But is it bad for the U.S. economy?
Two economists debate the issue
By Timothy Aeppel
Wall Street Journal May 10, 2004.

DOES OFFSHORE outsourcing hurt the U.S. economy by draining away jobs and investment, or does it ultimately make the U.S. stronger? Is it a cost-cutting tactic that should be encouraged, or should it be punished in some way? The issue has become a hot button this election year.

Framing the debate in economic terms can be tricky, because while economic theory offers tidy equations that lead to win-win situations, there are losers in the real world. Workers who see their jobs shipped overseas are hurt, even while companies and the economy as a whole may see benefits, such as lower prices for consumers.

It's also problematic that the pain is felt quickly and prominently, while benefits are spread out over time and hard to quantify, says Haseeb Ahmed, an economist at Economy.com, an economic-research company in West Chester, Pa. Still, many economists say offshore outsourcing is good for the U.S. for the same reasons that free trade is beneficial for a vibrant economy. "Arguing that outsourcing hurts is arguing that free trade hurts," says Mr. Ahmed.

There are many people saying precisely that these days, as reflected in a protectionist wave in Congress and in conversations on the streets of battered mill towns in North Carolina and among unemployed computer programmers in Boston. So we asked two economists, known for their positions on opposite sides of this debate, to conduct an e-mail conversation on the subject.

Jagdish N. Bhagwati is a university professor at Columbia University in New York and a leading expert on trade who has emerged as a defender of offshore outsourcing. He was born in India and was educated there as well as in England and the U.S. He earned his Ph.D. from the Massachusetts Institute of Technology and is currently the Andre Meyer Senior Fellow in International Economics at the Council on Foreign Relations in New York.

Prof. Bhagwati says the offshore-outsourcing controversy has arisen over the growing ability to import services from other countries through advanced computer technology, like having radiologists in Bangalore read X-rays taken in Boston. It's a form of trade, he says, and, as such, is a positive force.

Paul Craig Roberts is a former assistant Treasury secretary for economic policy in the Reagan administration and was once an avid free-trader. He's one of a small but growing group of economists raising warning flags about the impact of offshore outsourcing.

Mr. Roberts, who studied in the U.S. and England and has a Ph.D. in economics from the University of Virginia, argues that the world may have fundamentally changed and that economic thinking simply hasn't kept up. He says companies are now freer to move capital and technology around the globe in search of cheaper labor. And as countries like China and India have emerged, with their vast pools of skilled and well-educated workers, it becomes harder for any industry to justify investing in or employing people in the U.S. and other high-wage countries.

Mr. Roberts is currently chairman of the Institute for Political Economy, a think tank in Washington.

Here are excerpts from their discussion.

MR. ROBERTS: From the perspective of trade theory and economic- development theory, it is hard to see the benefit to the country whose firms outsource. With domestic capital and technology reallocated to the employment of foreign labor, there is less to employ domestic labor. Either unemployment results or the remaining capital is spread more thinly with a decline in labor productivity and real incomes. As industries move offshore, suppliers are forced to follow. The domestic economy becomes a less-efficient place to produce as concentrations of skills are diluted by movement offshore.

If outsourcing were a limited phenomenon driven, for example, by domestic scarcity of a few specific skills, it is possible to imagine scenarios under which a country gains from outsourcing. But even here caution is appropriate. For example, if technology jobs are outsourced because of domestic supply constraints, the mechanism for expanding domestic supply is short-circuited. If a shortage of nurses is met by importing foreign nurses under a visa work program, domestic nursing schools are unlikely to increase their enrollments.

Outsourcing is a problem for the U.S. and First World in general, because all tradable goods production and service jobs can be outsourced. The higher the value added, the greater the incentive to outsource the work to India or China where enormous excess supplies of labor guarantee relatively low wages for years to come. Faith that new industries and occupations will rise to replace lost ones is problematical, because the same incentive will encourage replacement industries to be outsourced as well.

With excess supply overhanging Indian and Chinese labor markets, First World wages and salaries can fall swiftly and sharply long before Asian wages rise. The resulting declines in employment and/or real wages can bring political instability to First World countries.

MR. BHAGWATI: Since arguing over unwarranted criticisms of international trade theory is hardly productive, let me turn instead to the important issues at stake in the furor over the outsourcing of online services today. First, that the transition to new jobs is a hardship for the workers who are losing jobs; and second, that the new jobs are less good, that in the famous words of Vice President Mondale, our workers will lose good jobs and we will become a nation of "hamburger flippers." Or, in modern parlance, that the programmers who were earning $60,000 will wind up bagging groceries or stocking shelves for $15,000.

Take the issue of whether we are going to lose skilled jobs so that Mondale's scenario is vindicated. For starters, it did not [happen] when he was sketching it in gory colors. Fast-food jobs increased for sure; but by no means did they overtake the expansion of skilled jobs. And there is little fear of it happening now either. Look at the facts for 1999-2002. The Bureau of Labor Statistics shows that, counting four IT-related sectors, the jobs expanded; slowly no doubt, but contract they did not. In 2002, the number of jobs in these sectors was over 17 million.

Contrast that with the estimate of gross numbers of outsourced jobs: They were around 100,000 per annum, and the upper estimates of job loss annually over the next 15 years has been put at 225,000, which is less than 1.5% of the stock of available jobs in 2002. I must add that the net estimates show that the U.S. has many more people employed in services that are exported than are "lost" in services that are imported.

And these jobs will surely expand because the main driver of growth in our economy is our prodigious technical change. Technical change nearly always substitutes for unskilled labor, but it creates new skilled jobs, both by creating new products and processes but also because the maintenance of technology also requires skilled labor.

THE WALL STREET JOURNAL: Mr. Roberts, what should the U.S. do about all this? Do you favor some sort of protectionist response?

MR. ROBERTS: To get to the "solution" stage, we have to pass through the "identification of the problem" stage. Jagdish says that there is no problem, but I am concerned that comparative advantage [theory] might be broken. [The theory says countries should specialize in goods they're better at producing than other countries and then trade for things in which they don't have the edge.] One virtue of comparative advantage is that a country doesn't need a trade strategy, because comparative advantage causes all free-trade outcomes to be beneficial. But if comparative advantage is broken and cannot be fixed by restoring its premises, the U.S. needs to develop a trade strategy.

A successful trade strategy would require careful thought from many, and require economists first to get their minds around the problem. Perhaps this exchange will lead in that direction.

I am calling for a policy of thought to examine whether real-world conditions still support the case for free trade. If real-world conditions differ from the premises of the free-trade case, we must learn to think differently and to develop a strategy based on recognition of synergies between industries and occupations and geared toward retaining high-productivity industries.

MR. BHAGWATI: While your approach, based on views of international trade analytics which I believe are flawed, is not overtly protectionist, it will take you quickly into protectionism in reality. "Trade strategy," worked out with "careful thought from many," can only mean, if it means anything concrete, some sort of industrial, and associated, managed-trade policy.

One thing you need to remember, Craig, is that "strategic" trade and industrial policy, devised by gifted bureaucrats and wise economists, sounds fine in theory but is hard to work with in practice.

MR. ROBERTS: I agree that government policy is capable of worsening any situation. At the same time, I am aware that economists, long accustomed to shouting down "protectionist impulses," can fail to carefully examine whether changed real-world conditions or new developments in theory undermine the assumption that every act of free trade is beneficial. All I am asking is that economists seriously re- examine the case for free trade and verify that the conditions necessary for the case still hold.

In my opinion the issue will be settled by developments in the U.S. labor market and not by economic debate. If there is a recovery in high-productivity, high-value-added jobs in the U.S., the issue will dissipate. However, if U.S. labor continues to be reallocated toward lower-pay, nontradable, domestic services, the issue will come to a head, especially as wages in domestic nontradable services would experience downward pressure both from entry from displaced manufacturing and knowledge workers and from high rates of legal and illegal immigration.

WSJ: So what about the jobs, Prof. Bhagwati? Where are the good- paying ones going to come from in the future?

MR. BHAGWATI: Fifteen years ago, how many of us knew that there would be an obesity epidemic, with associated expansion in liposuction, diabetes management, etc.? How many could have forecast that our aging women would be increasingly flocking in huge numbers to plastic surgeons for cosmetic surgery of all kinds? And yet these and countless other new jobs in unforeseen and unforeseeable occupations, requiring new skills, have emerged and will continue to emerge.

True, we will need to extend our adjustment assistance programs beyond manufacturing. We will also need imaginative programs to assist the older folks who cannot readily acquire new skills for the new jobs. We will finally need to delink medical benefits from employment: a change whose time has come, now that increased exposure to trade means that flexible responses to changing opportunities are possible.

But what we do know is that protection will only compound manifold the difficulties of adjustment for our skilled workers. We live in a globalized economy where foreign firms sell in our markets and we sell in their markets and in third markets. If foreign governments do not share our hysteria, and they continue to outsource (as the British have openly said they will), several of our firms will become seriously uncompetitive and could fold.

MR. ROBERTS: Jagdish, retraining programs are a misplaced hope. As all tradable goods and services production can be outsourced today, retraining is limited to domestic services, an increasingly crowded field, and even here foreign labor is brought in under various work- visa programs.

I appreciate your optimism, but it needs to be tempered with realism. According to economist Charles McMillion's report in the April 2 Manufacturing & Technology News, the U.S. has lost its lead in advanced-technology products and now runs a deficit in advanced technology with China (supposedly a low-tech producer of clothes and shoes) that is almost five times larger than the U.S. technology deficit with Japan. It is not clear how a country benefits from losing its superiority in advanced-technology products.

Neither is it clear how a country benefits from declining incomes. Occupations where jobs are growing pay considerably less than occupations that are contracting. Americans are heavily in debt, and their debts are not indexed to their incomes. With any luck, perhaps our discussion will prevent economists and policy makers from being caught off guard in the event there is a deterioration in U.S. economic welfare.

WSJ: Sen. John Kerry is proposing tax initiatives to slow offshore outsourcing. Is that a good idea? And what about other countries: Why isn't this issue causing a similar uproar in Europe or elsewhere in the developed world?

MR. ROBERTS: In the current economic climate, "tax subsidies for hiring foreigners" is an easy political target. As I have made clear, I would prefer a reasoned assessment by economists to policy crafted in a political campaign.

I believe that the First World in general is vulnerable to employers' substituting cheaper foreign labor for more expensive domestic labor. The U.S. and U.K., being the most open economies, are first to experience the impact. Japan, Germany and France are closed by attitude if not by trade agreement. Executives of tire companies, for example, report that it is difficult to purchase inexpensive Korean tires in Germany, because German tire suppliers will not sell them. France and Japan have their own ways of discouraging unwanted imports.

Another difference is that business executives in Japan, France and Germany have a stronger sense of national identity and national interest. Perhaps this comes from being more homogeneous populations or from the influence of a trade strategy. Unlike U.S. executives ruled by quarterly earnings reports, they are free to focus on long- term strategy.

Such differences and the overburdened European welfare systems might result in different responses to the supplies of inexpensive Asian labor. Political reasons would probably dictate that European employers would first turn to labor supplies in Eastern Europe. The European internal market is a large one. So is the North American one. There is plenty of room within these markets and in trade between them for specialization and division of labor.

MR. BHAGWATI: I do think that the reactions of the British producers and government have been very much more positive than ours. Historians of the 19th-century British embrace of free trade, when Britain was the biggest dog on the road, have argued that the British politicians opted for free trade because they expected Britain to win in open markets. Why then does the United States, which is a hyperpower, the Rottweiler on the road, begin screaming protection every time trade with the poor nations, the French poodles, is at stake: Mexico, the Far Eastern exporters of labor-intensive goods (the "yellow peril") and now India (the "brown peril")? I think there are two answers.

First, our social safety net is not as strong; and the family has been frayed, so neither the social nor the personal safety net is available to meet difficult problems of adjustment to import competition. So, when the fear of job losses is high, anxiety is immense, as now.

Second, despite its waning numbers, the AFL-CIO has managed to get a stranglehold on the Democrats, and it shows in their strange obsession with covert protectionism, masked as demands for higher labor and environmental standards in trade treaties as preconditions for market access, and now with overt protectionism in the shape of demands to ban outsourcing and even direct foreign investment. Astonishingly, a liberal leadership of the Democratic Party that professes to better credentials on altruism in regard to developing countries is now committed to policies that are aimed at the developing countries which are using the trade opportunity to work themselves out of poverty, while a Republican president has taken the high road on both outsourcing and on foreign investment!

In this election year, it will be interesting to see how all this plays out. But there is little here that does credit to our politics and our probity.

Mr. Aeppel is a staff reporter in The Wall Street Journal's Pittsburgh bureau. He can be reached at [email protected]