Friday, April 15, 2005

Are we becoming a "service" economy?

(This is from a comment I left on Larry Kudlow's blog.)

I'm very big on free trade. Very big, and I'm concerned about all the myths today. We talk about "trade imbalances" and "trade deficits" -- words that, to some, imply a balance is ideal, no matter the cost. There are a lot of other terms thrown around which also confuse most people, like "exporting" jobs.

We must be careful about the word "service," which can mean different things to different people. Socialist-liberals like the EPI, or 89, think heavy industry has always been the key to American economic success. They think we're turning into a nation of waiters and janitors while our "good jobs" are "exported" abroad. I disagree because the evidence shows quite the contrary. The EPI likes to claim that we've had declining real (adjusted for inflation) wages since the 1970s. That was true, but it started to reverse in the early part of this decade. Wages are now rising faster than inflation, which is why Social Security needs to be tied to prices, not wages.

The U.S. has continued to prosper because we have a comparative advantage in innovation, and we have a high degree of freedom and prosperity that attracts innovators from abroad. It's true that in the past, our innovation was in heavy industry, or at least we depended a lot on it. Everything's changed with the return to free trade, and companies using foreign labor pools.

Today, we still have a comparative advantage in innovation. However, it's no longer based in heavy industry. It's in design. It's in thinking. As Ed Leamer (a great UCLA professor and economist) once put it, companies like Microsoft and Disney provide us with cheap plastics and textiles. We create the software, movies, etc., that China and India cannot easily make. Meanwhile, China, India and others create plastics and textiles more cheaply than we can. Then we trade, and it raises the standard of living for everybody.

So many worry about American companies moving manufacturing plants overseas, but most R&D stays right here. The R&D jobs are the ones we want to keep: they're the thinking jobs, the highest-paying jobs, unlike the low-grade manufacturing jobs set up in Bangalore or wherever. (If they didn't pay better than manufacturing, then by definition nobody would want to do them.) Sure, Intel and others have set up R&D centers in India, but most that started here will stay right here. If it's true that Indians and Chinese will work for a fraction of our workers, why do the jobs stay here at all? Ah, that's simply because there are things the Indians and Chinese can't do as well as we. Maybe you can hire six Indian programmers for the price of one in Redmond, but Microsoft knows they get better output from their American employee.

I'm not being racist, just observing that China, India and other similar nations have a comparative advantage in labor-based work. There are things they can't do as well as Americans, because we (and most other Western nations) have a comparative advantage in capital-based work. That's true even in these days of supposed high capital mobility. I argue that capital mobility hasn't equalized any economies, let alone made the U.S. a "service-based" economy of waiters and hamburger flippers ("race to the bottom" just isn't true). Uninhibited capital mobility, I think, is actually sharpening the delineation between labor-intensive economies and capital-intensive economies.

I highly recommend reading what Ed Leamer has said about this. He's pointed out that technological advancement has destroyed more jobs than free trade. You want manufacturing jobs? High-paying ones? Fine, let's start destroying the robots at auto plants. In fact, let's destroy all our factories, all our technology that reduces the need for human labor. They're destroying jobs, don't you know?

Caroline Baum once wrote for Bloomberg that there's an economy with 100% employment, and in fact it'll have more work than workers: a hunter-gatherer society. Plenty for everyone to do, just no free time to enjoy life, and no excess income to have anything beyond food and shelter.

Our economy has gravitated to a pretty good compromise. We have a high standard of living, a really good unemployment rate, and sustained economic growth. Americans are lazy and stupid, we're always told, compared to Europeans and the Japanese? For being smarter, where are the Europeans? For being better working, where are the Japanese? They're graying cultures sitting on demographic time bombs, mired in economic stagnation.

For being such supposedly stupid and lazy people, we've done pretty well, haven't we? I firmly believe the U.S. is blessed by God. It started with the blessings of prosperity on our original colonists, and with the bulletproof George Washington. You may recall that Washington was shot at during one battle of the French & Indian War, and none of the many bullets could hit him. That was the Hand of Providence. It's the individual blessings that have sustained our great country.



Anonymous Anonymous said...

I wouldn't take too much comfort in the observation that most R&D is still done here, rather than over there. Outsourcing of knowledge work has just started in ernest, so it's a little early to pass judgement on the amount that will eventually be outsourced; let's see where we are in 10 or 15 years.

As an example, consider the pharmaceutical industry. This is an R&D intensive industry, and the majority of R&D costs for drug development are labor related (PhD scientists are expensive in the US). India is now starting to develop it's own pharmaceutical industry. I've seen estimates that drug development costs in India should be ~$100 million, versus $800+ million when done in the US. The advantage comes from the availability of cheaper labor over there. That kind of cost advantage will be hard for US drug companies to ignore, particularly as they start to get squeezed on profit margins.

You distinguish between capital based industries (our forte) versus labor based industries (their forte). In my experience, capital intensive industries are things like steel making, papermaking, oil refining, and chip manufacturing. We clearly don't have a dominant position in a lot of those industries.

Labor based work is not limited to repetitive factory jobs or manual labor. A lot of high tech knowledge work is labor intensive. Software development is a good example: computers and development software are cheap; it's the labor component that runs up project costs. It pays to outsource it to India precisely because it is so labor intensive.

At the moment, higher level knowledge jobs have remained in the US, while more routine types of knowledge work get outsourced. But the Indians and Chinese don't intend to have it stay that way. They are very interested in moving up the food chain. They have the labor pool and the labor cost structure to do just that.

Tuesday, May 31, 2005 2:34:00 PM  
Blogger Perry Eidelbus said...

To be sure, other nations would love to compete in capital-intensive industries. "Capital-intensive" simply means an endeavor that requires a great deal of assets, unlike labor-intensive, which is principally. Industries like software development and aircraft manufacturing have significant labor costs, but they're still classified as capital-intensive. It requires a great deal of technology and other capital goods to back up the human component.

Steel: we don't have a comparative advantage in all types, but there are still certain types of steel that are more worthwhile to manufacture here. Even with competition, we could make even more here, because steel is rather difficult to transports. However, the U.S. steel industry is so antiquated, and instead of improving its efficiency, it prefers to use its lobbying power.

Oil refining: like steel, transportation costs are significant. Remember that only half of imported U.S. oil comes from the Middle East. Oil tankers won't go from Venezuela, Mexico, et al, to China and India. Nor will oil from the Persian Gulf go to China and India, where it will be refined and then have to travel across the Pacific.

The basic manufacturing of pharmaceuticals might go overseas, but I would be greatly surprised if R&D does. For one thing, and this isn't borne of racism, we're dealing with Third World countries. Even with the best quality control, the FDA might have grave concerns about pharmaceuticals being manufactured in

Remember also that Dell, Intel, IBM and other big firms almost couldn't wait to take advantage of cheap overseas labor. But after several years, they still keep their top brain jobs in the West. Dell also brought its overseas call centers back to the U.S., prompted by customer complaints. It shows that some consumers are willing to accept higher costs for what they deem better service.

Rote manufacturing will probably move overseas, but remember that higher productivity and technological improvements (automation) still destroy far more jobs than outsourcing.

Jagdish Bhagwati of Columbia has written a couple of pieces about the needless American fear of outsourcing. As a native of India, he knows his people's strengths -- at least for now.

Why Your Job Isn't Moving to Bangalore

Americans Manage to Convince Themselves They Are Underdogs

Tuesday, May 31, 2005 10:09:00 PM  
Anonymous Anonymous said...

While I agree with you mostly, to say that the success of the American economy is a result of a "blessing from God" is quite troubling as well as America-centric.

To extend it further, are we to assume all other countries' economic policies are forever doomed since they aren't included in God's "Inner Circle"??

While I am a church-going Christian, I'm also a realist when it comes to economic policy and the last thing I want to depend on is the Almighty if my job ever got exported to India.

Wednesday, November 15, 2006 3:52:00 AM  
Blogger Perry Eidelbus said...

I didn't see your comment until today. I really do think this country is blessed by God -- we couldn't have gotten this far without the Big Boss' help. But it's a logical fallacy to say that if we're blessed, then others are damned or cursed. That's like saying if a parent likes one child more than the other, then it must hate the other.

If your job gets exported to India, nothing personal, it means that you were uncompetitive. That's the free market working itself out. Would you have complained if you were a factory worker who lost his job to a machine? There's no difference: you lost your job to someone who can do it more cheaply, and in the end, society will grow more wealthy because the new producer can produce more than you could.

Nothing personal, again, but "church-going Christian" means nothing to me now. Not to say anything about you, only the term: the problem is that I've met too many church-goers who are hardly Christian at all.

Saturday, September 22, 2007 12:38:00 PM  

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