For several years I have been tracking US job losses and seeking to understand the causes. I have written enough columns about this subject to have caused angst among some inside-the-beltway think-tankers.
Two critics, Bruce Bartlett and Daniel T. Griswold have yet to comprehend the argument that they dispute. This is puzzling. Whereas international trade theory is very complex, my statement of the job loss problem, or more accurately, my posing of the question is very simple.
Are the job losses that are everywhere in the news and the decline in US manufacturing the result of competition in the markets for tradable goods and services and, thus, reflect the benevolent workings of free trade, or are they manifestations of David Ricardo’s case of internationally mobile factors of production flowing to countries with the greatest absolute advantage where their productivity is highest?
It is easy to take free trade for granted and to forget the conditions on which its case rests.
To briefly review: David Ricardo discovered the principle of comparative advantage, the basis for free trade. Instead of striving for self-sufficiency, countries should focus on what they can do best and trade with one another for other wants. Ricardo showed that shared gains from trade would result from each country specializing in areas where it had comparative advantage.
For comparative advantage to reign, factors of production must be mobile within each country so that they can move to the uses where they have comparative advantage.
The principle does not work, however, if factors of production are internationally mobile and can leave the country. If factors are internationally mobile, they will flow to countries that have the greatest absolute advantage where their productivity is highest.
The countries with greatest absolute advantage will capture the gains.
Historically, there have been barriers to the international mobility of factors of production. In Ricardo’s time, GDP was largely determined by climate and geography, neither of which can migrate.
In our own time, world socialism served to constrain capital and technology within the first world of North America, Western Europe and Japan. Multinational corporations would have felt unsafe investing in China even if they had been permitted.
The collapse of world socialism has made vast pools of cheap and willing labor in Asia and Mexico available to US capital and technology. The Internet has made the physical location of employees unimportant for many knowledge and Information Technology jobs. The Internet, out-sourcing, and offshore production for the home market allow US firms to substitute cheap foreign labor for expensive US labor in their production functions.
The question I ask is Ricardo’s: Are internationally mobile factors of production flowing to where their productivity is highest?
Does the ease with which foreign labor can be substituted for US labor in the production functions of US firms make foreign labor internationally mobile to the U.S. where its productivity is highest?
Alternatively, does the international mobility of US capital and technology allow these factors of production to flow to countries where their productivity is highest—countries with abundant and cheap labor?
Until recently first world capital and technology were confined to the first world, no area of which had a massive labor cost advantage that would convey an absolute advantage and suck in capital and technology from other first world areas. The Internet, changes in Asian receptivity to foreign investment, and the willingness of first world corporations to make high-tech investments in third world countries are new developments.
It is irresponsible to assume that the US will not be affected by these new developments or to assume without careful thought that the impact on the US will be beneficial.
Some people feel so threatened by the questions posed that they deny the obvious job loss and decline in US manufacturing. Space is lacking to expose their many mistakes with data and its interpretation. Generally speaking, it helps to keep in mind that historical data report the past, not new developments.
Thus, Griswold and Walter Williams are wrong to conclude that the larger US investment position in Canada and Europe disproves the attraction of low labor costs in China and India. Both overlook that over the decades when Asia was not an alternative the US built up large stocks of investment in first world locations. This stock of investments requires new investments to maintain profitability. These investments can be abandoned only gradually as it is very expensive to close a factory. Real world adjustments are not instantaneous.
Commentators would also benefit from awareness that in recent years direct foreign investment in the US consists primarily of merger and acquisition activity, not new plant construction.
Griswold cites American exports of manufactured goods as proof of our manufacturing potency.
He overlooks, as Bartlett did earlier, that the US is an even larger importer of manufactured goods and produces each year fewer of the manufactured goods that it consumes.
Which fact best illustrates our position?
Without doubt some US job losses are due to the recession. But the decline in manufacturing’s share of US GDP from 19.2% in 1988 to 14.1% in 2001, a decline of 27 percent, is inaccurately described by Griswold as “the passing pain of a recession.”
Commentators should stop hiding behind bogus data and address the questions.