Our Word is Our Weapon

The McKinsey Global Institute recently published a timely analysis of the costs and benefits of US companies off-shoring work to other countries such as Ireland and India, asking ‘Offshoring: is it a win-win game?‘. This is the source of the much-discussed factoid that of every $1 of US spend off-shored to India, India benefits to the tune of 33 cents and the US gets an extra $1.12-1.15. Hey presto, a win-win game!

Before getting to a couple of criticims of the report, I’ll just point out some positive aspects of offshoring. For all the problems it causes in the offshorer country, offshoring tends to benefit developing countries, who could generally do with all the benefitting they can get. And as George Monbiot has pointed out, the whole phenomenon acts as a form of compensation for some of the countries victimised by colonialism - India and Ireland are the main offshoring destinations because of their status as former English-language colonies. Lastly, it’s impossible at the moment to judge whether offshoring leads to improved quality, but it’s at least possible that workers in remote developing countries can overcome the disadvantages of distance to provide an equivalent service.

Put simply, the main conclusion to be drawn from a critical analysis of McKinsey’s research is this: While labour costs (i.e. wages) account for most of the hypothetical $1 lost to the US through offshoring, the bulk of the ‘extra economic value’ generated from offshoring goes to corporate investors.

McKinsey say that “For every dollar of spend offshored, 58 cents are captured as net cost reduction to businesses even as they often receive an identical (or better) level of service” (p. 7). Initially, they say, “the savings will flow to investors, or they will be invested in innovations or new business ventures. Eventually, as offshoring becomes more prevalent, competition will yield the savings to consumers”.

The problem is that the latter conclusion assumes competitive markets in the US. But in relatively uncompetitive markets with few big players and high barriers to entry, companies are more likely to simply keep the profits from reduced costs without passing them on to consumers through lower prices.

The other main source of benefit to the US is from ‘redeployed labour’:

As low value-added service is sourced from overseas, U.S.
workers previously engaged in providing those services are freed up to take
other jobs. If redeployment continues at the rate it has over the past two
decades, then for every dollar of spend offshored, the economy will capture an
additional 45 to 47 cents per dollar of offshoring from the new jobs that are
generated. (p. 9)

What they don’t mention until later is that “the wage loss for every dollar of spend offshored is 72 cents” (p. 11), and the 45-47 cents figure comes from an assumption - based on data collected in the US on trade-related job losses - that 69% of workers losing jobs to imports will be re-employed, with the ‘mean wage recapture’ being among these lucky people being 96.2%. A close look at these reemployment statistics shows that “36 percent of displaced workers soon found jobs that matched or increased their wages but 55 percent were at best working for 85 percent of their former wages. As many as 25 percent saw pay cuts of 30 percent or more”.

So while corporate investors will tend to gain significantly from offshoring, workers will definitely lose. And given the profile of jobs lost to offshoring, it will mostly be the poor and unskilled, those least able to cope and adapt, who will take the biggest hit. McKinsey’s absurdly rosy-tinted view that laid-off workers are being ‘freed up’ to take better jobs is not borne out by reality: low-earning workers are 30% less likely to receive on the job training. Off-shoring, combined with existing inequalities in education and training, is thus likely to contribute to further socioeconomic polarisation.

McKinsey suggest that companies could take out a form of insurance to be paid-out to laid-off employees for a period of time after any redundancies due to offshoring. While this would be nice, it seems unlikely that many companies will be persuaded to care about the fate of soon-to-be former employees enough to enter into the massive insurance arrangements required. A better arrangement would surely be for governments to levy a ‘windfall tax’ on companies offshoring, since it is governments who will probably be picking up the tab for unemployment benefits and subsidised training.

EDIT: I’ve a had a few more thoughts on this topic, which I’ll add on here:
-First of all, I should have simply said that the McKinsey analysis makes the mistake of methodological nationalism, a mistake then unabashedly perpetuated by economic libertarians who apparently can’t see the contradiction. Methodological nationalism is when you treat countries as basic units of economic analysis, when obviously they are not. To say that ‘the United States’ is a net gainer from offshoring is to say nothing whatsoever about the distribution of costs and benefits within the United States.
-Taking a more nuanced view (as the McKinsey analysis eventually does, though you wouldn’t know it from the simplistic treatment it got from the press or free trade ideologues) reveals that offshoring is a ‘win-win-lose’ game, where the offshoring company and ‘offshoree’ companies and labour win and the workers in the offshoring company lose.
-McKinsey’s analysis arrives at a net ‘profit’ to ‘the US’ of 12 to 15 cents, but this doesn’t seem to take into account the costs associated with the job losses and lower wages it also identifies. The costs of higher unemployment benefits and lower health insurance coverage will be significant, and will be borne by taxpayers and vulnerable households.
-McKinsey put forward a very weak proposal for addressing concerns about job ‘displacement’ (which they’d rather not admit includes unemployment): “for as little as 4 to 5 percent of the savings companies realized from offshoring, [offshoring companies] could insure all full-time workers who lost jobs as a result.” But this is rather absurd, since no company which intends to offshore jobs is going to take out non-compulsory insurance for its soon to be ex-workers. The companies who are most likely to shed jobs through offshoring will be least likely to want to take out such insurance since it will reduce the benefits of offshoring. I still think that a ‘windfall tax’ that is applied after offshoring to capture some of the easily-calculable benefits may be a better idea.

I’ve started doing an evening course in economics, and this
is my first bit of coursework, an essay on the concepts of supply, demand and elasticity as applied to the housing market(s) in the UK and especially London. It’s pretty basic stuff, and any comments would be welcome.

Interesting piece of econometric research here by Zvika Neeman, M. Daniele Paserman and Avi Simhon, on corruption, openness and growth. The abstract:

We consider a neoclassical growth model with endogenous corruption. Corruption
and wealth, which are co-determined in equilibrium, are shown to be negatively cor-related.
Richer countries tend to be less corrupt, and corrupt economies tend to be
poorer. This observation gives rise to the following puzzle: If poorer countries do indeed
experience higher levels of corruption, and if indeed as suggested by a number of em-pirical
studies corruption hampers growth, then how did rich countries, who were poor
once, become rich? Our answer is simple. In the past, economies were mostly “closed”
in the sense that it was difficult to transfer illicit money outside of the economy. In
contrast, today’s economies are mostly open. In the relatively closed economies of the
19th century, the gains from corruption remained inside the country and became part
of the economy’s productive capital. In contrast, in today’s open economies, corrupt
agents smuggle stolen money abroad depleting their country’s stock of capital. We con-firm
this intuitive explanation by testing the hypothesis that the e .ect of corruption
on wealth depends on the economy’s degree of openness using cross-country data.

All of which is quite depressing, because it is just another way in which poor countries are punished for being poor. They need productive capital more than anyone, yet they’re leaking it like a sieve. The open ones, that is. Is this an argument for closing off your economy? Not really - it’s primarily an argument for world cooperation in controlling, tracking and where possible returning illicitly obtained and/or transferred capital. The US have found seizing the overseas assets of Iraqis a fairly straightforward matter - why can’t they help track down the stolen billions of Mobutu, Marcos and others?

“International law is unequivocal - Paul Bremer’s economic reforms are illegal”. So says Naomi Klein in the Guardian:

Naomi Klein
Friday November 7, 2003
The Guardian

Bring Halliburton home. Cancel the contracts. Ditch the deals. Rip up the rules. Those are just a few of the suggestions for slogans that could help unify the growing movement against the occupation of Iraq. So far, activist debates have focused on whether the demand should be for a complete withdrawal of troops, or for the United States to cede power to the United Nations.

But the “troops out” debate overlooks an important fact. If every last soldier pulled out of the Gulf tomorrow and a sovereign government came to power, Iraq would still be occupied: by laws written in the interest of another country; by foreign corporations controlling its essential services; by 70% unemployment sparked by public sector layoffs.

Any movement serious about Iraqi self-determination must call not only for an end to Iraq’s military occupation, but to its economic colonisation as well. That means reversing the shock therapy reforms that US occupation chief Paul Bremer has fraudulently passed off as “reconstruction”, and cancelling all privatisation contracts that are flowing from these reforms.

How can such an ambitious goal be achieved? Easy: by showing that Bremer’s reforms were illegal to begin with. They clearly violate the international convention governing the behaviour of occupying forces, the Hague regulations of 1907 (the companion to the 1949 Geneva conventions, both ratified by the United States), as well as the US army’s own code of war.

continues …

It’s all very well for Klein to say that the new Iraqi regime will be well within its rights to cancel the contracts, but it won’t be that simple. Iraq is likely to be heavily involved with the World Bank / IMF and they’re always horriffied at the idea of a government doing something so un-’market friendly’ as re-nationalising an industry, no matter how bad an idea the privatisation was in the first place.

This kind of reform is pretty hard to reverse. Oh and it’s worth pointing out that when Russia and other former Soviet states underwent similar ’shock therapy’ their economies pretty much collapsed and living standards plunged.

Coalition Provisional Authority Order 39: Foreign Investment

America continues to use its overseas ‘development’ aid to bribe poorer nations into liberalising their economies, regardless of whether it’s in their interests or not. Or so says this story from the World Bank’s press review.

A top US trade official on Tuesday said only countries that back Washington’s policy of trade liberalization should receive trade-related assistance from the World Bank and IMF, reports Reuters.

Poorer nations, especially in Latin America, have argued they need massive economic and technical assistance before they can sign on to the Free Trade Area of the Americas, or FTAA - the ambitious effort for free flow of goods and services between the 34 countries in the hemisphere. The IMF, the World Bank and the Inter-American Development Bank are looking into ways they can help countries to open their borders to trade, but Deputy US Trade Representative Peter Allgeier, who oversees the Americas-wide FTAA said there would be strings attached.

“Our view is that one should not be injecting huge amounts of money into environments where the policies are also not undergoing change, including trade liberalization policies,” Allgeier told the Washington International Trade Association, a group that brings together businesses, officials and diplomats to discuss trade issues. “So any assistance in the trade area from these institutions should be related to policy changes in the form of trade liberalization.”