The Great Outsourcing Scare of 2004

From the Hoover Digest, Spring 2004

People are worried that Indians are going to take away all of America’s good jobs. The “outsourcing” of call-center and software coding jobs to India has been a tough pill to swallow for an educated workforce. The alarmists, from presidential candidates to think tank economists, see a dim future for America if nothing is done to arrest the flow of jobs from West to East.

The level of fear reminds me of an earlier time. In the early 1990s, Japan was thought to be the great threat to the American economy. Japan was strategically pursuing a policy of stealing America’s jobs. America was being hollowed out. Back then, Amazon was a river and Spam was a food, sort of, anyway. The focus was mainly on manufacturing jobs, which back in the early 1990s were more numerous than they are today.

I remember a Frontline documentary from those days. It’s a wonderful world we live in. A few hits on Google and I was able to find the Frontline web site and a description of the documentary: Losing the War with Japan Frontline looks at the challenge Japanese-style capitalism poses to the U.S. market. The program examines three industries–automobile, video games, and flat panel displays used in computers.

Robert Krulwich introduces the hour-long documentary and anchors a closing half-hour roundtable discussion. The show ended with a parade of returning veterans from the first Iraq war that had recently ended successfully. The voiceover was something like, “We won that war, but can we win the economic war?” The implication of the war imagery was that economic competition was a zero-sum game–the economic pie was a fixed size and every slice that went to Japan was a slice taken from our plate.

Economics takes a different view–trade is mutually beneficial. Both parties benefit and the pie gets bigger. But there was a second part to that documentary that I haven’t thought about for a decade. It comes back to me now in the alarm over outsourcing. The documentary paid a lot of attention to Nintendo. Nintendo was accused of the nefarious strategy of keeping all the best jobs, the creative jobs designing new games, in Japan. The lousy jobs were relegated to America. And as an example of those lousy jobs the Americans were given, we were shown American kids answering the phones, giving advice to gamers who had questions about how the games worked. A call center!

So in 1991, the world was going to hell in a handbasket because we’d be stuck with the call center jobs. In 2004, the world is going to hell in a handbasket because we’re losing the call center jobs. Hard to understand how both of those arguments can be right. At the heart of these fears is a theory about how nations prosper–the key is to get the good jobs. Ross Perot had a simple way of expressing it. He said it’s better to make computer chips than potato chips.

In this mistaken theory of how jobs affect our standard of living, wages depend on the title on your business card. If somehow the foreigners corner the computer chip market, we’re left peeling potatoes for minimum wage, if we’re lucky. The problem with this theory is that, if a nation’s skill level is low, making computer chips makes you poorer, not richer. It’s like me at 5′ 6″ deciding to be a basketball player because basketball players have high salaries. Or Haiti trying to jump-start its economy by creating a domestic pharmaceutical industry sector because pharmaceuticals are very profitable.

Ironically, perhaps, the potato chip business in America is rather high tech. Perot’s slogan makes you think of a bunch of folks with potato peelers standing over vats of hot oil. In fact, a potato chip factory (like virtually everything else in a high-wage economy) uses a high ratio of capital to labor. Basically a truck dumps a bunch of potatoes into one end of a highly customized and sophisticated piece of machinery run by a computer. Bags of potato chips come out the other end. Designing and building that machine, along with the software that makes it tick, are not exactly what Perot had in mind. Our wages don’t depend on our job titles but on our skills and the amount of capital we have to augment those skills. Opening our economy to trade in goods and services allows us to use our skills and capital as productively as possible.

There are two ways to get things in life. The first is to make them for yourself. The second is to let someone else make it for you and trade for it. When others can make something more cheaply than you can make it for yourself, it makes sense to outsource it. You specialize in what you do most productively and swap for the rest of your desires. That specialization creates wealth. If Indians have low wages and can write computer code more cheaply than Americans, it makes sense to import that code. It’s no different from importing inexpensive televisions from abroad and saving our resources for other things we can do more effectively.

It’s no different from finding a new production technology that lets you produce at lower cost. It’s about getting more from less. That’s the true road to wealth. Make the pie bigger by getting more from less. That’s the story of the last 100 years of economic progress in America. We’ve found ways to get more from less. Imagine a world where Indian tech workers were really cheap. Cheaper than cheap. Free.

Suppose India decides to give us free software and run those call centers just out of kindness. Would it ever make sense to refuse the free software in order to preserve high-wage jobs in the software industry? Oh no, not the free software, must be a trick.

Refusing inexpensive software is no wiser. It makes us poorer as a nation, not richer. Imagine reacting that way to high-quality Japanese cars. Imagine refusing to allow Japanese imports into the United States in order to preserve the size and wages of the auto industry. With less competition, the quality of American cars would fall. But the real loss would be all the resources we’d have to devote to cars–all the people and capital and technology and managerial talent–when there would be a less expensive alternative. Savings those resources is what allows us to create the new jobs that come from lower-cost automobiles. In 1900, 40 percent of the workforce was in agriculture.

Technology, figuring out ways to get more from less, allows us to produce more food today with only 2 percent of the workforce. That transition was hard on a lot of farmers, but their children and grandchildren live in a better world because of those changes. The lower costs meant higher profits at first for those farmers who stayed in business, but competition among farmers forced them to share the gains with the rest of us. The result is that food is dramatically cheaper than it was. That means more resources are available to make the myriad of products that we have now in addition to having the food.

The same transition will take place with today’s computer programmers who lose their jobs to Indians. There will be personal challenges as workers look to find new jobs. Some new jobs will be created because businesses will have access to less-expensive software. Other opportunities will come along because cheaper software means more resources will be available elsewhere to create new companies and new products. The skeptic wants to know now what the new jobs will be. What if there aren’t any?

OK, says the skeptic, I accepted the argument for trade when we outsourced the assembly line jobs or the textile jobs. Those were the bad jobs. But the computer jobs? Those are the jobs we wanted to keep! Those were the good jobs. We went from a manufacturing economy to a service economy to an information economy. There’s nothing left! We’re going to have to go back to the “bad” jobs, flipping hamburgers and doing each other’s laundry. What sector will come along if we’ve used up all the information jobs? I don’t know, but I’m sure it will be something that uses creativity and knowledge. This uncertainty frightens people.

If we can’t think of what the next generation of jobs will be, how can we be confident that something will indeed, come along? Think about that farmer back in 1900. Imagine telling him that in 100 years, farm jobs will only be 2 percent of the workforce. Two percent! What jobs could possibly come along to replace the farming jobs? Well, you explain, there will be jobs at Federal Express and Motorola and Intel and Microsoft and even General Motors. The farmer won’t even be able to even imagine the products that those companies will make. Imagine being told a decade ago that some people would make their living writing software for iTunes at Apple. What’s iTunes? Oh, it’s a place where people download music into their iPods. What is downloading music?

Just think how much the world has changed in only 10 years, all the jobs we couldn’t have imagined that are now here. Back in the early 1990s, when people were up in arms about Japan, we ignored the alarmists. We mostly kept to our naive policy of letting people buy freely from around the world. It turned out fine. The alarmists were wrong.

Japan didn’t steal our jobs or ruin our country. Employment in the United States grew steadily, as did wages, helped in part by imports from Japan and the rest of the world. Japan, in the meanwhile, has stagnated. My guess is that today’s alarmists will turn out to be wrong as well. There’s another interesting parallel to the early 1990s. Then and now, the critics of open markets claimed a new paradigm. In the early 1990s, the new paradigm was the unique partnership in Japan between industry and government that supposedly threatened our standard of living.

Today it’s the loss of software jobs, the alleged last frontier of employment. But the real reason those arguments have popular and political traction is that both today and in the early 1990s, we’re coming out of recessions with sluggish employment growth. When the economy warms up and the jobs come, the worries about outsourcing will fade into the background.

A final thought. Can you imagine how strange our worries about outsourcing must sound to India? Hearing us complain about their low-wage competition is like listening to the Yankees complain that the Red Sox signed Pokey Reese to a contract. You don’t know who Pokey Reese is? That’s the point. It’s the Red Sox who have it rough. But baseball is a zero-sum game–when the Yankees win, the Red Sox have to lose. Unlike sports, international trade makes both sides better off. Outsourcing lets Americans get less-expensive software and the Indians get better wages and the chance to buy more American goods. It’s a good deal for both of us.