access to our markets. Second is the unpublicized gradual withdrawal of Asians from US Treasury auctions. They have talked about regional support of a new Asian credit market. Trade friction will push their initiative into a reality. Isolation and impoverishment are the typical consequence of trade protection. The isolation suffered by the USA is almost sure to take on both commercial and financial implications. The backlash will seem harmless at first. Any new jobs, or protected jobs, might come at the cost of more unemployment and price inflation. A company which cannot compete without lower costs might lay off workers rather than pay them a higher wage. Products blocked at our loading docks from Asian sources will enable domestic suppliers to raise prices. My personal suspicion is that either constructive materials or food supplies (grains and soybeans) will lie at the heart of trade conflict with China. Halted projects can cost jobs. Higher food costs are very visible. Shipments of grain and soybeans to China are of a staggering magnitude, and growing.

No solution comes without a price. The last decade resorted to several underhanded devices to ensure a perceived economic prosperity. We as a nation have little to show for the claimed prosperity. The foundation of the 1990 decade of growth was debt and inflation on the one hand, contrasted with falsehoods on productivity and corporate earnings on the other hand. The 2000 “naught” decade is the time for payback to natural forces, which demand the reality of a painful ebb after the celebrated flow into the jaws of the bubble and bust.

THE COMPARATIVE ADVANTAGE MYTH

Much hubbub has been made of “comparative advantage” and how the United States benefits from round after round of creative destruction. The hollow message has that in free trade, both sides win, and where a job is lost, new jobs are created. Few if any advantages can be identified in the present framework, whereby lost jobs seem to be replaced mainly by debts inside the US Economy. The automobile invention ruined the horse carriage industry, but it spawned an entire new burgeoning industry. Failed businesses, poorly run, outmoded operations, when plowed under, they release valuable labor and capital for other growing businesses, so goes the theory. The current climate, however, reeks of much more sinister forces at work, operating on a playing field badly tilted out of American favor. American businesses are not replaced in an evolutionary advance, but rather moved elsewhere. Biotech and fuelcell R&D are two new promising areas, but Japan leads in follow through developing the latter. The previously sacrosanct service sector is under siege. US labor pay scale is five times greater than in India, and up to 20 times greater than China. The supply of their labor seems endless. Platforms have been capitalized, in a literal sense, to establish business and produce wealth, built upon lower labor costs. But those platforms have been driven by the market place not to be inside the USA. Foreign direct investment in China by US firms is responsible for roughly two thirds of the emerging giant’s growth.

The S&P500 has quietly become a leading indicator of world economic growth, led by China and Asia, yet another signal misread by our economists. Many US firms operate as multi-nationals, looking to expand in growing foreign markets. Dell made news this spring, as it announced it has more employees abroad than in the USA. Many US firms continue to invest in offshored mfg plants, to exploit lower labor costs. Many US firms make decisions to outsource services in “Chindia” but also in other economies whose labor force is smart, connected, and works cheaper. The S&P index reflects less and less on the USA and its economic prospects, with each passing year. This is a massive curve ball for our economists, who swing and miss.

Economists badly misinterpret the labor market here in the USA. They incorrectly label the delay in domestic job creation as “short-run friction,” when the entire business cycle clearly has been altered, perhaps permanently broken. What failed to arrive in reality, has now arrived in statistical models for jobs reports. Imbalances are worsening even as a recovery is supposedly gaining hold. Evidence is the acceleration of job outsourcing, and an escalation of debts. The largest segment for domestic business investment has been information technology known as “IT,” critical to the import of knowledge-based output. The Federal Reserve’s reflation initiative is having a perverse effect, raising production costs, which has increased pressure to outsource and reduce labor costs further. Fast rising health costs aggravate the cost situation. Stalwart among the various industrial segments has been the computer and networking systems. The IT segment is the USA’s comparative advantage. Unfortunately, it enables job loss when service jobs are sent overseas to Asia. Project requirements, progress reports, and finished products all fly along the network. The deliverables take the form of working software, accounting ledgers, medical reviews, legal briefs, and product designs.

The US Economy enjoys no comparative advantage, when investment takes place abroad by our corporations to exploit cheaper and competent foreign labor in diverse industries. Paul Craig Roberts wrote a highly enlightening article on this subject, entitled “The Harsh Truth About Outsourcing.”  David Ricardo’s doctrines, outlined in 1817, are misunderstood. His work 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.”  The US has an absolute disadvantage on labor costs, across the board, which affects manufacturing, service, and more. We produce at a higher cost uniformly. Health care and education seem the main sectors immune from exportation. The medical patient and academic student hold residence and live here. Nothing can stop progress in info-tech. Its future is enhanced, since it is invaluable in the outsourced of services. Leverage off computer and network systems, linked by broadband high-speed connections, serves as a catalyst platform for outsourcing the free trade of knowledge output.

Roberts stresses the key is the location of business investment, the mfg plant, which lately has been China and India in a major way. Our technology is unwisely being given away, freely transferred abroad (e.g. product or chip design), or used as the vehicle for shipping the final product (e.g. broadband connectivity) in the process. Wealth is being created abroad, not at home. In the information age, the comparative advantage enjoyed by the US is its technology, which we foolishly are not protecting. The open market is a one-way street. Americans will mainly be involved in the design, marketing, distribution, and sales. It is no wonder that wages are in decline. Increasingly, the design task (highest in food chain) is taking place in a foreign land, along with the building task which delivers wealth to the middle class.

The United States, with its higher wage structure, has an “absolute disadvantage.” Computer and network systems are our only advantage. However, lest one rejoice for IT as our great upper hand, be sure to know that Asian workers build most of our IT products. Asian plants build PC’s, mother boards, disk drives, network products such as routers and switches, even more complex fiber optic devices and servo motors. Recently, Dell announced they will conduct design functions in Taiwan from here on. The design cost is cheaper there, versus the USA, more evidence of absolute labor disadvantage even within the niche where we dominate.

As the work of John Maynard Keynes has been misapplied on federal stimulus, so now the work of David Ricardo is being misinterpreted on imported labor. Expect the entire topic of job export and its misconstrued benefits to become a raging explosive issue. Our national leaders are flying blind, and listen to very poor economic advice. A bias exists in economic counsel, which favors the corporate balance sheet at the expense of workers. Job outsourcing will become a class struggle issue. The crew of US economic experts in our nation has the worst track record in the entire world. They extend micro-economics to a national level, and deem it expert macro-economic analysis. Macro-economics and currency management are enormous defects and blind spots among the brain trust. A clear view is missing of the minefield ahead, as insufficient income will be available to service rapidly growing debt. We have passed the point where our income can support our debt. We are having great difficulty competing, since globalization has changed the entire landscape, exposing our absolute disadvantage. Job loss will eventually undermine our debt maintenance.

However, as both THE TIMES OF INDIA and ECONOMIST have recently noted, some jobs are in turn leaving India for even cheaper locales. Some are heading to China, Russia, Vietnam, the Philippines, Malaysia, and the Czech Republic. They are moving toward even cheaper labor costs than those in India.

COMMENTARY FROM THE DIVIDED EXPERTS

Pro outsourcing:
"The fact that foreign competition now impinges on services as well as manufacturing raises no new issues of principle whatever. If a car can be made more cheaply in Mexico, it should be. If a telephone enquiry can be processed more cheaply in India, it should be. All such transactions raise real incomes on both sides, as resources are advantageously redeployed, with added investment and growth in the exporting country, and lower prices in the importing country. Yes, trade is a positive-sum game."

-         "The Great Hollowing-out Myth," THE ECONOMIST (Feb 2004)

JW:  If trade is a positive-sum game, where is the trade? What does the US Economy receive on the income side of the accounting ledger in the course of ten thousand such transactions? We gain in lower costs for corporations. We lose worker income. That sums up the trade from my view. To claim that the cost savings result in new jobs is naïve and shallow, except in building the devices which enable the outsource itself. Usually, the savings come in the form of jobs which would have been axed without the outsourcing. It is a mystery how such intelligent analysts can overlook the aggregate loss of income.

"Calls for new trade restrictions to preserve current jobs are misguided. There is no significant difference between jobs lost because of trade and those lost because of technologies or work processes. All of those job losses are a painful but necessary part of the larger process of innovation and productivity increases that is the source of new wealth and rising living standards." 

-         Brink Lindsey, "Job Losses and Trade A Reality Check," THE CATO CENTER

JW:  A gross error is made in comparing creative destruction from jobs lost due to technology advances. When fiber optic and cell phones came along, old copper cage telecom jobs were displaced. However, the US benefited with a new niche creation. Entirely new and broad businesses were spawned which continue to expand today. When hybrid and fuel cell cars come along, old internal combustion jobs will be displaced. However, the US will benefit inasmuch as it possesses the insight and initiative to pursue the new trend. Japan might dominate this new burgeoning niche. The current service job outsourcing movement bears almost no resemblance whatsoever. It is a mystery how such intelligent analysts can overlook the investment made in foreign lands, and the total absence of creative destruction since no creation is evident.

Anti outsourcing:
"Millions of jobs in manufacturing and technology are shipped overseas to countries where companies can pay employees far less money. There are a number of companies that have continued to get federal funding while at the same time outsourcing jobs overseas...The Defending American Jobs Act of 2004, sponsored by more than 50 legislators, proposes to cut federal funding from companies that lay off workers at higher rates in the US than abroad. The legislation would also require companies that apply for federal grants and loans to declare the salaries of employees in the US and abroad."

-         Joel Barkin, spokesman for Rep Sanders, I-VT., principle sponsor of HR 3888

JW:  Loss of federal funds might only serve as a drag on a process which has huge momentum. US firms see domestic labor costs as uncompetitive. Besides, how many companies enjoy federal funding which outsource heavily? This issue might erupt into some weird battles, especially when military contracts are involved. Smart bombs used in the Fall of Baghdad contain inertial guidance systems, the magnets for which are outsourced from China. Will the proposed law apply to a subsidiary or conglomerate, perhaps with selected firms immune from the law? In the final wash, such laws seem like putting plywood on windows when the entire house is blown away. On the other hand, such laws are the beginning of protectionist measures, sure to expand in coming years. The foundation for protection is being laid.

"The argument that we will create new jobs in highly paying fields simply is not true. We have no comparative advantage or superiority in innovation. To assume that we are inherently more creative than our foreign competitors is both arrogant and naive. We are currently empowering our competition with the resources to innovate equally as well...The costs of the decision to outsource are not borne by the decision maker. Loss of jobs reduces the tax base, creates high unemployment benefit costs, and raises the cost of government retraining programs."

-         Rory L. Terry, "Answers on Outsourcing for The Dobbs Report," CNN/FN

JW:  Foreign lands have caught up in education. At least six times as many advanced degrees per year in technology and computer science are granted in Asia, versus the USA. This comment is the only one which even addresses the lost income to our economic base and impact on the federal govt from its safety net. Aggregate interpretations are sorely lacking, but are refreshing here.

"Some have suggested that the jobs lost to outsourcing are offset by the millions of American workers hired by foreign companies to produce new goods and services. However, the vast majority of employment associated with new investments by foreign companies has taken the form of acquisitions of ongoing US companies, such as Daimler's takeover of Chrysler. As a result of insourcing, 2.78 million US jobs were lost in foreign-owned firms between 1991 and 2001."

-         "'Insourcing Myths: Jobs and insourcing ," Economic Policy Institute (April, 2004)

JW:  The offset to job outsourcing appears to be creative acquisition, not creative destruction. Absent is any new birth of key niches at all. Govt officials point to foreign firms engaging in the same sort of activity on our soil as we do on foreign soil. Perhaps they should check their information. New foreign direct investment in China is enormous, and led by US firms investing abroad in new (read: NEW) plant and equipment. At the margin, the US loses jobs. At the margin, US firms create jobs abroad. At the margin, foreigners do NOT create new jobs with their investment here.

It is astonishing that the ECONOMIST and CATO CENTER fail to comprehend that lost jobs contribute to the decline of income at an aggregate level. Their focus is far too narrow and myopic. They can only see the benefit to the individual firms. They are thinking micro-economically in a macro world, erroneously. The cast of US economists fully embraces the essence of the Fallacy of Decomposition. What is good for one firm is a disaster for the aggregate, when a significant number of firms conduct business in a similar manner.

When I attempt to figure something complex out, I tend toward the extreme and then ask key questions. What if 30% of all US firms dispatched half their jobs to take advantage of lower Asian labor costs? What would be the impact to our economy? The result would be massive unemployment, reduced consumer spending, enormous govt subsidies to jobless, the drain of household savings, and systemic collapse. Why is this not more easily seen? Would the collective savings to our firms result in new job creation domestically? If business opportunity is seen abroad from systemically lower labor costs, why would that motivate domestic business investment? We are moving in the wrong direction, a direct result of decades of inflation.

If we enjoy a comparative advantage, its identity is clear. It is our INFORMATION TECHNOLOGY, with its vast computer and networking industry. Given that almost all of the IT sector manufacturing is done in Asia, how deep an advantage do we command? The latest news from Dell reveals a new directive to send PC design functions to Taiwan. The desktop portion of the IT industry has become heavily commoditized, and thus has seen Asia dominate. Software is slipping away slowly from our dominant grip, toward India. The server (especially with multi-processing), network switch & router, along with inter-connective products are still our advantage. The IT sector has been a leader among various mfg groups. A strange dynamic is evident. Our IT comparative advantage is a critical catalyst in the service outsource movement, even as its lower level IT portions are sliding toward Asia. Taiwan has been the center for PC mother board mfg, and will now move toward complete PC design. Dominance in mfg functions enables strong likelihood, due to proximity, to wrestling control of additional higher level functions such as design. The IT industry is at risk.

Kurt Richebächer calls macro-economics the enormous blind spot by US economists. Either they are incompetent or their thought process is subverted by local vested interests. My opinion is that both factors are at work. The outsource issue is but one more element to his argument. Few questioned the March report issued by a US Manufacturing organization, when it claimed net job creation from job outsourcing to Asia. The report seemed biased and worthless. It failed to identify reliably where the new jobs were created as direct consequence to the benefits of outsourcing.

NEWS TIDBITS

The nation has been put through a national security fire drill. The origin of the tipped information extends from the Al Qaeda subversive arrested in Pakistan last week. The President took this opportunity to recommend to Congress the creation of a single director to coordinate the intelligence community. Numerous targets were identified within the USA, including the Citigroup building in Manhattan, which has ties to a senior Saudi royal family member. Over the weekend, five Christian churches in Baghdad and Mosul were bombed in Iraq. A total of 7 people were killed as an increasing religious dimension is emerging in the conflict. Christians number less than 3% of the Iraqi population. The US Treasurys benefited from the safe haven sought.

More money might depart from Janus Capital Group following in the footsteps of an investor who plans to pull $5 billion away from the 10th largest mutual fund firm before the year end. News that the Denver company will lose roughly 3.7% of its assets under management in the next months, disclosed in a regulatory filing. The Federal Reserve announced it will close 9 check processing sites and cut 270 jobs (6% of current employees involved in such operations) as part of an ongoing restructuring as the use of paper checks yields to electronic forms of payment. Credit card association MasterCard said purchases using its credit and debit cards rose 11.7% in the second quarter of 2004 to $257 billion, propelled by an improving global economy and sunnier consumer confidence.

Construction spending declined by 0.3% in July. The ISM (Institute of Supply Mgmt) index rose to 62.0 for July, from 61.1 in June. American Airlines rescinded a $5, one-way increase in its domestic fares intended to offset record high fuel prices, after other carriers did not follow suit. Each 1-cent rise in the price of a gallon of jet fuel costs American Airlines more than $30 million a year, the carrier said. Each 1-cent rise in the price of a gallon of jet fuel costs American Airlines more than $30 million a year. In Q2 of 2004, American Airlines and its regional affiliates spent more than $900 million on fuel, up nearly 42% year over year. US steel prices, already at record levels, are surging higher on rebounding prices for scrap steel. Since the beginning of the year, steel prices have risen steadily, nearly doubling in some grades, buoyed by strong global demand, a weak USDollar, and the steep raw material surcharges used by many steelmakers to pass on rising costs to customers.

In early June, all 37 hedge fund managers surveyed by International Strategy & Investment thought President Bush would win a second term, but by last week, 53% were expecting a Kerry victory. For mutual fund managers, the figures have not changed much, with about 80% still seeing Bush back in the White House. On electronic betting exchanges like Dublin-based Intrade, the odds of Bush's re-election slipped from 75% in January to a low of 49% in mid-July, before regaining some ground to 54% today. "There are a lot of people here who have second thoughts about the war (in Iraq)," said Robert Hormats, vice chairman of Goldman Sachs International. "And there are far more than that who are concerned about fiscal responsibility in Washington." Friday's White House report saying the US budget deficit will hit a record $445 billion this year stoked those concerns.

TODAY’S MARKET

Today the Dow Jones Industrials wrapped up at 10,179 (+39), S&P at 1107 (+4.9), Nasdaq at 1892 (+5), TENS yield 4.45% (-2.3 bpt). Currencies closed with Euro at 120.28 (+0.21), JYen at 90.39 (+0.48), Can$ at 75.08 (-0.01). Metals finished with gold at 392.4 (unch), silver at 662.0 (+7.0), copper at 130.55 (-0.25). Energy ended with crude oil at 43.82 (unch), natural gas at 581.3 (-28.7), unleaded gasoline at 128.62 (-1.84). Prices are at major futures contracts.

Jim Willie CB

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