Sunday, September 19, 2004
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Paul Samuelson's mistake about offshore outsourcing
One of the more common critical responses to defenses of offshore outsourcing is the claim that defenders of the practice are being deluded by a set of archaic economic ideas that only work in the ivory towers -- they need to get out in the real world, man.
Beyond ignoring the intrinsic value of economic theory as a device for understanding the world, what's amusing about this line of argumentation is that protectionists throw it out the window the moment someone comres up with an economic theory that seems to support their argument. Which is fine -- except that, far more often than not, the models they embrace rest on assumptions that are often harder to satisfy in the real world than the standard neoclassical trade models.
For exhibit A on all this, consider Paul Samuelson's recent contribution to the outsourcing debate. In The American Prospect, Eamonn Fingleton has a rhetorical field day proclaiming that Samuelson's bombshell has eviscerated the orthodoxy of free trade. One excerpt:
There's just one problem with all of this -- Samuelson's paper has nothing to do with offshore outsourcing as it's commonly understood.
Arvind Panagariya -- Professor of Economics at Columbia -- provides a concise explanation for where Samuelson gets confused on offshore outsourcing (thanks to Asif Dowla for the link). Here's a long excerpt to explain what Samuelson was arguing:
Samuelson employs the standard Ricardian model, which assumes two countries (called America and China), two goods (called 1 and 2) and one factor of production (called labor). Because the endowment of labor is taken as fixed in the Ricardian model, any change in the total national income are reflected fully in the change in the real wage. If the real wage rises, real incomes of all individuals and therefore the nation rise. Alternatively stated, the wage also represents the per-capita income in the model....posted by Dan on 09.19.04 at 12:51 AM
Correct me if I'm wrong. No blogger yet has found the paper - just the rebuttals to what Samuelson will publish. Folks have made this mistake before - rebut what they thought Samuelson had said. I look forward to his article - and then will go back to the comments.posted by: pgl on 09.19.04 at 12:51 AM [permalink]
pgl: I believe the paper is available on the Journal of Economic Perspectives web site, but only if you're a member of the American Economics Association.
An economist was kind enough to send me the paper, and I've read it. All I can say is that Panagariya -- who's an economist, not some pajama-wearing blogger -- is correct in his summary of what Samuelson is saying.posted by: Dan Drezner on 09.19.04 at 12:51 AM [permalink]
I sent you an e-mail regarding this piece from Slate. It describes how Kerry's plan to end the incentive for outsourcing, thus removing a distortion from the tax code and enhancing free trade. I wanted your thoughts on it. Is there any particular reason that you didn't respond?posted by: Brian on 09.19.04 at 12:51 AM [permalink]
Why do you suppose Samuelson made such a big error?posted by: Brian on 09.19.04 at 12:51 AM [permalink]
Re Kerry's proposal, consider the following: an American company makes MRI scanners in Milwaukee, using many parts sourced from other countries. Electric motors come from their own plant in China.
Under Kerry's plan, punitive taxes would be leveled on the company's operations in China (since the motors are not for Chinese domestic consumption) Thus, the American company will close its Chinese plant and source its motors from some other business operating in China (a German company, for example) which has no such tax burden. The result will be to hurt the global electric motor business of the American company and reduce employment opportunities for its US-based engineers and marketing people, while benefiting the German company.
Why is this a good thing?posted by: David Foster on 09.19.04 at 12:51 AM [permalink]
Economists may talk about winners compensating losers, but I've never heard a convincing story about how a 50-year-old mother of two is to be compensated after her manufacturing job is outsourced. She may, if lucky, find a comparable job somewhere, but only at the price of uprooting the family. Her husband may find another job in their new place of residence. Staying put, her only alternative may be a low-paying job.
Economists trumpet the virtues of free trade as if the differences between textbook theory and the world were of little importance. No wonder economics is hard to translate into a language that addresses the concerns of ordinary folks. The great 20th century economist John Maynard Keynes began "General Theory of Employment, Interest and Money" by observing that before we can construct relevant theories for the present, we have to unlearn the useless theories of the past. In Keynes' view, shedding the old was more difficult than building the new. He concluded with the observation that "practical men" who chart national policies are more often than not the slaves of useless theories.
The practical men and women who are responsible for trade policy today are equally the slaves of outmoded dogma. The first step to a better trade policy is to clear our minds of the cobwebs of comparative advantage, the refuge of those who find it easier to justify the havoc wrought by outsourcing than to re-examine received ideas. We need trade and we need trade policy. We don't need free-market mantras.
Stephen A. Marglin is Walter S. Barker
posted by: bhaim on 09.19.04 at 12:51 AM [permalink]
Are you sure you understand Kerry's proposal? Which site told you about it?posted by: Brian on 09.19.04 at 12:51 AM [permalink]
bhaim wrote: "Economists may talk about winners compensating losers, but I've never heard a convincing story about how a 50-year-old mother of two is to be compensated after her manufacturing job is outsourced. She may, if lucky, find a comparable job somewhere, but only at the price of uprooting the family. Her husband may find another job in their new place of residence. Staying put, her only alternative may be a low-paying job."
I am not sure I have ever heard economists, at least in the context of the economic theory, talk about conpensating of economic losers by economic winners. I have heard politicians talk about it - usually fairly incoherently, and I imagine some particular economist may conjecture what could help lessen the burden of the economics losers, but is this type of compensation a real concern for the Economists at large?
Perhaps Dr. Drezner can confirm or deny. Certainly, my Econ. professors were not overly concerned with equitable distribution unless their field of work was in Labor Markets.
Overall, as pleasantly compelling as your [bhaim] argument sounds on the surface, it seems that what you are really saying is that a US-based 50-year old, who may or may not have children to support, and may or may not get a lower-paying job, and may or may not want to move, with a hypothetical husband presenting its own set of issues should under no circumstances lose her current - presumably decent-paying manufacturing job (which have been disappearing for 3 decades now without India's involvement). And if she does lose the job, it would under no circumstances be used to reward an Indian worker who would be toiling tirelessly anyway (or doing nothing, I am not clear on that point) for less money, especially since the new found wealth will corrupt the otherwise stolid foundations of this Indian's family and social life.
I write the above merely to see if I understand the crux of the problem you are describing. If so, then the example basically classifies people as "deserving" of some fate and "non-deserving" of some other one. Nearly as I can tell, economics does not deal with "deservedness" of outcomes, just the outcomes themselves.
Nothing written above by me should be taken to mean that I advocate indiscrimate job cutting for immediate transfer of jobs abroad. I am also, personally, very much interested in what kind of political and social solutions can be created to help people get better and more rewarding jobs. I just do not think trade [global and otherwise] can be ignored as the driving variable for *creating* these jobs but singled out as the cause for *destroing* them.posted by: Con Tendem on 09.19.04 at 12:51 AM [permalink]
The [wage insurance] plan would have been designed to address the well known sharp drop in wages that typically accompanies job dislocation and would act as an additional social safety net. The plan would have been modeled on the work done by Lori Kletzer and Robert Litan. I believe it would have been an effective way to address the rising political anger about international trade and corporate offshoring (or outsourcing) in a way that still made economic sense. It would have finally put some money where trade economists mouths are on the idea of the winners from global trade compensating the losers. And it would have done more than just say lets educate workers better --which is not a meaningful answer for this generation's middle aged workers.posted by: bhaim on 09.19.04 at 12:51 AM [permalink]
Dan: thanks. It looks like I have some homework. As soon as I get home, I'll put on my PJs, download the paper, and take a look!posted by: pgl on 09.19.04 at 12:51 AM [permalink]
Is this post meant to end with a "%"? I get the feeling some of the excerpt is truncated.posted by: Sigivald on 09.19.04 at 12:51 AM [permalink]
Brian...the Kerry proposal is summarized in a Slate article linked to by an earlier comment on this post. It's totally consistent with the explanation of the Kerry proposal that I've seen in other places.
Is there some specific point in my scenario that you believe is not supported by the Kerry proposal?posted by: David Foster on 09.19.04 at 12:51 AM [permalink]
CPA definition of an economist.......someone who can be wrong about everything during his/her entire career and not get sued for malpractice.
Discussing trade theory is fun, but in the northern tier of Ohio we are setting our third consecutive annual bankruptcy filing record, not to mention another record year for foreclosures. Most of this is occurring AFTER the end of the recession.
From an American perspective, it appears all 50 states are enjoying the benefits of trade while about 10 states, many of them in the "Rustbelt," are taking most of the damage. How do we iron out that little problem?
Having the Sheriff auction off your house is not a theoretical exercise.
I certainly don't think there is a "right" to prosperity, but when we pay taxes to a government which then develops trade policies that harm us, we gotta wonder.
Due to the magic of the electoral college, we (Ohio and Michigan) are ground zero this year, although I doubt either candidate will care about us after the polls close. In one of those wild little ironies, our near-bankrupt cities are having to pay huge police overtime for all of the campaign visits, so both candidates can promise to fix our finances.
Kerry's tax ideas suggest to me that either he doesn't understand international taxation or he is just blowing campaign smoke. Very few CPAs understand international taxation, so it's not likely Kerry does.
Bush wants more education and training for the Rustbelt, but can't answer the basic question, "training for what jobs?"
Nice of you smart folks to let a humble accountant join the thread.
Tom Ealey, CPA
Totally agree generally with bhaim's insert. And,TomE of Ohio(tragic what is going on), but you're dealing with the ivory towers false religions, smugness and non-realtiy of buying foreign made goods, etc. etc. here (as on any academia blog. I may have to start my own--with some others who may be Thinking Independents who deal in the real world.( your occupation would have been much easier had we restructured the tax system and put controls on execs and attorneys several decades ago). The outdated universities have ruined the country and hemorrhaged the country with all the paper so-called professionals/yuppies. All continues with their offspring guppies now too young and too inexperienced to be in any univs. A farce. A con job on American society. Tragic effects.
The Slate piece talked about how Kerry's piece would enhance free trade.
Am I missing something?posted by: Brian on 09.19.04 at 12:51 AM [permalink]
I totally agree with the idea of such a plan. As someone who is forced to deal with outsourcing and offshoring every day I am well aware of the difficulties it imposes on people here and people in the other countries. I am also aware, first-hand, of how flimsy many of the hyped benefits of offshoring are (at least in software development industry). It is actually interesting to see how all the parties are adjusting to reality 2-3 years after the initial projects started.
Nevertheless, there *are* real benefits to doing some of the things offshore for american companies, and increasingly, non-american companies can also compete in similar markets (like software development). The question I am forced to ask then is -- what should the government do, if anything, for people whose jobs are lost despite most valiant efforts of their parent companies?posted by: Con Tendem on 09.19.04 at 12:51 AM [permalink]
I hate to say this, but even considering the fact that outsourcing isn't half the problem that we're lead to believe that it is, there are still people losing their jobs to workers in foreign countries. Yes, it makes economic sense to companies (and the CEOs who stand to see their own salaries increase) but for the American workers on the ground losing their jobs, and the sense of security that comes with employment, things aren't so good. Your dismissal of those people is rather offensive - sure, they're just employees, but somewhere, somebody's worried about how their kids are going to eat next week. It's unfortunate that your legitimate critique of anti-outsourcing advocates would have to make you come off as so callous and mean-spirited, particularly when there's no real threat that your position will be shipped overseas any time soon.
"Economists may talk about winners compensating losers, but I've never heard a convincing story about how a 50-year-old mother of two is to be compensated after her manufacturing job is outsourced. She may, if lucky, find a comparable job somewhere, but only at the price of uprooting the family."
Most of whom are grown or nearly so, but never mind that...
"Her husband may find another job in their new place of residence."
Yeah. He might even find one that opened up because of trade. You know such jobs tend to be more numerous than the ones that "moved overseas" (i.e., disappeared because of changing technology or our own governments' boneheaded policies, but those funny looking people "over there" make such great scapegoats so we'll blame it on them instead).
"The only clear winner would seem to be the Indian worker, who enjoys an increase in income and consumption without any corresponding increase in work time or effort. But even here the standard explanation oversimplifies: The Indians are unambiguously better off only if we don't count the costs of the disruption to their communities and other "externalities" such as the substitution of rapid Westernization for a more gradual evolution of Indian culture colliding with globalization."
How in the world could you possibly characterize "rapid Westernization" as a bad thing? Most of the "traditional communities" in the world could stand more than a little "disruption" and "Westernization", the quicker the better. I'd bet money that you'd think so if you actually had to live there. I know I would.
"From an American perspective, it appears all 50 states are enjoying the benefits of trade while about 10 states, many of them in the "Rustbelt," are taking most of the damage. How do we iron out that little problem?"
With the help of a nifty tool known as the "moving van".posted by: Ken on 09.19.04 at 12:51 AM [permalink]
I'm certainly glad I read Ken's post. It is really all so simple.
So if I am a 57-year-old tool-and-die maker who gets dumped after 32 years on the job I just jump in a moving van and go somewhere else. Good grief, why didn't us Rustbelt blockheads think of that?
Thanks Ken, we are now enlightened.
By the way, there is a good probability that Mr. tool-and-die maker has a Combat Infantry Badge or Marine Expert Marksman medal at home, 'cause while all the budding young economists, lawyers and politicians were smoking dope and listening to Peter Paul and Mary he was humping the boonies, coutesy of that wonderful Harvard MBA Bobbie McNamara. But why should we care about that? We have jobs.
Anyway, the secret is that all of the displaced workers in the Rustbelt just call United Van Lines and go somewhere else. Wow!
Thanks Ken. I'm guessing you are a well educated guy who drives an expensive foreign-nameplate auto and has the world by the tail. Your advice is very helpful. Sorry we are so dumb.
Tomposted by: TomE on 09.19.04 at 12:51 AM [permalink]
"So if I am a 57-year-old tool-and-die maker who gets dumped after 32 years on the job I just jump in a moving van and go somewhere else. Good grief, why didn't us Rustbelt blockheads think of that?"
Some of them did.
"By the way, there is a good probability that Mr. tool-and-die maker has a Combat Infantry Badge or Marine Expert Marksman medal at home, 'cause while all the budding young economists, lawyers and politicians were smoking dope and listening to Peter Paul and Mary he was humping the boonies, coutesy of that wonderful Harvard MBA Bobbie McNamara."
Are his veterans benefits adequate for the sacrifice he made? If not, take it up with Congress or the VA, not some guys in India or consumers buying from same.
"Thanks Ken. I'm guessing you are a well educated guy who drives an expensive foreign-nameplate auto and has the world by the tail. Your advice is very helpful. Sorry we are so dumb."
No, I'm a well educated guy who drives a moderately-priced Japanese auto, had to leave Louisiana and endure the frozen climate of Pennsylvania for a couple of years after a layoff, and has resigned himself to the fact that he'll probably never live in his native Louisiana again, and probably will never see it more than once every couple of months unless we ever finally relegate groundcars to the museum and get some modern personal transportation. I'm also a programmer who realizes that programming wasn't going to remain an arcane art forever, that something like Visual Basic was bound to come down the pike and open up the fields to huge numbers of competitors (some foreign, some American) that can now be productive in my field, and that what we really need is a continuing stream of new industries to come into existence and grow and develop like the computing industry did. That would require a lot of political changes, but none of them involve cutting off trade. Deregulation across the board to the level enjoyed by the computing industry before the Microsoft trial would be much more helpful.posted by: Ken on 09.19.04 at 12:51 AM [permalink]
Maybe your title has confused me as to what you are saying. Samuelson's paper as Bhagwati et al. note is not about outsourcing but about the effect of productivity changes in a world where the terms of trade are endogenous. It is not - as some would suggest - an argument for trade protection or an argument against outsourcing. Rather it is simply saying from what I can tell is that a productivity change may not benefit one nation if the terms of trade offset the benefits of the productivity change. Of course, Harry Johnson made similar claims many years ago. What am I missing here?posted by: pgl on 09.19.04 at 12:51 AM [permalink]
It seems that most of the comments here are a bit off-topic of the alleged error in Samuelson's critique of free trade. I'm not an economist and I'd never encourage the elected leadership of the U.S. to legislate on the basis of the advise of economists. I have observed the havoc caused by outsourcing and I understand the ideology from which it emanates: free trade and the belief that national ("Westphalian") political structures are obsolete.
I think that one must understand that outsourcing is far more than a political issue of convenience for opportunistic politicians; it's a threat to national sovereignty and wide sections of the American middle class. As the movement of American middle class jobs offshore increases with the related movement of low-wage Third World "guest" workers into the U.S., a new political dynamic will be more visible. There really isn't a new "high-tech" jobs boom on the horizon and there will be no reprieve for the American middle class.
Of course, one is inclined to discuss outsourcing primarily in the context of the present presidential horse race but either Bush and Kerry fail to understand the issues or they refuse to be candid with the rest of us. Outsourcing isn't a "win-win" situation for Americans and others around the world, it's the logical outcome of a political system dominated by the most powerful economic interests -- multi-national corporations.
I'm actually sorry that Dan didn't mention Kevin Phillips once in his Foreign Affairs article. Corporate power and influence is really the issue underlying the reasons why outsourcing will continue regardless of who is elected in November. I'm sure that we will have to wait a few more years before the full economic and social implications of outsourcing are felt in America but I envision a society much more sharply divided between "haves" and "have nots" while millions of low-wage foreign guest workers make the entire concept of an American nation, American economy or American society increasingly unbelievable. Without the intervention of a strong national government and real statesmen, I'm afraid that the middle class like the U.S. is in a period of decline. Given the unscrupulous nature of American politicians, I'm sure this is unlikely.
How can an idiot receive a nobel prize for making such a huge mistake and destroying the american economy? Why dont he give back the nobel and start over by taking econ 101 and see how everything is interrelated and how everything suffers together in the american economy?posted by: David on 09.19.04 at 12:51 AM [permalink]
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