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America's New Competition


Take a ruler out of your desk drawer, lay it down on top of some economic trend graphs, and extend the lines out to 2015. What you're seeing is one vision of what lies ahead for the U.S. as China and India rise, and it ain't pretty. Three million U.S. manufacturing jobs have been lost in the past half-decade, so by the ruler method 6 million more will go poof in the coming 10 years. The U.S. merchandise trade deficit with China has been growing 20% a year, so the ruler says it should surpass a trillion bucks by 2015. By straight-line projection, China stands to trounce Detroit in autos and Silicon Valley in infotech, while India captures software and high finance. That would leave Americans to export raw materials, colony-style, and give each other haircuts. No wonder Paul Craig Roberts, a senior fellow at the conservative Hoover Institution, says that the U.S. is heading toward becoming a "Third World country."

Now put away the ruler, because real life rarely goes in straight lines for long. Remember the predictions about Japan's coming dominance in the 1980s? Or how Britain was called the sick man of Europe in the 1970s? Again today, the world economy may be on the verge of changes that will twist current patterns beyond recognition.

The rise of China and India will be better for the U.S. than the direst predictions hold -- yet worse than the Panglossian projections of boosters in America and Asia. On the upside, American consumers will clearly benefit from the availability of inexpensive goods and services. American shareholders of well-positioned multinationals will enjoy higher profits. And Americans employed in successful U.S. export sectors will benefit because China and India will buy more Western-style goods and services -- from cosmetics to jets to banking -- as they get richer and increase their consumption.

On the downside, life will be tough for those who are less skilled, less educated, and less able to adapt as the world changes around them. Even many highly skilled American service workers, from programmers to financial analysts, will suffer as low-cost Asian giants target U.S.-dominated businesses. "The individuals who are able to take advantage of the new opportunities do extremely well. Those who are poorly situated get hammered," sums up Gordon H. Hanson, an economist at the University of California at San Diego.

While it's impossible to say exactly who will feel the blow, it would be a mistake to assume that the trends of recent years will persist unchanged. For one thing, the U.S. won't keep producing less than it consumes forever. The winds of change blew this spring when the U.S. trade deficit shrank in the April-June quarter. That boosted GDP growth by 1.6 percentage points, trade's biggest contribution to economic growth since 1996. In coming years, India and China will consume more goods and services from the U.S. and elsewhere -- both because they will be richer and because they will shift somewhat from export-led growth toward meeting serious domestic needs. In China, the shift will mean more money for health care, housing, and the environment, and less for steel and chemical plants. China's health-care spending per dollar of GDP is only one-third that of the U.S., so there's lots of room for improvement. India, too, will divert more of its newfound wealth toward uplifting its poor. This will create opportunities to sell American products and services.

The beginnings of the new Asian opportunities are already apparent. As China modernizes, it needs more of the high-tech stuff the U.S. specializes in. Tech accounted for 22% of U.S. exports to China last year, up from 14% a decade earlier. American culture is a highly successful export to Asia. Such icons as Baywatch, The Apprentice, and American Idol have been licensed to satellite broadcasters in China and India. And America's financial giants like American Express Co. (AXP) are positioning themselves to provide sophisticated products and advice ranging from mortgages to brokerage accounts to retirement planning. Deals of this kind benefit American workers indirectly by creating a bigger market for products and services developed in the U.S.

American farmers are some of the clearest beneficiaries. U.S. agricultural exports to China tripled from 2000 to 2004, to $5.5 billion. Exports to India are also up. Mohnish Seth immigrated with his family from New Delhi to Chico, Calif., in 1990 to grow almonds for customers back home. Now family-owned Farmers International Inc. has thousands of acres of almonds and employs around 70 people, half of them fulltime. Says Seth: "This market is going to grow further because of the rising purchasing power in Asia."

There will also be plenty of jobs for Americans in meshing the U.S. economy with those of China and India. Tom Manning, a part-time resident of Hillsborough, Calif., has carved out a niche as a board director for Chinese companies that need American representation. He speaks fluent Mandarin, has lived in Hong Kong most of the time since 1995, and ran the Asian operations of several U.S. outfits. He and some partners even created a company called China Board Directors LLC. Participating in China's development miracle, Manning says, "has been a phenomenally supercharged growth experience."

But while China and India are opportunities, they are also threats. In Forest Grove, Ore., the library's budget had to be cut recently after one local electronics plant closed and another cut jobs under competition from Asia. In Casey County, Ky., the Economic Development Authority has stopped trying to attract call centers because it cannot match the low wages of rival operations in India. In North Canton, Ohio, Maytag Corp.'s (MYG) Hoover vacuum cleaner factory is laying people off under pressure from cheap Chinese vacuum cleaners. Melissa Knight, 28, a single mother, was laid off in June from a $15-an-hour job at the Hoover plant. She's collecting unemployment while hoping to be rehired. "It's all our fault," she says. "The American economy wants cheaper things.... I'm guilty of this, too."

`TRADABLE' OCCUPATIONS

Factory workers have been fully exposed to low-wage competition for years. Service-sector workers are just waking up to the threat. J. Bradford Jensen and Lori G. Kletzer, economists at the Institute for International Economics in Washington, say other economists have vastly underestimated the number of U.S. service jobs that could -- at least in theory -- be performed overseas. In new, little-noticed research, Jensen and Kletzer calculate how many people in the U.S. work at a distance from their customers, figuring that if their jobs can be done, say, 200 miles from the customer, they could almost as easily be done half a world away by people in Shanghai or Bangalore. By the distance criterion, they calculate that half of U.S. jobs are in occupations or industries that are "tradable."

Sure, not all 'tradable" jobs will go offshore. But under pressure to increase profits, American companies from General Electric Co. (GE) to IBM (IBM) are changing their business processes so they can take advantage of cheaper foreign labor wherever it is possible. Because their high salaries make a fat target, certain skilled employees can be highly vulnerable. Says Allen L. Weinberg, a McKinsey & Co. principal: "We are seeing a surprising amount of activity for some higher-end functions" that are easy to carve out and send offshore, including equity research and credit-card fraud detection. For Americans, offshoring of such jobs knocks out the lower rungs on the career ladder.

Among economists, the mainstream view continues to be that the full entry of China and India into the global economy is a plus for the U.S. as a whole, while producing some individual losers. A 2004 study that economic researcher Global Insight Inc. of Lexington, Mass., conducted for the Information Technology Assn. concluded that offshoring of computer software and services would add $124 billion to U.S. gross domestic product by 2008 by lowering inflation and interest rates and by increasing productivity and economic activity. And McKinsey Global Institute estimated that America gains $1.14 for each dollar of output that it sends offshore.

But those studies have come under criticism for being too optimistic. In a briefing paper this month, L. Josh Bivens, an economist with the Economic Policy Institute, says that the Global Insight study overestimates how much offshoring will reduce the cost of software in the U.S. The study by McKinsey, Bivens writes, incorrectly assumes that what's good for individual outsourcers is equally good for the American economy as a whole.

The U.S. benefits the most from trade when it and its partners specialize in very different things. The problem is that China and India are concentrating their efforts on the same areas that the U.S. already specializes in, like high tech, says New York University economist William J. Baumol.

It could get worse, according to a collaborator of Baumol, mathematician Ralph E. Gomory, president of the Alfred P. Sloan Foundation, who is a former chief scientist for IBM. Using linear programming, Gomory demonstrated that a rich country like the U.S. can in certain circumstances lose from outsourcing industries to a poor but rising country like China or India. Gomory's work is built on the common-sense notion that a country's share of global buying power depends on its share of global output -- and America's share of output is shrinking. Says Gomory: "If your trading partner is sufficiently underdeveloped, then if you lose industries to it, it's good for them and it's good for you. As the other country becomes more developed, the situation starts to turn around." While that's still a minority view, economists are beginning to grasp the possibility.

INNOVATION TRUMPS BRAWN

The good news? Even Gomory and Baumol say that the U.S. can still thrive if it invents new industries to stay one step ahead. So far, the surprise is not that China and India are pressuring American workers. The surprise is that the pressure hasn't been worse. Over the past two years, the U.S. has added 3.7 million jobs. Some of the fields most vulnerable to foreign competition have seen healthy gains because demand growth has more than offset the effects of offshoring. The number of jobs in computer systems design rose 6.9% from July, 2003, through July, 2005, the government says. In the graduating class of '05, the average salary offer this spring for computer science majors was nearly $51,000, up 2.3% from a year earlier and among the highest for any major, says the National Association of Colleges & Employers.

Even manufacturing is doing better than one might expect. Although the field continues to lose jobs, pay for those who remain is rising -- in part because workers are earning higher pay through higher productivity. Wages and benefits for blue-collar workers in manufacturing rose 3.7% over the past two years after adjusting for inflation.

Many Indians and Chinese are more confident about Americans' future than Americans are themselves. "By focusing on innovation rather than brawn, and ensuring labor and regulatory conditions are attractive...the U.S. will continue to attract and retain the best and brightest," says Manoj Singh, the Hong Kong-based chief executive of Deloitte Asia Pacific. Singh participated in a recent BusinessWeek Online roundtable of international experts on India and China, which is posted at businessweek.com/go/china-india/.

China and India are undeniably on the rise. Whether the U.S. can match Asia's dynamism is in America's own hands.

By Peter Coy, with Michael Arndt in Chicago


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