Outsourcing is No Scapegoat A Harvard Business School Case entitled “American Outsourcing” by Richard Vietor and Alexander Veytsman presents a multitude of arguments for and against outsourcing in the United States. The primary argument against outsourcing is that it leads to unemployment and increased domestic inequality. Although this anti-outsourcing perspective has many proponents and some merit, the case in favor of American outsourcing is more convincing when the ideas of maximizing efficiency through comparative advantages, decreasing international inequality, and increasing domestic jobs and equality by technological innovation are included in the discussion. Exhibit 17 in “American Outsourcing” compares the costs in various countries of one unit of labor when wages are divided by labor productivity. Although this data is dated (2002) and is not specific to a particular industry, it highlights how countries like Mexico have a significant unit of labor cost advantage to the U.S., whereas others such as Sweden do not. If outsourcing were to become restricted through government intervention, there would be less market efficiency due to the inability to take advantage of favorable labor cost differences. Moreover, limiting outsourcing would decrease competition and create a more monopolistic or oligopolistic market with the accompanying drawbacks. These include higher prices, less production, increased producer surplus relative to consumer surplus, deadweight loss, and ultimately, decreased producer surplus due to rent seeking. The businesses involved would unproductively lobby for outsourcing restrictions rather than producing goods. In terms of economic efficiency, restricting outsourcing is unviable and decreases collective welfare. Questions remain as to how outsourcing impacts employment and inequality. Vietor and Veytsman highlight how U.S. jobs in some sectors such as information industries, textiles and apparel, computers and electronics, and the auto industry have been particularly affected by outsourcing. They sight an alarming Berkeley study from 2005 claiming that 14 million jobs, 11% of total labor force, were susceptible to outsourcing. While increases in unemployment do negatively impact equality in the U.S., “American Outsourcing” does not quantify the net effect of outsourcing in the United States. Some industries suffer, but others like the U.S. export sector thrive. Also, foreign countries outsource to the United States, as evidenced by Toyota’s presence in auto part manufacturing in Tennessee. The technical and managerial capital available in the U.S. lends itself well to foreign outsourcing, and Exhibit 19a in “American Outsourcing” shows that the U.S. is second only to China in a ranking of foreign direct investment (FDI) confidence. The net impact of outsourcing on employment is not made clear by Vietor and Veytsman, and the increases shown in FDI and jobs in Mexico, China, and India cannot be used as direct evidence of lost U.S. jobs or investment. However, low-skilled domestic workers are likely to lose jobs. The Economic Policy Institute cites decreases in wages and benefits for employed low-skilled workers contributing to increases in inequality as evidenced by a measured rising Gini coefficient. Though domestic inequality may be on the rise temporarily, the effects of outsourcing include the provision of jobs and investment abroad, thus decreasing international inequality. Exhibit 3 of “American Outsourcing” shows more than a 250% increase in FDI to Mexico attributed to NAFTA, and some of that money has enabled infrastructure improvements particularly in power generation and cell phone lines. India and China have also shown significant FDI increases. While there is some tradeoff between decreasing inequality abroad and increasing inequality domestically, the solutions to America’s employment and equality woes do not include limiting outsourcing. The rise in inequality in America from outsourcing can be traced to a displacement of the domestic equality benefits gained in the skill-deepening phase of the Kuznets curve. Initially, labor saving technological change increases inequality because only a few are wealthy or skilled enough to take advantage of the change. Increasing demand for skilled workers and high wages attract low-skilled workers to become skilled workers. This increases the supply of skilled labor and leaves a void in the unskilled labor market, thus increasing the wages to unskilled labor relative to skilled labor wages and decreasing inequality. Some of the downstream domestic benefits of the skill-deepening phase are lost when technological change is disseminated to other countries as they are allowed to experience the same skill-deepening benefits. The solution to this problem exists in the Solow model. The steady state in the model is achieved when the savings rate equals the depreciation rate of capital. An increase in savings alone will increase productivity per worker and output/income per worker, but at the expense of decreased consumption. To improve the actual conditions for laborers, the depreciation rate of capital must decrease or the production function must increase from technological innovation. Then, adjusting the savings rate to equal the depreciation rate at the point where the slope of the production function equals the slope of depreciation rate will increase income per worker, maximize consumption, and decrease inequality in the long run at this “golden rule of savings.” Investment in education and new technology is the probable solution to the innovation challenge. While it is convenient to blame rising inequality in the U.S. on outsourcing due to “globalization,” it is highly misleading. Government restrictions on outsourcing would protect only a small portion of domestic jobs and at the cost of increased worldwide market inefficiency. Furthermore, increases in American inequality are offset by increases in international equality. If America wants to protect domestic jobs, continued technological innovation is the key that ultimately leads to decreases in U.S. inequality as laborers acquire the new skills necessary to accompany technology growth.
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