The Perils of Outsourcing

1
The Perils of Outsourcing

• Michael Smith and Chu-Yi Hsiung

2
The Perils of Outsourcing

• Outsourcing The practice of subcontracting
  work to outside and especially foreign
  companies
• Low cost countries Countries that produce
  goods at prices that are advantageous for firms,
  compared to the US economy.
• Destroy to ruin the structure, organic
  existence, or condition of
• US Economy the structure of the production,
  distribution, and consumption of goods and
  services in the United States.

3
What Makes a Good Economy?

• A good economy is one that provides adequate
  goods and services to all its citizens.
• Broadly, it is characterized by
• Low, stable Unemployment
• High, stable Wages
• High, stable GDP per Capita
• A healthy level of equality
• A sound legal framework to support the exchange
  of goods and services
• A healthy financial system to provide the
  financing of enterprise

4
The Perils of Outsourcing

• Outsourcing to low-cost countries will destroy
  the U.S. Economy
• Arbitrage of our capital resources is occurring,
  causing lost jobs and reduced wages
• Outsourcing contributes to a massive trade
  deficit
• Corresponding Capital Surplus could eventually
  lead to a run on our currency

5
What Comparative Advantage Proponents Want You
to Think

• In this scenario, China and the US simply trade
  in the goods and services market, leaving Labor
  and Capital markets intact
• The result is that both sides will use
  comparative advantage to trade in the Goods and
  Services Market and raise real production of both
  economies
• The Problem is, this scenario assumes relative
  immobility of capital, and that the US will keep
  its factors of production

6
What is Really Going On

• The fact is, China has 5 times as many people as
  we do, and although it has a tremendous amount of
  undeveloped capital, it is underutilized
• Since capital in this market is relatively
  mobile, there is nothing to prevent the free
  exchange of capital for finished goods
• Until these resources are fully utilized (which
  might take a century or more), The US will enjoy
  both a comparative (relative to labor) and
  absolute advantage in Capital, and thus will
  continue to lead capital in exchange for finished
  goods until US wages fall to Chinese levels

7
Capital Arbitrage

• One counter-argument is that the U.S. could
  switch to engineering and design jobs, leaving
  the low-tech jobs to the low-cost providers.
• Unfortunately, there is no wall between the
  manufacturing and engineering of design jobs.
  We're losing high-level jobs, too.

8
Capital Arbitrage
9
Capital Arbitrage

• Wages would continue to fall until it reached the
  level of Chinese pay.
• Equilibrium would be at the weighted mean of U.S.
  and Chinese pay.
• Because there are so many Chinese workers
  compared to U.S. workers and because their pay is
  so low, the equilibrium would be a very low pay
  indeed.

10
Trade Deficit

• Current Account Deficit
• Massive outsourcing contributes to our massive
  trade deficit
• Trade deficit must be financed with capital
  surplus
• Capital Account Surplus
• The Capital Account Surplus requires us to sell
  American assets to foreigners
• What will happen when the returns of these assets
  exceed the returns on our assets

11
Why is there a trade deficit?

• In a free-floating currency, the Trade Deficit is
  generally equal to the capital account surplus
• Because our credit is so good, our risk-adjusted
  interest rate is higher than that of other
  countries
• Because our income is so high, we purchase goods
  in massive quantities from overseas, while our
  goods are less attractive
• Because of the capital account surplus, the
  exchange rate does not increase to balance our
  current account
• One can look at it as offering up our capital as
  collateral, to finance the deficit caused by
  outsourcing

12
Trade Deficit

• The trade deficit for 2004 was 617.7B, over 5
  of GDP. Projecting along the currently
  exponentially-increasing trend
• The trade deficit will be at 10 of GDP by 2008.
• In line with this trend, the February 2005
  deficit was 61.04B, a yearly rate of 732.5B,
  over 6 of GDP.

13
Trade Deficit

• The trade deficit in 2005 with China alone was
  202B up 25 from 2004's 162B, which was up over
  30 from 2003, which was up over 20 from 2002
• This is important because this deficit is mostly
  a result of outsourcing

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Trade Deficit

• The accumulated trade deficit is now at 40 of
  GDP
• Best fit projections indicate it will be at 50
  of GDP in 2007 and at 100 of GDP in 2012
  (assuming 5 GDP growth from 2005 on).

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Trade Deficit and Accumulated Capital Surplus
16
Capital Account Surplus

• Eventually, the returns on this foreign
  investment will cause more investment income to
  flow out of the economy than is flowing in,
  leading to a depreciation of the dollar
• Depreciation could lead to a run on our currency.
• As investment income on the 2.5 trillion (and
  climbing) exceeds the investment income flowing
  into the US, our risk-adjusted interest rate
  falls, and people buy fewer US assets, leading to
  a further depreciation of the dollar, and so on.

17
Currency Run

• What will be the effect of a Currency run?
• Import cost will rise dramatically, but the trade
  deficit will still increase because of the
  J-curve
• Our fiscal deficit will have to be funded
  internally, leading to a massive increase in the
  interest rate and further increases in the
  deficit
• Loaning money for US citizens will become
  prohibitively expensive.

18
Conclusion

• Possible Solutions
• Import Certificates
• Value-added Tax
• Other Possible Solutions

19
Sources

• America's Growing Trade Deficit Buffett, Warren
  E. Loomis, Carol J.. Fortune, 11/10/2003, Vol.
  148 Issue 10, p106-116, 7p, 2 graphs, 3c (AN
  11217761)
• Warren Buffet cries wolf Redenbaugh, Russell
  Davis, Natalia http//www.readingtheworld.com/arti
  cles/Warren20Buffet.pdf
• Thought For Labor Day Roberts, Paul Craig,
  http//www.vdare.com/roberts/050904_marx.htm
• Is our Trade Deficit Sustainable? Powell, Robert
  Ph.D, 5/5/2005 www.exponentialimprovement.com/cms/
  uploads/MagellanTrade2.pdf
• A Systems Thinking Perspective on Trade
  Powell, Robert Ph.D 5/5/2005 www.exponentialimprov
  ement.com/cms/uploads/MfgTrad1_2ppNC.pdf
• The Trade Deficit and the Fallacy of Composition
  Powell, Robert Ph.D, 5/5/2005, http//www.exponent
  ialimprovement.com/cms/fallacy.shtml
• Americas Twin Deficits How Great the Danger?
  Global Economics Company, 1/16/2004
  www.globaleconomics.net/graphics/CommentaryNo4.pdf
  
• The U.S. Trade DeficitWhat is It and Should We
  be Concerned? Clemson University,--/--/----,
  business.clemson.edu/CIT/TradeDeficitBkgrnd.pdf
• Inequality and the American Dream   Economist,
  6/17/2006, Vol. 379 Issue 8482, p13-14, 2p, 1c
• Merriam-Webster Dictionary www.m-w.com