On Trade and Living Standards

Posted by: Michael Mandel on November 01

One of my favorite commenters, Ajay, writes:

Wow, when the chief economist at Businessweek is capable of writing a sentence like “if U.S.-based companies are doing their research and product development overseas and their production there as well, it’s tough to see how ordinary workers in the U.S. will gain,” it’s easy to see why this magazine was recently sold off for almost nothing, around $5 million, or around $15k per employee as one article estimated. The ordinary worker gains because they can buy goods for cheaper, it’s that simple.

Actually, it’s not that simple. If one nation improves its capabilities while others stand still, there’s nothing about the arithmetic of trade that requires that all nations benefit.

The simplest way to see this is to think about oil. Suppose that a very cheap substitute for oil was discovered in the U.S. Clearly U.S. standard of living would rise, and overall the average global standard of living would rise—but the standard of living in the oil producing countries of the Mideast would fall dramatically.

The parallel here—if China improves its R&D capabilities while the U.S. stands still, there is *nothing* about the arithmetic of trade in a multinational world that requires that Americans will benefit. Nothing.

I stand ready for people to argue with me.

P.S. Hopefully I’m not to blame for BW’s sale!

Added November 3: Novartis announced that it is going to invest $1 billion over the next 5 years for a new R&D facility in China. Just a few days earlier, the company announced that overall R&D expenditures were down by 6% over the previous year. You draw your own conclusion about the future path of spending.


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Reader Comments

lark

November 1, 2009 01:34 PM

Keep up the good work.

You are not just challenging the prevailing ideology, you are challenging the way that many people earn a living. You will get pushback.

Ajay

November 1, 2009 01:53 PM

Mike, let me preface this comment by saying this is the only blog I read regularly. Whatever my concern about your analysis or political goals, I always appreciate how you bring data to the discussion, particularly your national wealth per capita charts in the past. Perhaps the next Fed release would be a good time to chart that data again, to show how much exactly has been lost in the recent downturn. As to your point, you continue to fall prey to the fallacy of composition, using the extreme example of oil to make an incorrect point. While there is no doubt the engineers doing R&D here in the US lose out temporarily if their work goes to China, the rest of US consumers benefit by getting the same products researched in China for cheaper. On the whole that's a net gain, as the smart US R&D engineers are freed up to do something more innovative, that the Chinese haven't been able to think up yet, and US consumers get cheaper goods. You carefully avoid the gains to consumers that I pointed out, choosing only to focus on the relative R&D jobs in China vs the US.

As for Businessweek's sale, McGraw-Hill claims it's a money pit, losing $20-40 mil/year, clearly that's not your fault alone. However, I don't see how writing such half-baked analyses helps, plus as an economist, how have you helped monetization, which is clearly the key issue with Businessweek or any other publication? I've commented on this blog about micropayments being the solution for a year now, so you're clearly aware of the idea and its importance, yet I see no indication that Businessweek pursued that idea, while the WSJ announced a micropayments system 6 months ago. You may not have sunk the boat, but everybody in a business can help keep it afloat.

Brandon W

November 1, 2009 04:10 PM

I see two problems with Ajay's statement: "...the smart US R&D engineers are freed up to do something more innovative, that the Chinese haven't been able to think up yet..."

First (subpart A): This assumes that U.S. engineers are so much "smarter" than Chinese engineers, (subpart B) that they can come up with something revolutionary (because evolutionary won't cut it) like they make toast.

Second, that those engineers can do it while unemployed or working at Starbucks. Maslow's hierarchy comes to mind.

Stephen M

November 1, 2009 04:34 PM

Ron Hira has been writing about this topic for a while now. He agrees that when technological capabilities, not merely goods, are transfered from one nation to another, trade theory does not apply. See, for example, chapter 4 in this book:
http://www.americanmanufacturing.org/manufacturing-a-better-future-for-america/

Russ S.

November 1, 2009 05:16 PM

So basically, we have played the role of Spain in the 17th century (new world gold = USD), and China has played the role of 17th century England and Holland. In the end, English and the Dutch got both the manufacturing capabilities and the gold.

What a deal! I'm emigrating to Australia, where at least the resources-to-population ratio isn't as grim at it is in the US.

I love the blog, Michael. Keep up the good work.

Mike Reardon

November 1, 2009 06:59 PM

iPod classic, iPod touch, iPod shuffle, iPod nano, iPhone: and I’m not even going to give you the selling point of the brand “Created here, but made in China”, because that is not the real center of greatest profits from these inventions.

The real profits come from the iTunes services in Music, Movies, and web apps, that are purchased by the customers who use these inventions. These are in fact the real center of profits from these inventions in this and in world markets.

Even if you remove future creation from here but apply any new applications that these invention embrace, you can still generate future profits.

Business Week has to hope a Kindle 2 gains traction in selling your product into new markets. McGraw-Hill’s future Text Books sales, needs a Kindle reader service or any eBook service that can generate there future profits.

As long as you apply expanded technological services into your market you can generate new profits. The origin of the product has to be a secondary consideration.

And I’m not really sure but I’d bet, in the retail sale price of the Apple products. Its servicing the local cost that adds the most to the price, not the product cost itself.

logic

November 1, 2009 09:12 PM

I agree with Michael (and thanks Michael for taking an "unpopular" stand counter to the status quo in economics). To Michael's detractors, keep in mind that for high-wage country workers to be able to find new things to do, per the happy path free trade theory of David Ricardo from 200 years ago, capital has to relatively immobile between countries. This enables Ricardo's postulate that when one industry is done in by foreign competition, national investors have to look at what's new to invest in, *within their borders*. Pay attention please: in the very early 19th century when Ricardo wrote, this was true. How hard is it to transfer funds between countries today? It's ridiculously easy, even for non-financiers. This blows a huge hole in the notion of "relative advantage." What matters now is absolute cost advantage, and America loses, bigtime. The mobility of capital today means that American jobs will get axed until Americans are paid like Somalis, *then* capital will have a look around the U.S. for opportunities. Unless we recognize that David Ricardo's theory applied to David Ricardo's world, and not our century, American workers are going to be driven to extinction in the next 2 decades. Don't believe it? Wait and see.

Phanindra Palepu

November 1, 2009 09:16 PM

I agree and disagree with my dear friend Ajay..

1. It is not necessary that every R&D needs to be done in USA. They can outsource a portion of work to other countries which helps to reduce the cost involved in the overall process, allowing them to maximize profit.

2. At the same time it is absolute foolishness to outsource your entire production and R&D capabilities to another country. No country will progress by being a mere consumer of goods and not producing anything in house.

Strategery

November 1, 2009 09:30 PM

The "cheaper goods" argument is simply false. Sure, if a factory is moved to China, the goods MIGHT get cheaper--but usually the savings are kept as profits, not passed unto the consumer. In addition, not everything can (or should) be outsourced. While you take a pay cut because of outsourcing and enjoy SOME goods that are lower in price, things like housing, utilities and doctors cost the same amount, so your real wages are actually falling. History has shown time and time again that strong domestic industry means a strong country with a strong military to protect it. If you look at ancient Rome, Spain, the UK and soon the USA; the demise started with outsourcing and running trade deficits.

Tom E

November 1, 2009 09:51 PM

Michael, you are always ahead of the curve and the pioneers get the arrows.

Part of our problem is that we are being taken to the cleaners by mercantilists. For instance, Indians talk a lot about comparative advantage and champion outsourcing IN THE US, but ban outsourcing in India. There are Chinese who would do work for less in India, but they cannot get work permits.

We in the US were out selling the benefits of free trade and we accepted bad deals to keep the ball rolling. We can no longer afford to do that and we must revisit some of the previously made deals in order to get some balance.


Tom E

November 1, 2009 09:59 PM

Logic nailed it "David Ricardo's theory applied to David Ricardo's world, and not our century."

In addition, productivity improvement is good when the extra profits are reinvested in the US to create new jobs and industries, to sop up the displaced workers. Creative destruction.

However, when the extra profits from increased productivity are reinvested overseas, then all we get in the US is less jobs, less money spent in the US economy and a falling standard of living.

That is what is happening now.

Doug

November 1, 2009 10:26 PM

Ajay is quite smug to be calling Micheal "half baked", when it is he who has removed his buns from the oven before their time. There is no advantage to the American workforce in the present situation, and likely some sort of revolution is the only "change I can believe in"
I'd say that it comes down to the build up of a society over the last 70-odd years that drilled out, processed, and burned oil as quickly as humanly possible. It worked great-until the early 70's, when American production started to decline. Now that production is peaking world wide, the whole economic model is disintigrating. Companies have to scramble to cut costs, as consumers devote a higher percentage of income to energy, and less is left for other expenditures. We are only at the beginning of the "crisis" stage of this scenario.

Sanjay

November 1, 2009 10:43 PM

Let's not restrict this discussion merely to outsourcing to other nations. Businesses can easily outsource to partners outside of their own company but within the same nation. Businesses can likewise do away with less value-added forms of labor by replacing them with automation. The same arguments about arithmetic can likewise apply to these things too. Outsourcing to another locale is simply another form of economic choice. It's not as if Indian or Chinese businesses don't outsource as well - they certainly do.
Rather than merely think in terms of national boundaries, one could think in terms of other boundaries, such as the management-labor divide, and ask why blue-collar workers should selflessly trust in their trade skills being valued by a management that might ditch them at any moment in favor of automation/robotics. Why shouldn't the blue-collar grassroots have voted for socialism long ago, ignoring the arguments from a white-collar class that wasn't yet feeling the pain of being replaced? People only invoke nationalism and socialism when it's their own necks on the line, whereas previously they wouldn't have cared less when it was only someone lower down in the food chain being affected.

Sanjay

November 1, 2009 10:45 PM

Strange, I can't even get my comments to appear.

lark

November 1, 2009 10:49 PM

I think the next year will show up a very difficult truth: we are sliding into an unemployment abyss. We have outsourced too much and now we don't have a consumer class to support demand and related investment and jobs. We have hit the wall. That is because the trade models of win-win are wrong, and it is win-lose, and we are the losers.

KHM

November 2, 2009 02:52 AM

So, the "old" wealthy countries will get poorer, their people will be less able to buy the goods of the new "cheaper" countries. Who will the latter then sell to?

So, what will they do? Does anyone know?

Bart

November 2, 2009 05:21 AM

Once Americans no longer have jobs, and their savings and unemployment benefits have run out, it no longer matters how cheap the dress shirts are at Walmart.

Squeezebox

November 2, 2009 09:30 AM

Subsistence wages leads to subsistence consumption. Business is just now beginning to see the fruits of the commoditization of labor. As wages go down, consumption goes down, and the least efficient companies die anyway. That pushes wages down, that pushes consumption down, that pushes the number of companies down. It becomes a vicious cirle in which the people die of starvation.

Bob

November 2, 2009 11:07 AM

Here is the statement that always, always rings false: "While there is no doubt the engineers doing R&D here in the US lose out temporarily if their work goes to China, the rest of US consumers benefit by getting the same products researched in China for cheaper."

Why is that false? Because if everything goes overseas (as US companies are sending them), how will be able to afford anything, no matter what the price. I think that those in charge of multi-nationals WANT that. THEY want to be the power brokers while the rest of us work in crappy little jobs and eek out a living. And when they get in trouble by being greedy and stupid, they take what little money we have (through govt bailouts) and pad their nests while telling us all how lucky we are to have them.

Stop and think about this. How did China and India rise so quickly. By the US and Europe investing in them. Our stupid and shortsighted CEOs sold us out for short term gain. And if they say they can get things made cheaper "over there", then why do THEY still get paid like Kings? Can't we get our CEOs out sourced as well.....They have proven to be idiots...just like they think we are.

HiNetReturn

November 2, 2009 12:31 PM

While Europe was smart enough to enact a Value Added Tax allowed by GATT, the US took the approach that we don't need a European tax model. The EU now has a basically balanced trade picture while the US has gone from balanced to $1 trillion in the last 30 years. It will take only 5 more years to get to $2 trillion and 2 more after that to get to $3 trillion. Then we won't be able to afford health care, the space program, foreign wars or anything else. Wake up stupid. Get rid of the Washington Corporatists and the Free-Trade One sided Economists. Just look at the charts for the trade deficit and the national debt. They tell the true picture. You don't need 200 year old economic theories to see the truth.

AJ

November 2, 2009 12:32 PM

The argument made by the blogger is correct. More mundane and less value-added tasks will go overseas, freeing up talent in America to improve their productivity (and value) by only focusing on high value-added tasks. Of course, those without high value-added skills will suffer.

This explains in large part why unions are concentrated amongst those with the lowest value-added skills (i.e. assembling cars, writing code, cleaning buildings). They're trying to protect jobs that are easily replicable elsewhere or by others demanding lower salaries because they can't put up the barriers to entry (skills, knowledge base) against others who can easily match them.

Phanindra Palepu

November 2, 2009 12:55 PM

Wow.. Bob's last line looks perfect.. Its better to outsource CEOs than R&D.

I am from India... and as i quoted earlier it is never advised to outsource your entire work force to India.. definitely not.

But you can realize some benefits by outsourcing.. like 24 hours work in progress, cheaper resources for low profile projects etc.. Outsourcing all the work to any country is not the right way to do.

Dollar is losing its purchasing power due to these rising trade defecits and it will continue to do so until the Government learns that a self reliant country is a strong country.

Phanindra Palepu

November 2, 2009 12:56 PM

whats the matter with the comments section.... comments dont appear after posting?

LAO

November 2, 2009 01:54 PM

I'm not about to argue with Mike Mandel's premise here -- it seems self-evident to me.

Before anyone gets too far into the irony of a business publication losing money, note that Jack Welch himself has written a BW column for some time, certainly not for free, and his advice to those enraged at poor business leadership was to go to a baseball game -- a real slap in the face from an "I got mine" kind of guy, and totally useless.

Thanks to other contributors, like Mike Mandel, I've taken away from Business Week enough insight over the years to land squarely at the bottom of the top of the heap -- a lot better than the vast majority of Americans. BW told me years ago to anticipate major recession after a prolonged gas price spike. They noted in far more robust times that there has never been substantial long term growth in an economy where significant inequality prevails between the top and the bottom. It was probably Mike's earlier work that made me recognize that risk is being increasingly transferred to the individual, inspiring me to act accordingly -- sometimes it seems that I'm the only one who gets these messages. In other words, BW has consistently tried to give us the knowledge to keep from shooting ourselves in the foot, but we do it anyway, and then whine and blame the messenger. If the readership would pay attention and act like leaders, then the economy would probably be robust and the magazine would be fine.

I compliment Doug on his observation about energy. Though correlation does not constitute proof, one can easily construct the case that it is neither economists' cherished technology nor innovation that has driven economies forward, but cheap energy. It is my opinion that the encroaching lack of it will kill us if we don't reinvent the good life and the means to make it happen. Further, to deny a whole population the experience of creating much of what they require to live is to guarantee that they will not be the ones who save humanity from a steady slide downward.

The simple formula answer to everything that the Ajay's of the world expound upon endlessly grows tiresome. The U.S. dollar will not stay strong enough to keep imports cheap when the only resource we Americans have left is our large egos, having jettisoned the humility that enabled us to fashion what worked well in past times. No problem, Ajay would say, it will all come back to us when the pendulum swings, but the price of having forfeited expertise and infrastructure may be too great to pay.

Sorry for being so long-winded. It is too easy to be verbose, and too hard to actually become one of those leaders that I might admire.

Cal Bear

November 2, 2009 04:07 PM

Obviously Ajays angry reaction to Mikes blog post stems from a perceived threat to Indian outsourcing and H1B/L1 'temporary non immigrant' visas - most of which go to Indians.

Sanjay excoriates us for thinking in terms of 'national boundaries'. Yet, where are the angry Indians yelling 'racism', 'protectionism', 'xenophobia', or 'socialism' here?

India to Chinese investors: No more visas, hire Indians;

http://economictimes.indiatimes.com/India-to-Chinese-investors-No-more-visas-hire-Indians/articleshow/5019220.cms

Indian Govt tells expat workers on biz visas to leave

http://timesofindia.indiatimes.com/city/ahmedabad/Govt-tells-expat-workers-on-biz-visas-to-leave/articleshow/5053028.cms

Expatriate executives making way for local hires

http://economictimes.indiatimes.com/News/News_By_Industry/Jobs/Expatriate_executives_making_way_for_local_hires/articleshow/4039529.cms

“Request for employment visas for jobs for which a large number or qualified Indians are available should not be considered,” the ministry of commerce and industry has stressed in a missive to clarify the government stand on visas to foreign nationals.

http://www.financialexpress.com/news/getting-an-indian-work-visa-will-be-tougher-now/526347/

India Sends the Foreign Pilots Back Home;

http://online.wsj.com/article/SB124182155998502089.html

IT Jobs-for-locals demands Shiv Sena;

http://timesofindia.indiatimes.com/articleshow/323498.cms

Ironically; India to ask US for more H-1B visas

http://economictimes.indiatimes.com/news/news-by-industry/services/travel/visa-power/India-to-ask-US-for-more-H-1B-visas/articleshow/5137427.cms

ONLY western nations (US/EU/CAN/AUS) are expected to embrace 'multi-culturalism', 'diversity', and open immigration - or face the wrath of nations that don't!

http://www.japanprobe.com/2009/11/01/anti-foreign-protests-in-tokyo-on-halloween-night/

http://answers.yahoo.com/question/index?qid=20090218181856AAwSnoj

Never mind that nations that shun 'multi-culturalism', 'diversity', and open immigration - India, China, Korea, Japan, etc seem to be prospering in the 21st century - these blatant double standards are sure to raise racial/ethnic/national tensions in years to come.

Cal Bear

November 2, 2009 04:18 PM

Where are the angry Indians spewing vitriol and screaming 'protectionism', 'racism', 'xenophobia', and 'socialism'???

"India's restrictive commercial laws prohibit most foreign companies from setting up shop to compete with domestic retailers. So Wal-Mart's debut outlet, which will open in the city of Amritsar in northern India later this month, is a wholesale-only operation that will sell mainly to vegetable vendors, hospitals, hotels, restaurants and other companies."

http://www.time.com/time/world/article/0,8599,1898823,00.html

Phanindra Palepu

November 2, 2009 06:10 PM

And once again I agree with the views mentioned above partially only,

India with a population of 1 Billion cant afford losing jobs.. But thats entirely different than the China issue.. India and China are engaged in a cold war and they are threatning each other not to open their borders to each other for free trade to get their point across. Dalai lama issue looms large on their relations. India being a supporter of free budhist country of Tibet and China of course will not let that happen.

Regarding opening up markets, India started moving towards capitalism from last 10 years, so it will take time to become more corporate friendly... We are just 60 yr young country (got freedom in 1947), the socialist ideals coninued until mid 1990's. Its just a matter of time Walmart will open its store :)

And yes its true India thinks twice before allowing anybody step into their country because of the higher unemployment rate and being situated in a volatile political and military zone.

But thats different from USA's case, USA only allows H1b visa for skilled labor, IT professionals, Doctors, Engineers and that is because there arent enough US nationals planning to study in College in these fields.Everyone is dropping out after school and not interested in college education.

If there is a requirement for doctor in a hopital and and Indian doesnt fill it up, is it getting filled up by an american? Unfortunately the answer is a BIG NO!!! Which is sad, the worlds richest country doesnt have enough college educated people. Which is total failure of US governments in stressing on importance of education. More interested in Britney spear's day to day life than their own future, you are creating your own problems.

I know every Indian who ever visits an University here wonders at the facilities and infrastucture that are available, but unfortunately these are never utlized by the very citizens of USA. Half of the US college goers in skilled fields are Chinese, Indians, Koreans etc.. WHY????

Well, Dont bias yourself against any country. I agree that outsourcing is bad, I agree that free trade has its caveats and should be managed with caution.

I once again iterate that one should Only provide visas or outsource jobs, if and only if there is a shortage of expertise in that skill set.

Firing an american software engineer for an outsourced job is bad. I agree. But that also throws a question to you.. Why are the companies doing this and what can you do to prevent this?

The answer is to have good education, work hard and realize that there is nothing called easy money. How many folks in this forum have credit card debts?? I am sure most of you. Same with America, they kept borrowing from every country so that it can party!!

USA did not become a great country over night. There was lot of hard work and values involved. The future generations need to have good education for it to be a rich country again.

Kaleberg

November 2, 2009 10:45 PM

Whenever someone starts nattering on about the glories of free trade, I just ask them to name one country that industrialized and developed a middle class without some form of protectionism. It might have been high tariffs, government subsidies, ownership restrictions, currency manipulation or colonial mercantile restrictions, but no nation ever moved ahead by relying on free trade. (The Brits may have talked a good free trade game, but the British Navy talked a pretty good game as well.)

Rob

November 4, 2009 04:07 AM

WOW. Digesting Mandel's, general, somewhat generic observations of what's taking place with and the consequences of, US-based corporate capital & investment flight to foreign states/markets and finding it worthy of merit because it's fairly-ACCURATE. AND THAT'S WHY I'm SCARED...the robust repsonses posted, although passionate in tone, are completely off the wall. MOST OF YOU COMMENTERS reflect opinions, feelings, critisms that are wildly lacking academic-soundness with your pts/arguments not reflecting any basic rationale drawn from study/personal knowledge of(Econ-Theory/Observed models). IT'S SCARY. Mandel is ACCURATE - the prevailing forces sustantiating Mandel's perspective...is simple global "free"-market enterprise using it's related Economic theories, as a guide. Simple because - OUTFLOW($$$)-COUNTRY X/USA, and it's specific industry investing abroad, is doing so because it doesn't have a COMPETITIVE advantage in it's specific capacity/industry at home. RECEIPIENT$$$-COUNTRY Y/China DOES have the competitive advantage. Why would it be receiving such multi-national corp investment funds/etcc in the first place. If the US market cannot flex it's inventive/entrepreneurial business development muscle, or have persons through great mental dexterity to patent new products/research or even technologies where the by-product will be a newly created speciality niche-market/industry - that will demonstrate a US-competitive trade advantage within the global trade-mkts due to it's uniqueness/or highlyspecialized human-capital associated with it, then the US worker WILL suffer cue to less jobs available, less consumer spending, perception of less economic stability, all because the US industries could repsond to global market changes and identify a more efficient industry & competitive good to produce & peddle out.

Debora Edholm

November 13, 2009 07:55 AM

Global market changes are not really the issue here, currency is. The U.S. dollar is in the crosshairs of 3 schemes to dethrone it as the world's reserve currency. Inflation is on the horizon. The dollars value has sunk 11.2 percent on the N.Y. stock exchange in just 4 months. China and OPEC have their own plans to destroy the dollar. With all the jobs in the world the country is heading for disaster because the dollars people receive will not buy much. The only safe place is in the metals. I can see gold at 3 grand and silver at 50 to 100. It is not the jobs it is the currency................

Thank you for your interest. This blog is no longer active.

 

About

Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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