Tag: outsourcing

Enduring Myths that Obscure the Case for Free Trade

Most economists agree that free trade works better than restricted trade to increase the size of the economic pie. By enlarging markets to span national borders, free trade increases the pool of potential producers, consumers, partners, and investors, which permits greater specialization and economies of scale – both essential ingredients of per capita economic growth.

But, in practice, free trade remains elusive. It is the exception, not the rule. Sure, many tariffs and other border barriers have been reduced in the United States (and elsewhere) over the years, but protectionism persists in various guises. There are “Buy American” rules limiting government procurement spending to local firms and US-made products; heavily protected services industries; seemingly endless incarnations of agriculture subsidies; import quotas on sugar; green-energy and other industrial subsidies; shipbuilding and shipping restrictions; the Export-Import bank; antidumping duties; and, regulatory protectionism masquerading as public health and safety regulations, to list some. Ironically, protectionism is baked into our so-called free trade agreements. It takes the form of rules of origin requirements, local content mandates, intellectual property and investor protections, enforceable labor and environmental standards, and special carve-outs that shield entire products and industries from international competition.

Trade agreements may be the primary vehicle through which U.S. trade barriers are reduced, but they are predicated on the fallacy that protectionism is an asset to be dispensed with only if reciprocated, in roughly equal measure, by negotiators on the other side of the table. If the free trade consensus were meaningful outside of economics circles, trade negotiations would be unnecessary. They would have no purpose. If free trade were the rule, trade policy would have a purely domestic orientation and U.S. barriers would be removed without any need for negotiation because they would be recognized for what they are: taxes on domestic consumers and businesses.

Does Foreign Outsourcing Supplant or Augment Domestic Economic Activity?

Voters in Massachusetts, Georgia, Illinois, and elsewhere are being treated to a little 2012 redux, as desperate candidates try to paint their opponents with last election’s popular pejorative: “Outsourcer!” You may recall the accusations exchanged between President Obama and Mitt Romney two years ago, as each sought to portray the other as more guilty of perpetuating the “scourge” of outsourcing. At the time, I faulted Romney for running away from what I thought was his responsibility (as the businessman in the race) to explain why companies outsource in the first place, and how doing so benefits the economy and leads to better public policies. Had he done so, his explanation might have sounded something like this. 

For many people, the term outsourcing evokes factories shuttering in the industrial midwest only to be ressurrected in Mexico or China to produce the exact same output for export back to the United States. While a popular image of outsourcing, that particular rationale – to produce for export back to the United States – accounts for less than 10 percent of the value of U.S. direct investment abroad (as this paper describes in some detail). Over 90 percent of outward FDI is for the purpose of serving foreign goods and services markets and for performing value-added activities in conjunction with transnational production and supply chains. In most industries, it is difficult to succeed in foreign markets without some presence in those markets. And without success in foreign markets (where 95% of the world’s consumer’s reside), it is more difficult to succeed at home.

So, does “outsourcing” really deserve its bad reputation? Does it really hurt the U.S. economy?  Well, the U.S. Bureau of Economic Analysis collects and compiles the kinds of data that can help us begin to answer these questions, including data about inward and outward foreign direct investment, and the activities of U.S. multinational corporations – both U.S. parents companies and their foreign subsidiaries. The scatterplots presented below reflect the relationships between annual changes in various performance metrics (value added, capital expenditures, R&D expenditures, sales revenues, employment, and compensation per employee) experienced by U.S. parent companies and their foreign affiliates. Each point on each plot represents a combination of the annual percent change for the affiliate (horizontal axis) and the parent (vertical axis) in a given year. 

If a foreign hire comes at the expense of a U.S. job, if ramping up production abroad means curtailing output at home, if a $100 million investment in a new production line or research center abroad means that plans for a new line or center in the United States get scrapped, if foreign outsourcing is as bad as its critics suggest, then we should expect to see an inverse relationship (at least not a direct or positive relationship) between the economic activities at U.S. parents and their foreign affiliates. We should expect to see most of the points in the upper-left or lower-right quadrants of the plots below.

Anemic Business Investment Indicts U.S. Policies

Since the beginning of the Great Uncertainty – the period that began with the “stimulus,” the auto bailout, the push for another major entitlement program, Dodd-Frank, the regulatory dam burst, the subsidies for favored industries, and the proliferation of distinctly anti-business rhetoric from the White House – President Obama has appeared puzzled by the dearth of business investment and hiring. Go figure.

Nonresidential fixed investment fell off a cliff in 2009, and has yet to recover even in nominal terms. As a share of GDP and relative to the trend in investment growth prior to the 2008 recession, the picture is more troubling still. If tomorrow’s wealth and living standards are functions of today’s investment – and they are – reversing the decline in investment should be the economic priority of U.S. policymakers. 

Instead, the administration has been cavalier about the problem and aloof to real solutions, choosing to view investment as a casualty of partisan politics, as though business is intentionally holding back to sully the economy on this president’s watch. Such narcissism has obscured the White House’s capacity to grasp the power of incentives.

It’s not just domestic investment that is lagging. Foreign direct investment in real U.S. assets is also on the decline. The United States is part of a global economy, which means that U.S. and foreign based businesses can invest, hire, develop, produce, assemble and service almost anywhere they choose. And that means the United States is competing with the rest of the world to attract and retain investment. Of course, the implication of this – whether policymakers know it or not and whether they like it or not – is that globalization is serving to discipline bad public policy. Policies that are hostile to wealth creators chase them away, while smart policies attract them and harvest their fruits.

Business investment is ultimately a judgment about a jurisdiction’s institutions, policies, human capital, and prospects. As the world’s largest economy featuring a highly productive work force, world-class research universities, a relatively stable political climate, strong legal institutions, accessible capital markets, and countless other advantages, the United States has been able to attract the investment needed to produce the innovative ideas, revolutionary technologies, and new products and industries that have continued to undergird its position atop the global economic value chain. 

The good news is that the $3.5 trillion of foreign direct investment parked in the United States accounted for 17 percent of the world’s direct investment stock in 2011 – more than triple the share of the next largest single-country destination. The troubling news is that in 1999 the United States accounted for 39 percent of the world’s investment stock.

What the Candidates Won’t Explain about Outsourcing

Like almost everything about the 2012 presidential campaigns, the bickering between the major party candidates over who is most responsible for shipping jobs overseas has been banal and utterly uninformative. While politicians have scared many Americans with hyperbolized sales pitches about the costs of foreign outsourcing, most people remain in the dark about the causes and benefits of outsourcing. What is foreign outsourcing anyway? Why do some businesses invest in sales operations, research and development, production and assembly operations, or the provision of services abroad? Are low wages and lax environmental and safety standards in poor countries really the magnets attracting U.S. investment? If so, why is 75% of U.S. direct investment abroad in rich countries? What explains the fact that the United States (high-standard, rich country that it is) is the number one destination in the world for foreign direct investment? Doesn’t the fact that businesses have options in our globalized economy serve to discipline some of the worst government policies?

As I suggested in this recent post:

In a globalized economy, outsourcing is a natural consequence of competition. And policy competition is the natural consequence of outsourcing. Let’s encourage this process.

Answers to the questions raised in this post and some other thoughts about outsourcing are expressed in this cool 4+ minute video produced by Cato’s Caleb Brown and Austin Bragg:

The Trouble with Zakaria’s Assessment of the Economy

Fareed Zakaria is a good journalist. But he’s also human. In his Washington Post column yesterday, Zakaria concludes that President Obama has a stronger case to make for his economic prescriptions than does Governor Romney. However, that conclusion—at least as presented in the column—is premised on a misreading of some recently published data.

Zakaria distills President Obama’s message down to the belief that investment in infrastructure, education, training, basic sciences, and technologies of the future are key to economic recovery, while Romney argues that relief from taxes and excessive regulatory burdens is the answer.

While both views have merit in Zakaria’s estimation, Obama has the stronger case. Why? Because Romney is barking about a relatively insignificant problem, concludes Zakaria:

We need a tax and regulatory structure that creates strong incentives for businesses to flourish. The thing is, we already have one.

To support that claim, Zakaria cites a figure from the 2011-12 edition of the World Economic Forum’s Global Competitiveness Report that ranks the United States 5th (out of 142 countries) and concludes that “whether compared with our own past—of, say, 30 years ago—or with other countries, the United States has become more business-friendly.” The problem is that he’s citing the wrong number and, thus, reaching the wrong conclusion.

The United States is ranked 5th on the overall global competitiveness index, which is a weighted value reflecting scores assigned for 12 broad criteria presumed to affect “competitiveness,” including: (1) institutions, (2) infrastructure, (3) macroeconomic environment, (4) health and primary education, (5) higher education and training, (6) goods market efficiency, (7) labor market efficiency, (8) financial market development, (9) technological readiness, (10) market size, (11) business sophistication, and (12) innovation.  U.S. scores on regulations and taxes contribute to that final ranking, but 5th is not where the United States ranks on those criteria.

To add another layer of complexity, the scores assigned to each of these 12 criteria are derived by weight-averaging the scores from individual survey questions. For example, there are 21 questions related to the first criteria, “institutions”—questions about property rights, public trust of politicians, judicial independence, transparency of government policymaking, etc. There are nine questions that feed into the infrastructure score; six that feed into the macroeconomic environment score, 16 that comprise the goods market efficiency score, and so on.

Zakaria errs by citing the overall, weighted average U.S. rank of 5th to support his assertion that we already have a tax and regulatory structure that creates strong incentives for business to flourish. That relatively high ranking reflects a few obvious U.S. advantages—tax and regulatory structure not being among them. The United States ranks fairly high with respect to some criteria, including “market size,” “university-industry collaboration in R&D” (which feeds into the innovation criterion), “strength of investor protection” (institutions), “availability of airline seats” (infrastructure), “inflation” (macroeconomic environment), “extent of marketing” (business sophistication), and a few others.

But on taxes and regulations, the U.S. ranks poorly. On the “Burden of Government Regulation,” the United States ranked 58th with a score of 3.4 on a scale from 0-to-7, slightly above the global average of 3.3. On the “Extent and Effect of Taxation,” the United States ranked 63rd out of 142 countries. On “Total Tax Rate, % Profits,” the United States came in 96th out of 142. On the issues that President Obama is pushing, the United States performs better than on those Romney advocates, which seriously weakens Zakaria’s argument.

The United States ranks 24th on quality of total infrastructure, better than on taxes and regulations. Likewise for “technological readiness” and “innovation.” “Higher education” (but not “job training”) generates bad scores for the United States, but clearly not for lack of spending. You can dig into the data here, and you’ll find that they tell a very different story than the one you may have read in yesterday’s Post.

Of course, Zakaria might still believe Obama has the stronger argument. But we should all be clear about the fact that regulations and taxes are real and growing problems, and that dismissing them as insignificant, even if inadvertent, doesn’t help policymakers find the solutions. Combine those impediments to investment and hiring with the growing perception that crony capitalism is on the rise (U.S. rank: 50th out of 142), that customs procedures present obstacles to global supply chains (rank: 58th of 142), that U.S. public debt weighs heavily on the economy (rank: 132th of 142), and that government spending is on a ruinous path (rank: 139th of 142 countries), and it becomes more apparent why an increasingly mobile business community often seeks the refuge and relatively warm embrace of foreign shores.

Outsourcing for Dummies (Including the Willfully Ignorant)

In an era of misinformation overload, it is disheartening to see the Washington Post perpetuating the ignorance surrounding the issue of outsourcing. To be sure, in addressing the topic in Tuesday’s paper, writers Tom Hamburger, Carol D. Leonnig, and Zachary A. Goldfarb were merely presenting the case of Obama’s critics “primarily on the political left,” who claim the president has failed to make good on his promises to curtail the “shipping of jobs overseas.” That conclusion may be accurate. But the article’s regurgitation of myths about outsourcing and trade, peddled by those who benefit from restricting it, gives readers a parochial perspective that leaves them confused and uninformed about the manifestations, causes, consequences, benefits, and costs of outsourcing.

Outsourcing is a politically-charged term for U.S. direct investment abroad. Although the large majority of that investment goes to rich countries, the Post article claims that “American jobs have been shifting to low-wage countries for years, and the trend has continued during Obama’s presidency.” While that may be factually true, the numbers are likely fairly small. Many more jobs have been lost to the adoption of more productive manufacturing techniques and new technologies that require less labor. And we, overall, are much wealthier for it.

The article attributes 450,000 U.S. job losses to imports from China between 2008 and 2010 – a figure plucked from an “economic model” at the Economic Policy Institute that has been criticized by everyone in Washington but Chuck Schumer and Sherrod Brown. That estimate is the product of simplistic, inaccurate assumptions equating the value of exports and imports to set numbers of jobs created and destroyed, respectively, as if there were a linear relationship between the variables and as if imports didn’t create any U.S. jobs in, say, port operations, logistics, warehousing, retailing, designing, engineering, manufacturing, lawyering, accounting, etc. But imports do support jobs up and down the supply chain. Yet, so blindly committed are EPI’s stalwarts to the proposition that imports kill U.S. jobs that they even suggest that the number of job losses would have been greater than 450,000 had the U.S. economic slowdown not reduced demand for imports. In that tortured logic, the economic slowdown saved or created U.S. jobs. But I digress.

Contrary to the misconceptions so often reinforced in the media, outsourcing is not the product of U.S. businesses chasing low wages or weak environmental and labor standards abroad. Businesses are concerned about the entire cost of production, from product conception to consumption. Foreign wages and standards are but a few of the numerous considerations that factor into the ultimate investment and production decision. Those critical considerations include: the quality and skills of the work force; access to ports, rail, and other infrastructure; proximity of production location to the next phase in the supply chain or to the final market; time-to-market; the size of nearby markets; the overall economic environment in the host country or region; the political climate; the risk of asset expropriation; the regulatory environment; taxes; and the dependability of the rule of law, to name some.

The imperative of business is not to maximize national employment, but to maximize profits.  Business is thus concerned with minimizing total costs, not wages, and that is why those several factors are all among the crucial determinants of investment and production decisions. Locales with low wages and lax standards tend to be expensive places to produce all but the most rudimentary goods because, typically, those environments are associated with low labor productivity and other economic, political, and structural impediments to operating smooth, cost-effective supply chains. Most of those crucial considerations favor investment in rich countries over poor.

Indeed, if low wages and lax standards were the real draw, then U.S. investment outflows wouldn’t be so heavily concentrated in rich countries. According to statistics published by the Bureau of Economic Analysis, 75 percent of the $4.1 trillion stock of U.S. direct investment abroad at the end of 2011 was in Europe, Canada, Japan, Singapore, Australia, New Zealand, Taiwan, Korea, and Hong Kong (i.e., rich countries). In contrast, only 1.3 percent of total U.S. foreign direct investment stock is in China.

Likewise, if wages and lax standards were magnets for investment, we wouldn’t see the vast sums of foreign direct investment in the United States that we do, and the United States wouldn’t be the world’s most prolific manufacturing nation. At the end of 2010, foreign direct investment in the United States totaled over $2.3 trillion, one third of which was invested in U.S. manufacturing facilities. As the president and his critics (including candidate Romney) drone on about the ravages of “shipping jobs overseas,” they should take a moment to note that 5.3 million Americans work for U.S. subsidiaries of foreign companies (jobs “outsourced” from other countries). And they should note that Europe’s Airbus announced last week that it is making a $600 million investment in a 1000-worker aircraft assembly plant in Mobile, Alabama, just down the road from the $5 billion, 1800-worker steel production facility belonging to Germany’s Thyssen-Krupp, which is located within a few hours’ drive of a dozen mostly foreign nameplate auto producers, who employ tens of thousands more U.S. workers and generate economic activity supporting thousands more. These investments, jobs, and related activity are the products of foreign companies outsourcing.

Why do these foreign companies come to American shores to produce instead of producing at home and exporting? Because each company has determined that it makes sense from an aggregate comparative cost perspective. They’re not here because of low wages or lax enforcement of labor and environmental standards, but because all of the factors affecting cost that each company uniquely considers, weigh – in the aggregate – in favor of investing here. One very important factor for a growing number of companies is proximity to market. Shipping products long distances can be costly, particularly for time-sensitive products and parts. And having a productive presence in your largest or fastest growing market is a factor that carries significant weight.  Exporting is not always the best way to serve foreign demand.

But outsourcing has been stigmatized as a process whereby U.S. factories are disassembled rafter-by-rafter, machine-by-machine, bolt-by-bolt and then reassembled in some foreign location for the purpose of producing goods for sale back in the United States. There may be a few instances where that accurately depicts what took place, but it is simply inaccurate to generalize from those cases. According to the BEA research described in these two papers (Griswold and Slaughter), between 90 and 93 percent of U.S. outsourcing – investment abroad – is for the purpose of serving foreign demand. Only between 7 and 10 percent of that investment is for the purpose of making sales back to the United States.

In 2009, U.S. multinationals sold over $6 trillion worth of goods and services in the foreign countries in which they operate, which was nearly quadruple the value of all U.S. exports that year. Outsourcing helps make U.S. multinational corporations more competitive, and the profits they earn abroad (even if they’re not repatriated) underwrite investment and hiring by the parent companies in the United States. Typically, the U.S. companies that are investing abroad are the same companies that are investing in the United States for reasons that include the fact that U.S. MNC investment abroad tends to spur complementary investment and hiring in the U.S. parent operations.

The capacity to outsource also serves another crucial, underappreciated function: to safeguard against bad U.S. policy. Like tax competition, outsourcing provides alternatives for businesses, which help discipline sub-optimal or punitive government policy. Because of globalization and outsourcing, businesses can choose to produce and operate in other countries, where the economic and political environments may be more favorable. As more and more companies undertake these comparative aggregate cost-of-doing-business assessments, governments will have to think long and hard about their policies.

Governments are now competing with each other to attract the financial, physical, and human capital necessary to nourish high value-added, innovation-driven, 21st century economies.  Restricting or taxing outsourcing as a means of trapping that investment wouldn’t be prudent.  It would render U.S.businesses less competitive, and ultimately reduce employment, compensation, and economic activity. In this globalized economy, policymakers cannot compel investment, production, and hiring through threat or mandate without killing the golden goose.  But they can incentive U.S.companies to return some operations stateside and foreign firms to invest more here by adopting and maintaining favorable policies.

According to the results of a survey of over 13,000 business executives worldwide published in the World Economic Forum’s Global Competitiveness Report 2011/12, there are 57 countries with less burdensome regulations than the United States. That same survey found that business executives are increasingly concerned about crony capitalism in the United States, ranking the U.S. 50th out of 142 economies in terms of the government’s ability to keep an arms-length relationship with the private sector.  Then consider the fact that the United States has the highest corporate tax rate among all OECD countries. Add to that the prevalence of frivolous lawsuits, political uncertainty, out-of-control government spending, the dearth of skilled workers, uncertainty about the tax burden come 2013, and it starts to become clear why U.S. companies might consider investing and producing abroad.  But policymakers can improve policy – in theory, at least.

It boils down to this. About 95 percent of the world’s consumers and workers live outside the United States. We live in a world where U.S. companies have much more competition on the supply side, much greater opportunity on the demand side, and far greater potential for tapping into a global division of labor (i.e., collaborating across borders in production) than 50, 20, even 5 years ago. After a very long slumber, the rest of the world has come on-line.  We should embrace, not curse, that development.

In a globalized economy, outsourcing is a natural consequence of competition.  And policy competition is the natural consequence of outsourcing.  Let’s encourage this process.

Is Romney Going to Defend ‘Shipping Jobs Overseas’? No Way

The lead story in today’s Washington Post accuses Mitt Romney, while at Bain Capital, of investing in firms “that specialized in relocating” American jobs overseas. This gave cause to Obama political adviser David Axelrod to accuse Romney of “breathtaking hypocrisy,” which prompted Roger Pilon to spell out some differences between economics and “Solyndranomics” for the administration. Roger’s correct. But Romney—for running away from that record and playing to that same politically fertile economic ignorance that tempts devastating economic policies—is also worthy of his scorn. Romney should have written Roger’s words.

President Obama set the tone earlier this year during his SOTU address by demonizing companies that get tax breaks for shipping jobs overseas. By “tax breaks,” the president means merely that their un-patriated profits aren’t subject to double taxation. “Shipping jobs overseas” is a metaphor you’ll hear more frequently in the coming months, and Romney is more likely to deny any association with it than to defend it. That’s just the way he rolls.

Outsourcing has been portrayed as a betrayal of American workers by companies that only care about the bottom-line. Well, yes, caring about the bottom line is what companies are supposed to do. Corporate officers have a fiduciary duty to their shareholders to maximize profits. It is not the responsibility of corporations to tend to the national employment situation. It is, however, the responsibility of Congress and the administration to have policies in place that encourage investing and hiring or that at least don’t discourage investing and hiring. But for the specific financial inducements that politicians offer firms to invest and hire in particular chosen industries—Solyndranomics—this administration (and the 110th-112th Congresses) has produced too many reasons to forgo domestic investment. Let’s not blame companies for following the incentives and disincentives created by policy.

There’s also the economics. Contrary to the assertions of some anti-trade, anti-globalization interests, countries with low wages or lax labor and environmental standards rarely draw U.S. investment. Total production costs—from product conception to consumption—are what matter and locations with low wages or lax standards tend to be less productive and thus less appealing places to produce.

The vast majority of U.S. direct investment abroad (what the president calls “shipping jobs overseas”) goes to other rich countries (European countries and Canada), where the rule of law is clear and abided, and where there is a market to serve. The primary reason for U.S. corporations establishing foreign affiliates is to serve demand in those markets—not as a platform for exporting back to the United States. In fact, according to this study by Matt Slaughter, over 93 percent of the sales of U.S. foreign affiliates are made in the host or other foreign countries. Only about 7 percent of the sales are to U.S. customers.

Furthermore, the companies that are investing abroad tend to be the same ones that are doing well and investing and hiring at home.  Their operations abroad complement rather than supplant their U.S. operations.

During his unsuccessful 2004 presidential campaign, candidate John Kerry denigrated “Benedict Arnold companies” that outsourced production and service functions to places like India. Earlier this month, Senator Kerry introduced a bill in the Senate that effectively acknowledges that anti-investment, anti-business policies may be responsible for deterring foreign investment in the United States and for chasing some U.S. companies away. Maybe he should talk to the president—and Romney.