Thomas Palley

Over the last three years there has been an explosion of public concern about the wage and employment impacts of global outsourcing. As a result, worries about globalization have begun to move up the income ladder, infecting white-collar middle-class workers. For instance, a poll conducted in May 2004 for the Associated Press reported that sixty-nine percent of Americans believe outsourcing hurts the economy. Recognizing the potential threat this shift of public opinion poses to corporate globalization, business groups have been busy playing a game of catch-up seeking to allay these new more broadly shared public fears.

Recently, the world renowned Washington DC based Institute for International Economics (IIE) released a study praising the benefits of off-shoring the information technology (IT) industry, titled “Accelerating the Globalization of America: The Role for Information Technology.” The study argues that IT is good for the economy, and globalization is good for IT. Ergo, globalization is good for the economy. The only problem is that the argument does not stack up.

The IT industry provides an opportunity for observing the effects of global outsourcing on a cutting-edge “new economy” sector. A close inspection of the facts confirms the fears of the public, not the claims of corporations. The IT industry is not the apparel or shoemaking industry, which means the adverse effects of global outsourcing cannot be casually dismissed as just the inevitable shedding of outmoded industry.

The study’s thesis is that IT investment yields a high rate of return for the economy. Moreover, IT investment is very price sensitive, so that lower IT prices yield a proportionately larger increase in IT investment spending. Finally, globalization has driven down the price of IT products. Putting the three pieces together, globalization has been good for the economy by driving down IT prices, increasing IT spending, and thereby spurring growth.

Sounds very reasonable. Unfortunately, there is little evidence that globalization has caused lower IT prices, and without that the argument crumbles. IT hardware prices are driven by two factors – long-term trends and the business cycle. The long-term price trend captures the impact of technological innovation, and the trend of prices has been down for a long time. That trend is sometimes referred to as Moore’s law – after Gordon E. Moore a co-founder of Intel – and it states that the unit cost of computing power halves every eighteen months. Moore’s law was coined in 1965, long before the current period of globalization began, and there is no evidence that globalization has accelerated the trend of computing power price decline.

With regard to the business cycle, there is clear evidence that the price of computing power (DRAM or dynamic random access memory) is related to the utilization of DRAM production capacity. Prices fall when there is excess capacity, and they rise when capacity is tight. That is standard supply and demand analysis, which rests on economic principles that applied long before globalization. The only contribution of globalization is that much DRAM production capacity is now offshore because U.S. corporations have been building new capacity offshore rather than at home.

All of this casts huge doubt over the claim that globalization has benefited the economy by benefiting IT. However, whereas the benefits are in doubt, the costs are not. One clear cost is that the U.S. IT hardware industry has been significantly hollowed out. The U.S. used to run an IT goods trade surplus. Now, it runs a huge IT trade deficit, with many U.S. companies importing products made offshore by their subsidiaries or under license by foreign producers. In 2005 the U.S. trade deficit in information and communications products was $83.2 billion. The deficit with China alone was $50.8 billion, reflecting the huge off-shoring of IT production that has taken place.

With regard to jobs, there has also been a clear contraction in the level of U.S. IT employment. In 1999 there were 4.9 million technology-related jobs, but this had fallen to 4.6 million in May 2005 – a loss of 300,000 jobs. The bulk of these job losses were for workers earning less than $30,000 per year, but there was also significant job loss of 140,000 among computer programmers who made an average of $67,400 per year.

With regard to wages, the average real wage for lower paid technology related jobs was essentially stagnant between 1999 and May 2005. For mid-level computer support specialists whose annual pay averaged $43,380 in 2005, real wages actually fell 1.3 percent annually over this six-year period. However, the real pay of higher skill tech workers rose 1.6 percent per year. The bottom line is that global outsourcing of the U.S. IT industry has not been good for workers in the bottom half of the wage distribution. The IT sector therefore appears to be following a similar path to manufacturing, confirming the fears of working families about outsourcing.

An underlying claim is that outsourcing of IT hardware production has been a boon to the U.S. economy because it leads to lower IT prices from which the U.S. economy benefits. According to this logic, the U.S could benefit from outsourcing of its IT R&D capacity and from outsourcing its software industry. Indeed, these developments are to be encouraged, and under current globalization policy they are. Yet, this entire way of thinking has recently been challenged by Nobel laureate in economics, Paul Samuelson. Samuelson has shown that when the U.S. off-shores those industries in which it has historically held a comparative advantage (such as IT), the U.S.’s future gains from trade and standard of living can fall.

Changes in the structure of the U.S. IT industry are being driven by corporations, which are intent on maximizing their own profits. In a nationally based economy, such as was the case in the 1950s and 1960s, profit maximization by companies tends to maximize national income. In a global economy, that is not the case. Instead, profit maximization promotes the maximization of global income rather than national income. Companies are happy to outsource because they earn the profits on outsourced production, but that does not maximize national income. This fundamental insight is not yet appreciated within Washington policy circles.

There is no disagreement that IT is good for the economy. There is also agreement that globalization relies significantly on IT. However, there are two dangers. The first is that opposition to the current form of globalization gets misinterpreted as opposition to technology – a misinterpretation that advocates of corporate globalization encourage with charges that opponents are “Luddites”. The second danger is that globalization gets credited with the benefits of IT because of its heavy reliance on IT – that’s tantamount to a case of bait and switch.

The debate over globalization is not about the benefits of IT, and opposition to globalization does not mean opposition to technology. Instead, the debate is about the character of globalization – the absence of labor standards, the absence of rules for exchange rates, the implications of outsourcing for workers, and changed power relations that enable corporations to set economic policy and collar productivity gains for their top management and owners. The lesson from Moore’s law is that the benefits of IT would have flowed regardless of expanded globalization, and for working families they might have been even larger under an alternative globalization.

A final generic lesson for policymakers concerns numbers and public debate. The enormous resources of the business community means that it can commission studies, launch them with fanfare, and then broadcast their findings. In this way controversial calculations can quickly become received fact. That is a problem for which there is no easy solution. However, it does suggest that policymakers and journalists be skeptical of studies about trade and globalization promising four course free lunches.

Copyright Thomas I. Palley

This entry was posted on Thursday, October 12th, 2006 at 6:45 am and is filed under Globalization. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.