The Limits of Chindia

Comparative advantage works both ways.

August 24, 2010

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story_images_great-wall-of-chinaIn the midst of a jangly, nerve-wracking, jobless recovery, American workers and their political representatives are understandably trying out various explanations for their protracted plight. Offshoring, outsourcing and other euphemisms are freely bandied about – manufacturing jobs have left for Mexico or Asia, so have call centre jobs and now so are legal jobs, as the New York Times recently reported. Indeed, Americans are now moving to India to supervise their associates doing work for big American law firms.

The end of the world as we know it (commonly abbreviated as TEOTWAWKI on internet chat forums)? Not quite.

Let’s not forget the only economic law that has proved its merit: comparative advantage. Long ago, the economist Paul Krugman (regarded by some as somewhat bolshie) noted:

“Two goods, two countries, one productive factor, perfect competition: what could be simpler? Indeed, one of the fierce joys of being an international trade economist is that so many seemingly sophisticated tracts can be revealed as nonsense, so many self-important men unmasked as poseurs, using such a minimalist framework.”

More particularly, he focuses on productivity. “It is not obvious to non-economists that wages are endogenous. Someone … looks at Vietnam and asks, “what would happen if people who work for such low wages manage to achieve Western productivity?” The economist’s answer is, “if they achieve Western productivity, they will be paid Western wages” — as has in fact happened in Japan. But to the non-economist this conclusion is neither natural nor plausible.”

And so it goes.

Naked capitalist blogger Yves Smith offers an example:

“When I was on C-SPAN the weekend before last, I got a call I didn’t quite know how to field. It was from someone who by his accent was obviously Indian. He claimed that Indians represented 35% of the managers in American companies, and that American visa restrictions meant that they were all going to send those jobs to India. I stumbled around a bit, and took issue with his claim (it certainly isn’t true at the senior levels of major companies), and also pointed out I didn’t think the argument about managerial jobs being sent to India held up, since new MBAs in India are now making more than their counterparts in the US.”

So that’s one angle to offshoring, at least in the services sector. But what about manufacturing and all those good jobs sent overseas?

“In general, simple labor cost comparisons are vastly overrated in manufacturing. Factory labor is only 10% of the product cost of most manufactured goods, so the savings of having the work done in China is not all that large, and is often offset by other factors (shipping and inventory funding costs, greater management costs due to more coordination, plus greater risk, since longer lead times reduce responsiveness and produce greater risk of taking losses due to inability to cancel orders if customer demand falls).”

Want to gain a comparative advantage? To paraphrase Bill Clinton: “It’s the total factor productivity, stupid.”

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