Outsourcing

by Fred E. Foldvary, Senior Editor  The Progress Report

A company out sources when it contracts with other firms to provide a product rather than producing it internally. The source of the service is outside the company. Nowadays much of outsourcing by American companies is not only outside the firm but outside the country.

It has become common for a service done over the telephone, such as customer support and inquiries, to be handled in a country such as India, where wages are much lower. Usually the American caller does not realize that the technical support person is an Indian trained to speak like an American.

Outsourcing is a big political issue in this year’s elections. Millions of jobs have been outsourced to foreign countries in recent years. National output is recovering, but jobs are lagging behind. Outsourcing is blamed for the job loss and continuing unemployment. More and more, America’s goods are made in China and its services are done in India.

Will all American jobs vanish other than those that require a personal service? Maybe even haircuts will be done abroad in the future using machines that are controlled by a computer run by a foreign operator!

Maybe when you have a medical checkup, it will be an Indian doctor examining you with a camera and robot!

When an Indian answers a telephone call, this is an imported service just as much as if goods were being imported. The same economic principles that apply to the trade in goods apply to the trade in services such as telephone calling or accounting. The trade does not take place merely because the foreign service is cheaper in dollars. The trade is based on comparative advantage.

Consider a lawyer and her secretary. Suppose the lawyer charges $200 per hour for legal services. She can hire a good secretary for $20 per hour.

The lawyer happens to be a better typist; she can type twice as fast as the secretary. Should she hire the secretary or do the typing herself? She should hire the secretary. If she did her own typing, the lawyer would save $40, the price of two secretaries per hour, but she would lose $200 of legal-service revenue. The lawyer has an absolute advantage in typing, but the secretary has the comparative advantage in having a lower opportunity cost, what would be given up.

Now consider an example in international trade. Suppose the US can make $100 of computer parts with 2 hours of labor, and $100 of television parts with 3 hours of labor. Suppose that Japan can make $100 of computer parts with 1.5 hours of labor, and $100 of television parts with 1 hour of labor.

Japan has lower labor costs for both. Will it profit Japan to trade?

Yes. If Japan does not trade, it requires 2.5 hours of labor for $100 of TV and $100 of computer parts. If Japan only makes televisions and imports computers, it only requires 2 hours of labor. The U.S. requires 5 hours of labor to make both, but if the U.S. only makes computers and imports televisions, it can make $200 of computer parts with 4 hours. Even though the U.S. has a higher cost of labor, trade is mutually beneficial as each country specializes in its most productive industries.

Thus trade by itself does not create unemployment. Trade makes the economy more productive, and that has to be good for employment. In the long run, outsourcing is like any other trade, reducing costs and increasing the standard of living.

Of course, that is a long-run benefit. In the short run, sudden changes in trade will create unemployment in those industries that decline.

Workers need to shift to other industries, and maybe move to more productive locations. But this is no different from changes caused by advancing technology. For many decades, there is been a shift of employment from farming to urban industry because technology has made agriculture more productive.

The employment problem is not caused by trade or outsourcing, but by government intervention. Legal restrictions and taxes on labor and enterprise prevent some workers from becoming employed. Taxes and regulations about double the cost of employing labor. Companies are pushed to replace labor with machines and to out source abroad because government policy forces labor to be too expensive to hire.

A company buys a new machine and gets an investment tax credit. It hires a worker and gets no tax credit, but rather a set of punitive taxes: social security, unemployment, benefits, workers compensation for injury, liability insurance, the threat of lawsuits, and reporting requirements.

Policy punishes firms for hiring labor, so of course business seeks to minimize the punishment.

Many states are now considering legislation to limit outsourcing. There are some silly laws being introduced, such requiring the foreign telephone responder identify which country he is located in. These laws are futile attempts to treat the effects. We will see candidates complain about the lack of job growth and promise to grow jobs, but they won’t tell you how they will do it. Unfortunately, most voters are swayed by empty promises and are easily fooled.

Not one single major political candidate will point to the source of the employment problem, government intervention, and propose the effective remedy, the abolition of restrictions and taxes on labor. Shifting taxes from wages to land rent would create full employment. This would also make it less costly to shift employment as technology restructures industries.

When an Indian accountant gets paid by an American firm, dollars leave the U.S. These dollars eventually return to the U.S. to buy goods or assets.

Imports have to be paid with exports. Nowadays, the U.S. government has a budget deficit of half a trillion dollars per year, and Asians are using the dollars they get selling goods to the U.S. to buy U.S. treasury bonds.

The problem is not the U.S. buying goods from abroad but the U.S. government half-trillion dollar deficit that is largely financed from abroad, mostly Asia. Rather than the futile attempt to limit the importation of goods and services, Americans should demand an end to the horrendous budget deficits and an end to the punitive taxation of American labor.

— Fred Foldvary

 

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