Mankiw and Swagel Reflect on the Politics and Economics of Offshore Outsourcing

Well worth reading. Greg Mankiw and Phil Swagel reflect on their unfair trashing by the Washington media machine in February 2004:

The Politics and Economics of Offshore Outsourcing. N. Gregory Mankiw, Phillip Swagel. NBER Working Paper No. 12398. Issued in July 2006. NBER Program(s): EFG ITI POL

Abstract: This paper reviews the political uproar over offshore outsourcing connected with the release of the Economic Report of the President (ERP) in February 2004, examines the differing ways in which economists and non-economists talk about offshore outsourcing, and assesses the empirical evidence on the importance of offshore outsourcing in accounting for the weak labor market from 2001 to 2004. Even with important gaps in the data, the empirical literature is able to conclude that offshore outsourcing is unlikely to have accounted for a meaningful part of the job losses in the recent downturn or contributed much to the slow labor market rebound. The empirical evidence to date, while still tentative, actually suggests that increased employment in the overseas affiliates of U.S. multinationals is associated with more employment in the U.S. parent rather than less.

Mankiw and Swagel write:

Outsourcing was the topic of two questions at the press conference. It is useful to reproduce the complete answers to these questions to illustrate just how far out of context the subsequent public discussion was to take the comments made at the press conference. The response to the first question on outsourcing was:

I think outsourcing is a growing phenomenon, but it's something that we should realize is probably a plus for the economy in the long run. Economists have talked for years about trade, free international trade, being a positive for economies around the world, both at home and abroad. This is something that is universally believed by economists. The President believes this. He talks about opening up markets abroad for American products being one of his most important economic priorities. And we saw discussions this weekend of the Australia agreement. So it's a very important priority.

When we talk about outsourcing, outsourcing is just a new way of doing international trade. We're very used to goods being produced abroad and being shipped here on ships or planes. What we're not used to is services being produced abroad and being sent here over the Internet or telephone wires.

But does it matter from an economic standpoint whether values of items produced abroad come on planes and ships or over fiber optic cables? Well, no, the economics is basically the same. More things are tradable than were tradable in the past, and that's a good thing. That doesn't mean there's not dislocations; trade always means there's dislocations. And we need to help workers find jobs and make sure to create jobs here. But we shouldn't retreat from the basic principles of free trade. Outsourcing is the latest manifestation of the gains from trade that economists have talked about at least since Adam Smith.

Notice that the order of response was to first note the gains from trade, and only second to refer to the dislocation to affected workers; later we will discuss how, from a communications standpoint, this was a tactical error....

It was not at all clear following the press conference that a political firestorm was in the making. Indeed, reporters from the Financial Times, USA Today, and the Wall Street Journal complained at the end of the press conference that there had not been any news. A reporter from the Washington Post suggested after the event that the answer on outsourcing might be controversial, but more because of the inherently contentious nature of the topic.... [T]he reporters who missed the story at first were among the best in the Washington press corps in terms of their economic knowledge. The FT and Wall Street Journal reporters had the backgrounds one would expect of economics writers for those publications, while the reporter for USA Today was a 1995 graduate of Harvard who had majored in economics and written on the subject for the FT before moving to the mass-circulation USA Today. For these reporters (as for ourselves), a focus on the economic substance meant overlooking the newsworthy point that a White House adviser was talking straightforwardly about the subject of outsourcing in the first place during an election year....

The controversy arose instead from coverage of the press conference in the Los Angeles Times. Above a nuanced discussion of the costs and benefits of outsourcing, the LA Times ran the incendiary (and inaccurate) headline “Bush Supports Shift of Jobs Overseas.” In contrast, the Post headline above a similar story was “Bush Report Offers Positive Outlook on Jobs.”

It took less than a day for the words “Bush Supports Shift of Jobs Overseas” to be picked up by opponents of the President. However, it took more than half a day for this to happen, so that the issue of outsourcing figured little at the Congressional hearing on the ERP on February 10—-the day of the inflammatory LA Times headline.... This changed within the same day’s news cycle.... The next day, February 11, a story on the ERP in the Washington Post was headlined “Bush, Adviser Assailed for Stance on 'Offshoring' Jobs”... and quoted Senator Kerry decrying the White House desire to “export more of our jobs overseas,” as well as Republican Congressman Donald Manzullo from Illinois calling for the resignation of the CEA chairman. White House aides responsible for Congressional liaison warned of fury on the part of Republican members of Congress from Pennsylvania, Ohio, Michigan, and other industrial states....

An interesting note is that after the first day’s stories on the ERP and the press conference, subsequent press coverage focused largely on the political response rather than the substance of what was actually written and said. Indeed, reporters writing the stories universally acknowledged in private that the CEA Report was both correct and unremarkable on the substance. What was remarkable was the reaction, and as journalists they were obligated to cover the political reaction and fallout. The coverage reflected the unfortunate reality of the modern craft of journalism. In general, the coverage did not seem to us to reflect malice, bias, or sloppiness on the part of the journalists involved.... Matters of substance were left to editorial writers...

Well, it depends on what the meaning of "bias" and "malice" are.

Journalists may have been "obligated to cover the political reaction and fallout," but they were also obligated--an obligation they failed to perform--to inform their readers. If it was indeed the case, as Mankiw and Swagel say (and I believe them) that the "reporters writing the stories universally acknowledged in private that the CEA Report was both correct and unremarkable on the substance," then the reporters had an obligation to inform their readers of that fact--a obligation they did not meet, yet easily could have met. Had they met the obligation, they would have better informed their readers. They would also have annoyed a few members of congress by making them look ill-informed.

A reporter who successfully covered both the political reaction and the economics was the excellent Bob Davis of the Wall Street Journal, who wrote on February 12, 2004:

"Some Democratic Economists Echo Mankiw on Outsourcing," By BOB DAVIS February 12, 2004: WASHINGTON -- White House chief economist Gregory Mankiw set off a political firestorm this week when he said that outsourcing U.S. jobs helps the economy. But some prominent Democratic economists make the same argument.

At a Monday news conference, Mr. Mankiw said that sending U.S. service jobs abroad "is probably a plus for the economy in the long run." That is because foreign workers can do the jobs more cheaply, reducing costs for U.S. consumers and companies. "Outsourcing is just a new way of doing international trade," he added.

Since then, his remarks have brought sharp rebukes from lawmakers, including some Republicans. "Incredible indifference," said Democratic presidential contender Sen. John Edwards of North Carolina. "What planet do they live on?" Even Republican House Speaker Dennis Hastert of Illinois said Mr. Mankiw's "theory fails a basic test of real economics."

The White House has offered Mr. Mankiw only tepid support. Calls for his resignation were "kind of laughable," said White House spokesman Scott McClellan, because the economic team is "doing a great job."

Even among Democratic economists, though, Mr. Mankiw's remarks were mainstream. "Basically I agree with Greg's thrust," said Janet Yellen, who was President Clinton's chief economist. "In the long run, outsourcing is another form of trade that benefits the U.S. economy by giving us cheaper ways to do things."

But Ms. Yellen added that many moderately paid U.S. workers are suffering because of outsourcing, especially call-center workers whose jobs have been shipped to India and elsewhere.

The controversy surrounding Mr. Mankiw's remarks spotlights the political potency of the jobs issue this year. Since Mr. Bush has taken office, the U.S. has lost more than two million jobs -- a statistic that has become a major point of attack for Democrats who cite outsourcing as one cause. In recent months, the economy has sharply rebounded, but job growth remains weak .

Mr. Mankiw, who is chairman of the White House's council of economic advisers, may have been trying to put the outsourcing issue in perspective, and speaking more as an economist than a politician. But to some critics he sounded cavalier -- for instance, in suggesting that high-paying jobs in radiology might be better done abroad than in the U.S.

Said Laura Tyson, dean of the London Business School and another of Mr. Clinton's former chief economists: "The traditional economic response does sound hard-hearted and can be criticized for not taking nearly as seriously the dislocation as one should."

A chastened Mr. Mankiw said Wednesday, "I wish I had been more clear at the press conference; any loss of jobs is regrettable. If I suggested otherwise, I failed to communicate."

Though Mr. Mankiw also trumpeted the administration's job-retraining initiatives, the message was obscured by his outsourcing remarks.

"On efficiency grounds, he [Mr. Mankiw] is right," said former Clinton Labor Secretary Robert Reich, meaning that the economy becomes more efficient when costs are reduced through trade. But Mr. Reich, who advises Democratic presidential front-runner Sen. John Kerry, said the administration hadn't made "a serious attempt to deal with the profound structural problems of an economy in transition as it affects middle-class jobs."

Monday, Mr. Kerry joined in the Mankiw bashing, saying the administration wants "to export more of our jobs overseas." But Brad DeLong, a former Clinton treasury economist, cautioned that Mr. Kerry ought to be careful with his word because the outsourcing trend is bound to continue. "Linking outsourcing to aggregate employment decline is a bit of demagoguery that will bite him in the butt next February if he becomes president," Mr. DeLong said.

Comments

[CapitalistImperialistPig]

A lot of people, including this reader, are unpersuaded that economics is a solid enough science that we should believe the accounts of the benefits of outsourcing for this country (not the world).

What the heck is it that economists know anyway? Do they know why China's economy is growing like crazy, but most developed countries aren't? Do they know why Japan is stagnant, but grew mightily when it did? Do they know what Morocco would need to do to grow like China?

They certainly don't seem to have much skill in predicting our own economy. Why should we believe them on questions like immigration and outsourcing?

[Life Globe]

Why does outsourcing take place? Because it's in the interest of American workers? No, primarily because it's in the interest of the companies that do outsourcing. That does not preclude the possibility of it being in the interest of all Americans - or a lot of Americans. The competitiveness of the companies doing outsourcing is strengthened. That means that they may provide more jobs at home, often jobs in innovation, administration and design - and hence better paid jobs. In that sense it turns into a problem af education and qualification, or a problem of Americans moving up the international value chain.
Very often, however, a lot of workers are made redundant. Their chances of finding alternative employment depends on levels of education, - and on the business cycle at large. If there's an economic recession it may be difficult to find other types of employment. In rust belt areas this may not be easy, regardless of the state of the business cycle.
The most harmful effects of outsourcing may be in the countries that jobs are outsourced to. Local production may be lost, because local companies are not able to compete. A dependent local economy may be the consequence.
Outsourcing functions as a kind of expansion of the American labour market. That may lead to downward pressure on wages. Real wages for average American workers have bare budged for the last couple of decades. Getting access to lower paid workers removes incentives for companies to move up the technology ladder and increase productivity, which they would have been forced to, if the American labour were more expensive.
All in all you can conclude that oursourcing in the present form is in the interest of business and less in the interest of broad segments of labour.

[BillS]

Mankiw said "Notice that the order of response was to first note the gains from trade, and only second to refer to the dislocation to affected workers; later we will discuss how, from a communications standpoint, this was a tactical error..."

Yeah, you think! When it comes to the benefits of free trade economists will tirelessly produce hundreds of pages of studies and fervent op-eds while chastising the ignorant fools who don't see the light. Their charts trumpet the increase to the mean which is cold comfort as the median sinks in a age of unprecedented disparity. Somewhere toward the end they always drop in a line or two about "dislocations", that antiseptic euphemism for losing your job, your home and your dignity. They provide lame lip service to the idea that perhaps some relief should be provided to ease the adjustments. The economists argue tirelessly for trade bills and treaties, but hardly at all for the assistance. When the bills and treaties are finally signed, somehow the mitigation has been forgotten. Perhaps they have just lost interest, which is understandable coming from those with a tenured sinecure. I can imagine them sitting around sipping coffee in their Friday afternoon faculty gatherings tut-tutting about how the poor brutes will just have to tough it out, but the country will be better for it in the end.

[bakho]

"Though Mr. Mankiw also trumpeted the administration's job-retraining initiatives, the message was obscured by his outsourcing remarks."

What initiatives? This is the disconnect that started the firestorm. How does defending outsourcing by using an imaginary program to help the individual losers work?

Yes the press failed to grasp the benefits of outsourcing. However, Davis failed to criticize the Bush administration lack of support for displaced workers. This is equally as bad if not worse because displaced workers will blame outsourcing for their plight rather than inept, incompetent and uncompassionate government.

[Blissex]

«"On efficiency grounds, he [Mr. Mankiw] is right," said former Clinton Labor Secretary Robert Reich, meaning that the economy becomes more efficient when costs are reduced through trade.»

That is a strange definition of efficiency: because it fails to take into account the existince of the non-tradable sectors, and the distributional impact.

It can well happen that more than 100% of the efficiency gains from trade are captured by the non-tradable sectors, as their (relative) pricing power is increased by the decrease in pricing power of the sectors exposed to trade.

Perhaps offshoring software development or electronics engineering jobs makes software and electronics products cheaper in nominal terms in the USA, but perhaps this does not improve the welfare of buyers of software or electronics, but only that of their landlords or employers, as house prices grow faster than the decrease in the price of goods, or salaries grow slower than that.

And guess what? Housing costs have been growing must faster than salaries, and salaries have been growing slower than inflation.

Unsurprisingly Mankiw was bithely disingenuous when stating:

«That is because foreign workers can do the jobs more cheaply, reducing costs for U.S. consumers and companies.»

because it should have been ''some U.S. consumers and companies, those shielded from trade''.

[dubblblind]

"The empirical evidence to date, while still tentative, actually suggests that increased employment in the overseas affiliates of U.S. multinationals is associated with more employment in the U.S. parent rather than less."

Ah yes! Tentatively reality based!

[save the rustbelt]

Looking at the recent Brookings report, offshoring has cut the heart out of the Rustbelt economies.

Will we benefit in the "long run?"

The workers who filed bankruptcy and lost their homes probably don't give a damn about the long run right now.

More tenured professors braying about destroying other peoples jobs.

(And about job churning, the jobs being lost have been here for 20, 30, 40 + years, these were very painful job losses, not turnover at teh Dairy Queen).

[save the rustbelt]

Do economists really think that being able to buy cheap Chinese stuff at Wal-Mart makes up for losing 50% of your compensation?

Just wondering.

[Jon Fernquest]

Short-term-thinking in public opinion driving long term policy via democracy, or at least American democracy, a recipe for long-term disaster.

The democracies that the US should be looking with pride at, like South Korea, were nurtured during the cold war era with trade, which gave these countries the wherewithal to develop human capital.

Does the United States even think about economically empowering developing countries anymore?

Outsourcing is an education-based value-added export. Much more so than cheap labor exports. A world full of young minds educating themselves, driven by dreams of better lives, the win-win payoff for everyone is obvious.

One of the most frustrating things being a teacher in developing world universities is seeing the limited job opportunities for graduates who possess important skills that you know they would see a payoff for in the west like engineering, science, or business. Instead they flock to tourism. The valedictorian becomes a stewardess for Japan Airlines, instead of a business woman or a computer scientist.

I think there is a huge contradiction in trying to sell the western system of free markets and democracy and then not giving developing countries any chance to succeed at it, gaining part of vast majority of the world's wealth held by the west. Economics clearly shows that the west will also gain from this expanded economic pie in the future, but that requires some long-term thinking, no instant gratification.

As much as I hate shopping centers, consumer goods, and consumerism, my wife and the rest of the world love them.

Plow through the malls of Bangkok like I did this weekend with my wife and you can count all the Muslim families passing by you as your wife tries on the clothes. It's maybe the one thing that unites the Islamic world and the west.

If this argument doesn't work for you, think of the savings on bombs some will feel compelled to drop later on when the wealth disparity persists and the frustration at not being able to overcome it is chanelled through other avenues.

[save the rustbelt]

"...Congressional liaison warned of fury on the part of Republican members of Congress from Pennsylvania, Ohio, Michigan, and other industrial states...."

Curiously, (or perhaps not so curiously) the GOP Congressional delegation from Ohio said almost nothing.

The next time Bush showed up they all lined up to lick his boots.

Which is one of the reasons Ohio has the 49th worst economy in the country.

[liberal]

Blissex wrote, "Perhaps offshoring software development or electronics engineering jobs makes software and electronics products cheaper in nominal terms in the USA, but perhaps this does not improve the welfare of buyers of software or electronics, but only that of their landlords or employers, as house prices grow faster than the decrease in the price of goods, or salaries grow slower than that."

Right.

An example of the problem with economists is that they either do not understand, or refuse to acknowledge, the pecularities of the economics of land rent.

[liberal]

Jon Fernquest wrote, "The democracies that the US should be looking with pride at, like South Korea, were nurtured during the cold war era with trade, which gave these countries the wherewithal to develop human capital."

Note, however, that SK had extremely strict controls on capital flows.

[jon]

Why do economists seem to ignore the marginal value of money when it comes to free trade?

The US as a whole is worse off, on average, if someone loses a $30k a year job and the rest of America saves $30k a year on consumer goods. Those first 30k dollars are worth far more to that worker, than 0.01 cents of savings are worth to the other Americans. Considering the savings are significantly less than the full salary and are most likely captured by the wealthy rather than the poor, I don't see how one can argue that America is being made better off.

[wkwillis]

ion is right on marginal utility. I expect to sell a patent on solar power sooner or later and I do not think that the one million times uptick in my income is going to make me one million times happier.

[Jim S]

I think we should all pray for ever economist in the U.S. to be booted out on their ass to a nice job paying $9.00 an hour for 30 hours a week and no benefits. They should be told that this is it, this is their life. I think it's the only thing that might introduce them to reality. They never seem to get past the business owners and managers. They just cry crocodile tears at the poor workers who just won't go get an education. Guess what? They don't want education. I have a friend who went and did exactly what you're supposed to do. Unfortunately his 50th birthday hit just before he finished all that training. Want to guess where he's working? Around the house. Not one offer in over a year.

As far as offshoring is concerned the big companies have a simple strategy. Create a set of requirements. You need to have a degree, know these programming languages and these OSes and these other related bits of knowledge. Oooops. Can't find an American with that exact skill set. File for the H1-B or offshore it. Oddly enough the guy who comes in on the H1-B or the Indian fresh out of college doesn't have that skill set they claimed they needed so desparately. But they do work cheaper than that experienced American who doesn't quite fit the profile.

[Jim S]

Sorry...to clarify it's the business owners and management who don't want Americans with an education. Not really.

[liberal]

jon wrote, "Why do economists seem to ignore the marginal value of money when it comes to free trade?"

Because, despite all their protestations to the contrary, (many) economists don't give a hoot about distributional issues.

[bhaim]

Where were the economists when the expansion of the Trade Adjustment Act was being debated to help service workers effected by offshore outsourcing ?

"It is time for Congress to recognize that their free-trade policies, which support corporate globalization of our jobs, have an impact for all of U.S workers," said Marcus Courtney, President of the Washington Alliance of Technology Workers. "Today service sector workers, like their manufacturing counterparts, need TAA assistance to retrain themselves to meet the changing demands of the labor market. Congress should use the new decision by the Department of Labor as the sign that the TAA program needs to include more workers and pass TAA reform legislation this year."

http://www.washtech.org/news/legislative/display.php?ID_Content=5056

[Oskar Shapley]

"Mankiw also trumpeted the administration's job-retraining initiatives"

like what? One-week motivation training with Donald Luskin and John Stossel?

And how much is spend on it COMPARED to the gains from trade? How much do the immediate beneficiaries (the companies) for over?

[mere mortal]

The firestorm around this issue seems pretty straightforward, and quite rational.

First, the distributional issues that are discussed by the commenters above.

But second, and perhaps more important, is the dislocation. It's bad enough that a dynamic economy can quickly and unexpectedly cause certain jobs to disappear (or relocate in this case) and make certain skills obsolete. But when the political party in charge seems philisophically opposed to easing transitions for affected workers (small government, individual responsibility, etc), then free trade issues begin to accumulate quite rational and quite vocal opponents.

Under a government that has a "bad luck? tough luck" philosophy, it makes perfect sense not only for anyone who would be affected adversely by free trade (outsourcing, removal of barriers, etc) to oppose it, but also anyone who might worry that their job/industry might be next to oppose it.

Those who desire the increased efficiency and maximization of wealth that comes with freer trade must either defeat those utterly rational opponents or accomodate them with those icky liberal redistribution of wealth programs.

Since the republicans will not do the latter, they utterly deserved to get their heads bashed in by the former. It's politics, but there is nothing unfair, dishonest, or demagogic about it.