RUSS ROBERTS

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Outsourcing and Job Security

Note: Newsweek Japan asked me and others to comment on ten questions related to the global economy. Here’s the question they asked on outsourcing and job security, along with my answer.

Q8: Why are firms in many countries still restructuring and firing employees, even though the economy seems to be definitely recovering? With this as a lead, please also answer the following questions. Is there any good way to reduce the unemployment rate? How should workers defend their livelihood in this age of high unemployment with so many immigrants flooding into their countries?

From Newsweek Japan

The corporate urge to restructure is insatiable in today’s global economy. For some critics, this is the ultimate indictment of capitalism–profits are always preferred to people. Isn’t there some level of profit that’s sufficient? Why do firms incessantly look for ways to cut costs even in good times?

The world moves very quickly and quicker than ever. A firm that stands still risks going out of business. Consider the humble egg. A school teacher in America in 1900 had to work about an hour to earn a dozen eggs. Today the equivalent number is about three minutes! A twenty-fold improvement. How was that achieved? The technology of teaching hasn’t changed much in 100 years. Eggs would seem to be unchanged, too. The technology is inside the chicken. But the technology of eggs has changed. In 1900 a farmer put a bunch of chickens in the back yard and tossed some feed on the ground. Then he’d look to see if any eggs had been laid.

A chicken in those days laid about an egg a week. Today you still have to feed the chickens and collect the eggs. But over the last 100 years we’ve learned a lot about the breeding, health and nutrition of chickens. The average chicken in America now lays almost an egg a day.

But the increased productivity of chickens is dwarfed by the increased productivity of the workers who do the feeding and collecting. In today’s hen houses, two workers work alongside 800,000 chickens to produce 240 million eggs a year! How can those two workers be so productive? The key is the modern hen house, transformed by technology. The hen house of today does more than keep the chickens out of the rain.

By making the houses larger and by using computers and various mechanized technologies for delivering food and medicine and collecting and inspecting the eggs, only two people are necessary to manage 800,000 chickens. As our standard of living grows, there is a relentless substitution of this kind of labor-saving capital for labor. The amount of worker’s time that goes into an egg has fallen steadily over time. Older technology with more workers would mean costlier eggs.

A farmer in the 21 st century who uses the 19 th century techniques of letting a bunch of chickens run around in the backyard can only raise chickens as a hobby, not as a money-maker. He can’t compete with the technology of a modern egg facility. What drove the transformation of the egg industry and so many others like it? Competition. The risk of being left behind and going out of business.

The transformation of the hen house has taken away thousands of jobs that existed or would exist if we still had a bunch of chickens running around in lots of backyards. Was that transformation good or bad for America? Would it have been better in 1900 or 1950 or 1980 if egg farmers had been content with the level of technology and cost structure of the day rather than looking for ways to always cut costs? Wouldn’t it have been better to have kept more jobs in the chicken business?

To answer those questions, we need to ask another–who captured the gains from transforming the hen house? We did. The rest of us–the eaters of eggs. Technology and productivity lowered costs. That should have raised profits for egg farmers. But it didn’t. Instead, prices fell 20-fold.

The same competition that drove firms to innovate, also lowered prices. As one retired veteran of the egg business once told me, the problem with the egg business is too many eggs. Keeps the profits down. That does make it tough on the egg farmers. But it sure is good for the rest of us.

That process–the inexorable search for ways to cut costs and particularly the drive to replace expensive labor with less expensive capital is constantly taking place around the world–from cars to electronics, from cell phones to eggs. It would be natural to assume that this progress must come at a terrible cost in destroyed jobs.

Ironically, America has added about 100,000,000 jobs over the last 100 years at an almost steadily higher standard of living, year in, year out. The cost savings from higher productivity has allowed new products and new industries to be created with the capital and resources freed up by the improvements in productivity.

The latest manifestation of this drive for lower costs is outsourcing, the use by multinational corporations of skilled, but lower-wage labor in countries such as India and Ireland. This phenomenon is no different than a worker losing a job to an immigrant. It’s no different from a worker losing a job to a new technology. There are a lot of ways to cut costs. All of them lead to wealth eventually. In dynamic economies, that wealth is shared in the form of lower prices. But those innovations lead to unemployment in the short-run. Should a society tolerate this unemployment? How can a worker protect himself or herself from these challenges? The human cost of unemployment depends on the vitality of the labor market.

Every three months, the American economy loses between 7 and 9 million jobs through firms downsizing or going out of business. That’s about 6% of all the jobs in the economy. But incredibly, the American economy creates between 7 and 9 million jobs every three months.

And until the recession of 2001, the American economy steadily created more jobs than it lost. So unemployment is relatively short-lived compared to less dynamic economies such as Europe’s where job growth is flat.

What’s the difference between America’s job market and Europe’s? Most European countries make it expensive to fire workers and downsize. That’s good for workers–their jobs are safer.

But that security comes at a cost–fewer jobs get created. Creating a job is much riskier in Europe because a mistake comes dear. As a result, Europe has a much higher unemployment rate. The best way for workers to cope with the risks of unemployment is to have flexible skills and education. Workers in dynamic economies have to keep learning and investing in knowledge. It is important to remember that the world tomorrow need not be like the world today.

That makes for a challenging environment. It comes at a cost. But the benefit is a rising standard of living and the advances in health and well-being in the countries that have embraced the dynamic competition of the global economy.

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