Global Policy Forum

By Steven Pearlstein

In one respect, White House economic adviser Greg Mankiw is absolutely right: There is no economic difference between BearingPoint using cut-rate software engineers in China and India and Black & Decker making its power tools in Mexico and the Czech Republic. One's a good, the other is a service, but according to standard economic models, importing both is supposed to be beneficial to the U.S. economy. The problem with the standard model, however, is that it is based on a number of key assumptions that are increasingly at odds with reality.

One big one is that labor markets are either at full employment, or will get there real soon. What this ignores is that the world has just gone through a political revolution -- the end of communism -- which suddenly has dumped a billion underemployed, low-cost workers into the global labor pool, with multinational corporations champing at the bit to equip them with western capital and technology. At the same time, the arrival of the Internet and the digital revolution have suddenly made it possible for many of those workers to compete against tens of millions of U.S. service workers in sectors once immune to trade.

Taken together, these two extraordinary and simultaneous developments threaten to create such an imbalance in the supply and demand for labor that we could have an extended period of job dislocation and wage stagnation. Or as one wag put it: This may not be a jobless recovery, it's just that the new jobs are in Bangalore. Another assumption in the standard model is that in a world of free trade and free-floating currencies, countries won't run big trade imbalances. In the real world, however, two of our biggest trading partners, China and Japan, are manipulating their currency like crazy while using trade barriers to limit imports of American goods and services. The result: a large and persistent trade deficit. Or put another way, all those countries benefiting from "offshoring" haven't yet used much of their new income to buy American goods and services. Indeed, in a set of papers that has been used to boost public support for offshoring, the consulting firm McKinsey & Co. estimated that every dollar of service activity transferred to India generates only about 5 cents in additional U.S. exports.

Finally, the standard model relied on by defenders of offshoring assumes a world of perfect competition. But as Princeton University economist William Baumol and Ralph Gomory, IBM's former research director, point out in an intriguing new book, there are now many industries in which competition is imperfect because entry by new firms is virtually impossible. That leads them, by way of some fancy mathematical footwork, to the conclusion that trade may not always be the win-win proposition economists have always said it was, particularly when it is between higher-income countries or involves higher-skilled industries. The point here is not to suggest that offshoring is always bad or that it suddenly threatens every job in America. Rather, it is to cast a critical eye on the idea -- peddled by most economists and the burgeoning consulting industry that has developed around it -- that offshoring is always a good idea. McKinsey's much-cited study, for example, calculates that for every dollar in service work transferred offshore, the U.S. gets $1.12 back in benefits each year. But it turns out this calculation is based on the assumption that the economy will be as successful in finding jobs for displaced service workers as it did in the past, when the service sector was largely protected from global competition. Nor have any of the briefs filed in defense of offshoring even taken a stab at calculating what happens to income inequality when so much more of the labor force is subject to the "discipline" of low-wage competition. The experience of the last 25 years, however, is hardly encouraging. If you peel back the arguments in favor of offshoring, what you finally end up with is an article of faith -- faith that history will repeat itself and the U.S. economy will quickly generate enough new jobs in higher-paying industries to compensate for the ones lost to trade. What I've yet to see, however, is even an educated guess as to what those jobs might be.

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