Offshoring Is Here to Stay

Outsourcing is undoubtedly the crucial issue in the European Union today. Facing Union-wide competition, companies are eager to move to places where conditions are more favourable.

They may want to leave France, Germany, and Italy where labour legislation and regulation condemn many millions of workers to chronic unemployment. They may prefer to move to new EU member states where labour is less encumbered and production costs are much lower. But such moves give rise to loud calls for government intervention, especially in countries that see themselves as losers and victims of the freedom for companies to move.

Indeed, outsourcing is casting grave doubts about the future of the European Union.

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In the United States, offshoring - the business practice of moving operations overseas, usually to less developed countries with lower labour costs in Asia - has also become a major political controversy. It played a major role in the 2004 presidential election in which Senator John Kerry, the Democratic Party's candidate, denounced corporate executives who were offshoring American jobs as traitorous 'Benedict Arnolds' [the American War of Independence general who defected to the British].

Kerry, and many of his colleagues, proposed legislation to eliminate all tax breaks to corporations that export jobs. Offshoring undoubtedly will play an even bigger role in future elections when many more jobs will have gone abroad.

Loud voices of protectionism were heard already in 1992 when the North American Free Trade Agreement was to lower trade barriers and make the United States, Mexico, and Canada more competitive in the world market. It raised loud fears that it would lead to ever greater expatriation of US jobs to Mexico where labour is less expensive. The same voices now are sounding the alarm about American jobs going to China and other Asian countries. Moreover, they are greatly upset about the nature of the work being exported.

In the past, American companies had concentrated on transplanting low-skilled jobs which minimum-wage legislation and benefit regulation had made unlawful.

More recently, the voices have focused on professional jobs going to China, India, the Philippines, and Malaysia where university-trained technologists are engaged in software engineering, computer chip designs, and code writing. After all, many thousands of engineers in those countries studied at American universities and acquired such expertise. General Electric Corporation has sent most of its technology services to graduates in China; Aetna is sending them to India.

Many legislators are eager to call a halt to such exports of American jobs. They are ready to levy steep fines, raise taxes, or imprison the violators of their laws and regulations. But they are not willing to lower the benefit costs that they imposed. In their private lives many were attorneys, counsellors-at-law, civil servants, educators, or heirs to family fortunes before they embarked upon political pursuits. Few are knowledgeable economists familiar with basic principles of economics. Instead, they usually are enamoured by their own position and especially by their great legislative powers. The only limit they may recognise is the political clout and vote of other legislators.

Most members of the US Congress are unaware of the inexorable principles of foreign trade and international cooperation. One of the great 19th century economists, David Ricardo, clearly elaborated and stated them. He propounded the Law of Comparative Cost, better known as Ricardo's Law of Association, which applies to the common situation in which economic goods move readily across national borders, but governments prevent capital and labour from moving freely. Under such conditions, people everywhere benefit most if they concentrate on the production of those goods in which conditions are most favourable, leaving all other production to others.

The case is similar to that of a surgeon who concentrates on surgery and leaves all supportive work to his assistants although he also excels in their simple tasks. And it is similar to that of a master mechanic who relies on his apprentices and assistants for ordinary work, although he could outdo them readily, but chooses to concentrate on the work requiring greater skill. Cooperation and division of labour benefit all.

In Ricardo's time, the mobility of both capital and labour was limited rather severely. Later in the 19th century, under the influence of classical economic thought, both capital and labour became rather mobile.

They created the 'world market' with rapidly rising productivity and standards of living. During the 20th century, unfortunately, economic nationalism and rampant socialism closed many borders and precipitated not only ugly trade wars but also numerous armed conflicts. After World War II the 'cold war' between the Soviet and American blocs of nations divided the world, creating political tension and military rivalry short of actual war. Yet the comparative differences in production cost allowed both sides to benefit from peaceful trade.

Ever since the disintegration of the Soviet bloc the market order has gradually expanded to most corners of the world and business capital has assumed new mobility, seeking employment wherever production conditions are favourable. But no matter how mobile capital now may become, it cannot nullify Ricardo's Law of Association as long as labour lacks the mobility to move freely and expeditiously from country to country. The great differences in religious, racial, national, and cultural characteristics as well as the notable differences in birth rates and mortality rates will never allow man to spread evenly around the globe, but they may encourage him to engage in peaceful cooperation and international trade.

There cannot be any doubt that the problems of offshoring will be with us as long as economic conditions change and business is free to move. Western business may move abroad, and it may come back again.

Guided primarily by cost and yield comparisons many American companies are known to have cancelled outsourcing projects in Asia, citing poor employee training and performance, inadequate support, personal and property security concerns, and political arbitrariness, hostility, and corruption. They must cope with anti-offshoring legislation and political malice wherever they would like to leave and with unfair competition laws and regulations where they like to settle. After all, construction of a modern plant undoubtedly leads to the closure of many old shops and relocation and training of their employees. Surely, closure of shops and relocation of workers are painful also in Asia.

Economists like to reflect on all the effects of a business move to places and countries where it is more productive. They are ever mindful of Ricardo's Law of Association which affirms that trade benefits both countries. And they are elated when foreign competition persuades legislators and regulators to reduce their obstacles and restraints, trim mandated labour costs, and remove employment barriers. But they are saddened by the rising mood of protectionism in Europe as well as in the United States.

The voices of nationalism and socialism are rather persuasive; they speak of interest, not of reason. They pay no heed to the old precept:

What you do to others, they will do unto you.

Regards,

Dr Hans Sennholfor The Daily Reckoning

Dr Hans Sennholz is president emeritus of The Foundation for Economic Education (FEE) in Irvington, NY.

To get more from Dr Hans and a host of other daily contributors, check out the free daily email, The Daily Reckoning.