Outsourcing, Insourcing and Automation

China is losing its competitive labor advantage. Demographic trends mean that most if not all of the workers available to implement that country's industrialization effort are already engaged in it or being trained to do so. They are aware of their value in the global economy and are demanding compensation commensurate with their contributions.

In response, manufacturers are introducing more technology into the Asian workplace. This reduces the short term impact of wage increases but reduces their competitive advantage as US and European companies implement similar strategies. Previously understated costs of outsourcing such as transportation, insurance, loss of intellectual capital and managerial coordination are receiving closer scrutiny.

Which is all great. But it does not mean that simple, high paying jobs are returning to Birmingham, England or Birmingham, Alabama. As the following article explains, increasing aggregate demand is unlikely to reduce unemployment and may raise the inflation rate.

The challenge is that the jobs being created as a result of these changes are even more dependent on technology than ever. Workers are less likely to work directly with their hands on the product in question that to manipulate computerized machine tools whose operation required training, sophisticated skills and relevant experience.

The issue may not have much to do with trade policy and much to do with education, transition management and skills development.

Globalization has eroded some of the bonds that forged national social compacts. Corporations move money, production, people, tax burdens and legal responsibility to those locales offering the greatest return and lowest cost, both financial and operational. Nations facilitate this undermining of loyalty by competing for business in ways that reduce the value of the final decision to their jobless citizens and their tax coffers. And they decry the loss of patriotism even as the increase the incentives to ignore it.

The implication is that countries and the businesses still located within them can most profitably focus on what they can control - like funding education and training to facilitate the transition to ever-more automated production. That is the the reality and the optimal strategy is to address it. JL

Bruce Bartlett comments in the Economix blog:

One problem that economists always have in analyzing the economy is separating cyclical effects, which are temporary, from structural effects, which have long-term implications. In real time, it is almost impossible to separate the two, yet the distinction is important because policies to deal with the wrong problem may be ineffective or even counterproductive.

This is especially a problem when analyzing the labor market. If the central problem is a lack of aggregate demand, then the vast bulk of the unemployed are jobless through no fault of their own. This macroeconomic problem requires a more expansive monetary and fiscal policy.

But if the problem is structural, increasing aggregate demand is unlikely to reduce unemployment and is more likely to raise the rate of inflation.

Structural unemployment is much more difficult to deal with. Workers may require extensive retraining because the businesses and industries that employed them no longer exist, and their skills no longer have the value they once did.

The distinction between cyclical unemployment and structural unemployment is further complicated by something called hysteresis, which, basically, is the process whereby cyclical unemployment is converted into structural unemployment.

The longer someone is out of work, the less likely that person is to find a job. Skills deteriorate, younger workers tend to be hired for available vacancies, jobs move to new geographical locations and so on.

Another factor that contributes to structural unemployment is automation — the replacement of human labor with machinery, computers and robots.

Economists have been concerned about this since the time of Adam Smith.
Perhaps the most famous anecdote in the history of economic thought is Smith’s discussion of the pin makers and the division of labor in “The Wealth of Nations.” One pin maker working by himself could barely make one pin per day in the 18th century. But a group of pin makers working together, each specializing in one aspect of pin-making, could manufacture 4,800 times more pins per day. Ten pin makers could manufacture 48,000 pins rather than just 10 pins per day.

Smith’s story also points to another problem in dealing with unemployment, which is that productivity growth is sometimes the worker’s enemy.

Generally speaking, higher productivity — that is, higher output per man-hour — is a good thing. That is what generally gives workers higher real wages over time and increases the standard of living for everyone.

But it is not obvious that higher productivity will lead to higher output rather than lower employment. In Smith’s tale, the owner of the pin-making shop could have decided to lay off all his workers after one day and simply sold off the massive inventory over a period of years.

Usually, this doesn’t happen. Increased productivity tends to lower prices and increase demand, thus leading to increased employment in industries where productivity is rising. But in the immediate aftermath of some productivity-enhancing improvement, the first-order effect may be to reduce employment.

Unfortunately for workers, productivity gains may take place during times when cyclical unemployment is high. Indeed, some economists contend that in the long run recessions have a positive effect on the trend rate of economic growth by forcing businesses to adopt labor-saving technology, purge redundant workers and invest in productivity-enhancing machinery.

It is small comfort to workers suffering simultaneously from cyclical and structural employment, as is the case today for many in the manufacturing sector, but preventing businesses from laying off workers or investing in robotics is penny-wise and pound-foolish. Jobs may be preserved in the short run at the expense of better jobs in the future.

It is especially important for advanced economies, like those in North America and Europe, to facilitate investment in labor-saving technology even if it leads to higher unemployment. Increasing output per hour is the key to competing with low-wage economies like China’s.

People who are not economists often believe, incorrectly, that the United States can never compete with countries like China, where labor costs are a fraction of those here. This leads them to think that tariffs and import restrictions are an appropriate policy response.

In fact, what businesses really care about is not wage rates but unit labor costs; that is, labor costs adjusted for productivity. Thus a country with a poor, uneducated, unskilled labor force with minuscule wage rates is not necessarily the best place for a business to set up shop. A highly skilled, well-educated and well-equipped labor force may well produce more output at a lower labor cost per unit.

Although many workers still worry about offshoring, or the outsourcing of their jobs to China, this is a fading problem, in large part because of automation and rising wages in China, which have eroded its cost advantage. Some companies, including Apple, that previously moved production to China are now bringing it back to the United States, as unit labor costs have risen in China and fallen domestically.

According to a recent report from the Congressional Research Service, other companies have found hidden costs in overseas production that offset the lower wages. These include quality, transportation, safeguards for intellectual property, loss of managerial control and other factors. Benefits of situating manufacturing in the United States include close proximity to research and development and falling energy costs.

Unfortunately for workers who may have lost their jobs to outsourcing, the return of these jobs to the United States is unlikely to benefit them, because they aren’t the same jobs. New factories are unlikely to be situated where the closed factories were and the newly hired workers aren’t going to have the same skill set.

Instead of doing manual labor, workers increasingly are using computers to control robots or other sophisticated machinery. That raises productivity and allows well-paid American workers to compete with those working for a fraction of their wages in developing countries. But it also means that workers require more education and different skills, working with software rather than drill presses.

The goal of public policy should be to ease the transition to a more automated production process while cushioning the blow to those suffering through no fault of their own.