Tuesday, 16 June 2009

How many jobs are onshorable?

Offshoring has become one of those things everybody knows nothing about, but they still somehow manage to hate it. Offshoring seems to be one of the scarcest things on rich nations’ economic radar screens, all of our good jobs being sent overseas. In the US economist Alan Blinder was one of the first to point out the threat in his 2006 Foreign Affairs article “Offshoring: The Next Industrial Revolution?” In this article he said,
constant improvements in technology and global communications virtually guarantee that the future will bring much more offshoring of ‘impersonal services’’— that is, services that can be delivered electronically over long distances with little or no degradation in quality.
More recently Blinder has produced some estimates of the size of the revolution. And they make it look like "the big one". Blinder (2009): "I estimated that 30 million to 40 million US jobs are potentially offshorable."

Richard Baldwin takes issue with the implications of those numbers. In a column at VoxEU.org Baldwim writes
The trouble is that his numbers are being interpreted in the light of the “old paradigm” of globalisation – the world of trade theory that existed before Paul Krugman, Elhanan Helpman, and others led the “new trade theory” revolution in the 1980s.
Baldwin expands on this point by saying
Krugman’s contribution, which was rewarded with a Nobel Prize in 2008, was to crystallise the profession’s thinking on two-way trade in similar goods.1 This was a revolution since the pre-Krugman received wisdom assumed away such trade or misunderstood its importance. In 1968, for example, Harvard economist Richard Cooper noted the rapid rise in two-way trade among similar nations and blamed it for the difficulty of maintaining fixed exchange rates. Using the prevailing trade theory orthodoxy, he asserted that this sort of trade could not be welfare-enhancing. And since it wasn’t helping, he suggested that it should be taxed to make it easier to maintain the world’s fixed exchange rate system – a goal that he considered to be the really important thing from a welfare and policy perspective (Cooper, 1968).

Trade economists back then took it as an article of faith that trade flows are caused by macro-level differences between nations – for example, national differences between the cost of capital versus labour. Nations that had relatively low labour costs exported relatively labour intensive goods to nations where labour was relatively expensive.

This is the traditional view that Blinder seems to be embracing.

What Krugman (especially Krugman 1979, 1980) showed was that one does not need macro-level differences to generate trade. Firm-level differences will do.

In a world of differentiated products (and services are a good example of this), scale economies can create firm-specific competitiveness, even between nations with identical macro-level determinants of comparative advantage. Krugman, a pure theorist at the time, assumed that nation’s were identical in every aspect in order focus on the novel element in his theory (and to shock the “trade is caused by national differences” traditionalists). His insight, however, extends effortlessly to nations that also have macro-level differences, like the US and India.
This now brings us to interpreting Blinder’s 30 to 40 million offshorable jobs figure. Baldwin argues that,
Blinder’s approach is easy to explain – a fact that accounts for much of its allure as well as its shortcomings.
  • Step 1 is to note that Indian wages are a fraction of US wages.
  • Step 1a is to implicitly assume that Indians’ productivity-adjusted wages are also below those of US service sector workers, at least in tradable services.
  • Step 2, and this is where Blinder focused his efforts, is to note that advancing information and communication technology makes many more services tradable. The key characteristic, Blinder claims, is the ease with which the service can be delivered to the end-user electronically over long distances.
  • Step 3 (the critical unstated assumption, if not by Blinder, at least by the media reporting his results) is that the new trade in services will obey the pre-Krugman trade paradigm – it will largely be one-way trade. Nations with relatively low labour costs (read: India) will export relatively labour-intensive goods (read: tradable services) to nations where labour is relatively expensive (read: the US).
Note in passing the comment in Step 3: "the critical unstated assumption, if not by Blinder, at least by the media reporting his results". The media reporting on such issues often overlooks important details.

The catch in all of this? This last step is factually incorrect. That is step is wrong is shown in recent work by Mary Amiti and Shang-Jin Wei (2005). Baldwin continues,
They note: “Like trade in goods, trade in services is a two-way street. Most countries receive outsourcing of services from other countries as well as outsource to other countries.”

Source: Author’s manipulation of data from Amiti and Wei (2005), originally from IMF sources on trade in services. [Click to make larger]

The US, as it turns out, is a net “insourcer”. That is, the world sends more service sector jobs to the US than the US sends to the world, where the jobs under discussion involve trade in services of computing (which includes computer software designs) and other business services (which include accounting and other back-office operations).

The chart shows the facts for the 1980 to 2003 period. We see that Blinder is right in that the US importing an ever-growing range of commercial services – or as he would say, the third industrial revolution has resulted in the offshoring of ever more service sector jobs. However, the US is also “insourcing” an ever-growing number of service sector jobs via its growing service exports. The startling fact is that not only is the trade not a one-way ticket to job destruction, the US is actually running a surplus.
Baldwin's conclusion from all of this,
None of this should be unexpected. The post-war liberalisation of global trade in manufactures created new opportunities and new challenges. To apply Blinder’s logic to, say, the European car industry in the early 1960s, one would have had to claim that since the German car industry (at the time) faced much lower productivity-adjusted wages, freer trade would make most French auto jobs “lose-able” to import competition. Of course, many jobs were lost when trade did open up, but many more were created. As it turned out, micro-level factors allowed some French firms to thrive while others floundered, and the same happened in Germany. Surely the same sort of thing will happen in services, as trade barriers in that sector fall with advancing information and communication technologies.

In short, what Blinders’ numbers tell us is that a great deal of trade will be created in services. Since services are highly differentiated products, and indivisibilities limit head-to-head competition, my guess is that we shall see a continuation of the trends in the chart. Lots more service jobs “offshored” and lots more “onshored”.
Overall, offshoring isn't one of the scarcest things imaginable. In fact its something that should be embraced.
  • Amiti, M. and S.J. Wei (2005), “Fear of Service Outsourcing: Is it Justified?”, Economic Policy, 20, pp. 308-348.
  • Blinder, Alan (2006). “Offshoring: The Next Industrial Revolution?” Foreign Affairs, Volume 85, Number 2.
  • Blinder, Alan (2009). “How Many U.S. Jobs Might Be Offshorable,” World Economy, 2009, forthcoming.
  • Cooper, R. (1968). The Economics of Interdependence. New York: McGraw-Hill.
  • Grossman, G. and E. Rossi-Hansberg (2006a). “The Rise of Offshoring: It’s Not Wine for Cloth Anymore,” July 2006. Paper presented at Kansas Fed’s Jackson Hole conference for Central Bankers.
  • Krugman, Paul (1979). "Increasing returns, monopolistic competition, and international trade," Journal of International Economics, Elsevier, vol. 9(4), pages 469-479,
  • Krugman, Paul (1980). "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, vol. 70(5), pages 950-59, December.
  • Krugman, Paul (1991), “Increasing Returns and Economic Geography”, Journal of Political Economy 99, 483-499.

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