"A wild horse can do a lot of damage, but a bridled horse can be an invaluable
asset."
Posted by "Proud UAW Member" in response to "Politics of Globalization" at
www.thomaspalley.com, December 27, 2005
Understanding outsourcing
Outsourcing is a central element of globalization, and policymakers need to
understand its economic basis if they are to
develop effective policy responses. The practice of outsourcing should be
understood as a new form of competition, and responding to it calls for the
development of policies that enhance national competitiveness and establish new
rules governing the nature of global competition.
Viewing outsourcing through the lens of competition connects with
early-20th-century US institutional economics. The policy challenge is to
construct institutions that ensure stable flows of demand and income, thereby
addressing the Keynesian problem while preserving incentives for economic
action. This was the approach that was embedded in the New Deal put forward by
US president Franklin Roosevelt, which successfully addressed the problems of
the Depression era. Global outsourcing poses the current economic challenge,
and its solution requires a new set of institutions. The task is compounded by
problems associated with a lack of global regulatory institutions and changes
in the balance of political power that make it difficult to enact needed
reforms.
Global outsourcing is enormously facilitated by technological innovations
associated with computing, electronic communication, and the Internet. However,
it is important to recognize that the debate surrounding outsourcing is not
about the benefits of technology. It is a debate about the nature of
competition and what constitute appropriate rules for governing competition
within and between countries. Failure to recognize this can distract and
confuse the issue.
The economics of outsourcing
Globalization has dramatically changed the structure of international
competition. In many regards the process of change can be identified as
beginning in the 1950s and 1960s with the emergence of multinational
corporation (MNC) production. Initially, this output was primarily for local
markets, as shown by the activities of such companies as Ford Europe and
General Motors Europe, which manufactured for the European rather than the US
market. However, in the 1980s and 1990s the pattern changed significantly, when
MNC production became increasingly targeted for export back to the United
States. This change was exemplified by Mexico and China, which have become MNC
production platforms.
There are two important economic features about the MNC revolution. First, MNC
manufacturing has provided an important arena for businesses to learn how to
render state-of-the-art technology and production methods globally mobile.
Second, MNC activities offered a first margin within which capital was able to
put US labor in international competition, and this competition has had
significant adverse impacts on manufacturing wages, employment, and union
membership. [1], [2]
The MNC revolution has received considerable attention. However, while this was
taking place, a parallel and equally important revolution was occurring in the
retail sector. This retail shake-up was linked to a new sourcing model based on
big-box discount stores. [3]
Stage 1 of the US retail revolution started 40 years ago with the emergence of
large-volume discount stores such as Wal-Mart, which was created in 1962.
Initially, the business model was based on national sourcing, with the big-box
stores buying from the cheapest national manufacturer. Such stores pitted
producers against one another nationally, so that companies in New York were
forced to compete with those in California.
This new national rivalry provided lower prices, and it was largely beneficial
because all suppliers were located in the United States and operated under
broadly similar laws. However, even then there were negative effects, as the
new competition encouraged manufacturing to move south to non-union
"right-to-work" states where organizing workers was more difficult and labor
costs were lower.
Stage 2 of the US retail revolution began in the 1980s, when the big-box
discount stores started going global with their sourcing model. As a result, US
suppliers were no longer just in a national rivalry, they were now in an
international bidding contest. No longer was New York just competing with
California; US producers were now measured against companies in Mexico,
Indonesia and China. The economic logic of this global sourcing model is
simple: scour the world for the cheapest supplier and lowest cost - the
so-called "China price" - and then require US manufacturers and workers to
match it if they wish to keep your business.
This new global sourcing retail model has had profound effects. The commercial
success of the model has meant that once one retailer adopted it, the others
were also compelled to adopt it to remain competitive. Consequently, big-box
discounting has spread to every corner of retailing, putting the entire
consumer-goods manufacturing sector in international competition. Additionally,
the model pressures domestic companies to pursue offshore production (ie,
become multinational) to compete with foreign suppliers. These dynamics, though
originating in the retail sector, have also eroded manufacturing jobs and
wages. The model does indeed deliver low prices, but it does so at a high cost.
Outsourcing can be viewed as an application of the retail sector's global
sourcing model to manufacturing. In effect, manufacturers are now also looking
to source globally, and they too are asking their suppliers to meet the "China
price".
The spread of global sourcing is exemplified by auto-component giants Visteon
and Delphi. Initially spun off from their respective parent companies, Ford and
General Motors, Visteon and Delphi engaged in national competition. Last year,
Ford and GM both announced that they were shifting to a global sourcing model
and that their spinoffs would in future have to meet the China price if they
wished to keep business. Given their higher union wages and benefits, both
Visteon and Delphi have been shedding jobs and shifting production offshore,
including to China. However, both have found it increasingly difficult to
compete, and Delphi filed for bankruptcy protection last October.
It is now becoming clear that the global sourcing business model can also be
applied to the service sector. Because of improvements in electronic
communication and the Internet, many services that were previously non-tradable
have become tradable. These include basic computer-systems maintenance and
software programming, tax preparation and accounting, architectural planning,
and telephone call centers. Even retail sales are potentially tradable, as
indicated by the success of the Amazon.com business model. This means that
services will be the next area where the global sourcing model will be applied,
with corresponding effects on compensation and employment security.
Outsourcing and the maturation of globalization
The maturation of globalization can be viewed as combining the developments of
the past several decades into a highly synergistic system. There are three
facets to this mature system.
The first element is the global sourcing model discussed above, which was
initially developed in the retail sector and is now being applied everywhere.
The second element is the mobility of capital, technology, and methods of
production. This mobility combines MNC experience in foreign production
platforms with policies that have dismantled trade barriers and promoted
international economic integration. Whereas the initial globalization era was
one of classical free trade involving the movement of goods across
international boundaries, the new era also includes mobile capital and
technology. Consequently, all countries have access to similar methods of
production, so cost arbitrage (especially wage arbitrage) becomes a critical
driver of the system.
The third element of mature globalization is the addition of 2 billion workers
to the global labor market, given the end of economic isolationism in India,
China, and the former Soviet bloc countries. [4]
Putting the pieces together, changed competition (the Wal-Mart business model)
plus changed technological conditions and policy (globalization of production)
plus 2 billion new workers (the end of economic isolationism) add up to
downward wage and benefit pressures in US labor markets and rising income
inequality. The economic logic is simple. When two swimming pools are joined
together, the contrasting water levels will equalize.
Free-trade theorists (Wolfgang Stolper and Paul Samuelson, 1941) have long
acknowledged that when a rich, capital-abundant country engages in free trade
with a poor, labor-abundant country, wages in the rich country fall. By
combining global sourcing with globalization of production, the new system puts
the Stolper-Samuelson effect into hyperdrive.
How should policy respond?
If we view global outsourcing as an evolution in the structure of competition,
we link with the thinking of early-20th-century American institutionalist
economists. [5] The leading lights of institutionalism were John Commons,
Thorsten Veblen and Wesley Mitchell. The leading living proponent is John
Kenneth Galbraith.
Institutionalists emphasized the importance of the nature of competition and
the problem of destructive rivalry - what Commons [6] termed the "competitive
menace". This idea resonates with today's notion of the "race to the bottom".
What appears to maximize well-being from an individual's perspective can be
suboptimal once the competitive interplay of actions is taken into account.
Institutionalist thinking constructs the policy problem in terms of "regimes of
competition", with some regimes promoting societal welfare better than others.
In the 1930s the New Deal embodied institutionalist thinking. In combination
with the adoption of a Keynesian macroeconomic stabilization policy, the New
Deal solved the crisis of the 1930s Depression era and paved the way for the US
prosperity that followed World War II.
The innovations of the period included new US labor laws establishing the right
to organize, the minimum wage, the 40-hour workweek, and the right to overtime
pay. In the financial realm, creative reforms included the establishment of the
Securities and Exchange Commission to oversee financial markets. Today's
challenge is to come up with a similarly innovative set of arrangements that
addresses globalization and outsourcing.
The New Deal incorporated a collection of bold policies that fashioned an
acceptable regime of competition. Responding to global sourcing will also
require an insightful array of policies. As with the New Deal, there is no
silver bullet. With regard to rules governing worldwide competition,
international labor standards are key to establishing a floor under the global
labor market and ruling out retrograde competition. At the same time, they are
good for economic efficiency and development. [7], [8]
Concerning domestic issues, unions are key to ensuring that productivity gains
are shared equitably and result in a distribution of income that generates full
employment. This calls for labor-law reform that gives real meaning to the
legal right to organize.
There is also a need for new arrangements - both within the United States and
between countries - that prevent tax competition. Such competition is generated
by corporations shopping for tax abatements and lower rates as conditions of
making investments. The result is either an unfair shift of the tax burden on
to labor incomes or an underfunding of needed public investment and spending
when corporate tax avoidance strips the public purse of revenue.
Another area requiring new institutional arrangements is exchange rates. Here,
the need is to prevent countries from using undervalued exchange rates as a way
of competing. Engaging in competitive devaluation is a form of
beggar-thy-neighbor economics wherein countries rely on demand in foreign
markets rather than building domestic markets. Undervalued exchange rates are
an unfair subsidy that distorts the pattern of trade. They also risk causing
global deflation because they promote an increased supply of exports without
increasing global demand.
With regard to national competitiveness, countries need to invest in education
that raises worker productivity. There is also a need for job-loss assistance
and active labor-market policies that help displaced workers cope with income
losses and obtain training that prepares them for productive future employment.
In the United States there is a special need to attend to the problem of health
insurance, which is currently a job cost, since premiums are tied to
employment. This crisis is exemplified by General Motors, where the cost of
each car includes $1,500 of worker health insurance. Health-insurance coverage
needs to be detached from jobs, and this suggests a national health plan
financed out of general tax revenues.
The politics of policy response
The emergence of global outsourcing enormously complicates policy issues, both
intellectually and politically. The ability to outsource worldwide calls for
new forms of international regulation because it undermines the effectiveness
of many existing national arrangements. Yet construction of an acceptable
regime of international competition must be accomplished in a political
environment lacking effective institutions of international economic governance
and in which national governments are weakened and corporations strengthened by
the enhanced mobility of capital.
Creating a political climate that can secure the needed policy responses calls
for the development of popularly shared understandings of globalization. That
is why economics is so politically important. Economists tell stories about
what is going on in the economy. Today there is need for a different story than
that spun by neo-liberal economists.
Notes 1. K Bronfenbrenner, "Uneasy Terrain: The Impact of Capital Mobility on
Workers, Wages, and Union Organizing", report prepared for the US Trade Deficit
Review Commission, Washington, September 2000.
2. K Bronfenbrenner and S Luce, "The Changing Nature of Corporate Global
Restructuring: The Impact of Production Shifts on Jobs in the US, China, and
Around the Globe", report prepared for the US-China Economic and Security
Review Commission, Washington, October 2004.
3. The seminal article on the emergence of this sourcing model is G Gereffi,
"The Organization of Buyer-Driven Global Commodity Chains: How US Retailers
Shape Overseas Production Networks", in Gereffi and N Korzeniewicz, eds, Commodity
Chains and Global Capitalism (1994). The use of this sourcing model by
the retail sector is documented by G R Hamilton, "Remaking the US Economy: US
Retailers and Asian Manufacturers", prepared statement for the US-China
Economic and Security Review Commission hearing on China and the Future of
Globalization, New York, May 19-20, 2005.
4. R B Freeman ("Doubling the Global Work Force: The Challenge of Integrating
China, India, and the Former Soviet Bloc into the World Economy", lecture given
at the University of Utah, Salt Lake City, October 2004) has emphasized the
significance of the addition of 2 billion workers to the global labor market.
However, he believes that globalization is being driven by classical
comparative advantage, so the wage effects of increased global labor supplies
can potentially be offset by the production gains that come from reallocating
global production in accordance with the principle of comparative advantage.
5. G Atkinson ("Capital and Labor in the Emerging Global Economy", Journal of
Economic Issues, Vol 31, June 1997) has also emphasized the relevance of US
institutionalist economic thinking for understanding globalization.
6. J R Commons, "American Shoemakers, 1648-1895: A Sketch of Industrial
Evolution", Quarterly Journal of Economics, Vol 24, November 1909, pp 39-84.
7. T I Palley, "The Economic Case for International Labor Standards", Cambridge
Journal of Economics, Vol 28, January 2004, pp 21-36.
8. T I Palley, "Labor Standards, Democracy and Wages: Some Cross-Country
Evidence", Journal of International Development, Vol 17, 2005, pp 1-16.
Thomas Palley is the author of Plenty of Nothing: The Downsizing
of the American Dream and the Case for Structural Keynesianism (Princeton
University Press) and Post Keynesian Economics (Macmillan Press) and is
a regular contributor to Foreign Policy In Focus. This policy report is a
shortened version of a paper presented at a conference on "The Political
Economy of Governance" held at the University of Bourgogne, Dijon, France, on
December 2-3, 2005. His weekly economic policy blog is published at
www.thomaspalley.com.
