Free trade doesn’t work for most American workers

The aphorism “A rising tide lifts all boats” has become entwined with a basic assumption that free trade results in economic wins for all players in the global economy. Of course this assumes you are lucky enough to have a boat that has not run aground.

The classic case for free trade was made nearly 200 years ago by economist David Ricardo. This static argument relies on the principle of comparative advantage; that trade enables countries to specialize in goods and services they produce more efficiently than do their trading partners. This increases overall productivity and total output.

The conclusion follows from countries having different opportunity costs of producing tradeable goods. The opportunity cost of any good is the other goods that could have been produced by the same resources. Each country focuses on what it does best and everyone gains. This notion of free trade has a hallowed status among the cheerleaders for globalization.

Another way to understand comparative advantage is to consider the opportunity cost of undertaking a certain activity. Let’s assume that Lady Gaga, the famous entertainer, also happens to be a world-class typist. Rather than entertaining and typing, she should specialize in entertaining, where her comparative advantage is greatest and she could maximize her income.

In this example, Lady Gaga has a much higher opportunity cost of typing than does her secretary. If Lady Gaga spent an hour typing while the secretary spent the hour running the business, there would be a loss of overall output.

The real world is much more complex. Free trade has a downside: while its benefits are broadly distributed, costs are often concentrated. Consider the case of American textile workers. In the aggregate, American consumers gain by having access to cheap clothing, but unemployed textile workers bear the loss.

Many free trade cheerleaders confuse it with off shoring jobs, which is simply substituting, cheap foreign labor for more expensive American labor when nothing is in fact being traded. Moving production overseas has nothing to do with comparative advantage; it simply reflects wage and price competition from countries seeking jobs and economic growth.

If a firm shifts production to low-wage countries, its profits improve, driving up share prices and senior management performance bonuses. To paraphrase one-time presidential candidate Ross Perot: If you can build a factory overseas, pay about a dollar an hour, have little or no health care or retirement benefits and no environmental controls, then you are the greatest businessman in the world

But when many firms move overseas, American workers lose their incomes. So when do the costs of lower incomes resulting from job losses and government revenues exceed the benefits to consumers of lower prices? Put differently, do the costs of exporting good-paying American jobs outweigh gains from cheaper imports and contribute to a shrinking middle class.

Free trade advocates contend that the Americans left unemployed have acquired new skills and will find better jobs in “sunrise” industries. In reality, how many steelworkers do you know who have become computer software engineers?

This is one reason why Americans’ real incomes have stopped growing as manufacturing jobs have been moved offshore.

As then-presidential candidate Barack Obama said in 2008, “You go into these small towns in Pennsylvania and like a lot of small towns in the Midwest, the jobs have been gone now for over 25 years and nothing’s replaced them. And it’s not surprising, then they get bitter, they cling to guns, or religion or antipathy to people who aren’t like them or anti-immigrant sentiment or antitrade sentiment to explain their frustrations.”

A former General Motors CEO allegedly said “what is good for GM is good for America.” But offshoring challenges the conventional wisdom that American firms generally advance the nation’s economic interests. When they employ a large foreign workforce but few people within the United States, it certainly is good for the firms, but not for the American worker.

Originally Published: April 16, 2016.

The offshoring of the American Dream

By all accounts, Americans continue to experience the worst economy since the Great Depression. Unemployment remains unacceptably high, many of the jobs that produce real income have been offshored and the middle-class earnings are stagnant. Looking ahead, it’s likely to get worse before it gets better.

Yet corporate profits are doing just fine, thank you. Today they make up about 12.5 percent of  America’s gross domestic product. Just two years ago, they reached their largest percentage of GDP since the 1950s. On the other hand, wages and salaries, which accounted for 47 percent of GDP in 1985, are currently at around 42 percent.

Among the reasons for the combination of lower wages and high corporate profits in a weak economy is that American firms have discovered the advantages of exporting manufacturing and service jobs to countries with an abundance of productive, low-wage workers. Firms substitute cheap foreign labor for American workers. All the while, those Americans are told that offshoring is part of free trade and globalization.

Early offshoring was focused on manufacturing, but in recent years, U.S. firms have taken advantage of modem communication technology to outsource service activities. This trend cuts across all industries and occupations, ranging from lower-skilled manufacturing jobs to those requiring more skill and education, including those in the information technology sector. Put bluntly, they are exporting jobs to countries where wage rates are low, causing higher unemployment and lower living standards in the U.S.

Cheerleaders for offshoring argue that the money companies save will, in the long term, create new and better domestic jobs. These jobs must be disguised in the employment statistics; very well disguised, indeed. Moreover, they argue that when firms save money, consumers benefit from lower prices. So while free trade causes some dislocation, the benefits outweigh the costs. This pitch has become a totem of belief among free-trade advocates but it’s cold comfort for those whose jobs have been exported.

It was reported last month that IBM now employs more people in India than it does in the U.S. Its Indian workforce has grown from 3,000 in 2002 to about 112,000 last year. The reason is simple: The cost of labor in India is only a fraction of what it costs to employ the equivalent workers in the U.S. The average annual salary for an IBM employee in India is $17,000 compared with $100,000 for a senior American IT specialist.

Given such wage differentials, it’s not surprising that we are now witnessing the great migration of white-collar American service jobs. While India is the largest destination, the jobs have also gone to Eastern Europe, the Philippines, China and Mexico.

The offshoring of jobs may be one of the underlying reasons why Great Recession job losses look quite different from those of past recessions. American unemployment is becoming structural rather than cyclical and may worsen over time no matter how much public stimulus is provided.

So we have finally figured out how to make income redistribution happen on a global scale: American workers have to be less rich so their overseas counterparts can be less poor. Offshoring increases income levels in developing countries and the theory is that with greater wealth, those people will be able to demand and receive better treatment. The question is whether these interests should outweigh the interests of American workers.

Maybe jobs will return when American wages are as low as those of our foreign competitors and corporations decide to come home to exploit cheap labor. But it seems they first have to impoverish domestic workers so those workers can become rich again in the future.

originally published: November 6, 2013