Commentary & Analysis: Economists In Denial; Blind To Offshoring`s Adverse Impact

Manufacturing And Technology News

February 6, 2007 Volume 14, No. 3

At a Washington, D.C., press conference last

Harvard University economics professor Michael Porter

claimed that globalism was bringing benefits to
Americans (Manufacturing & Technology News,

Nov. 30, 2006
). Porter was introducing the latest
report, "Competitiveness Index: Where America Stands"
which he is a principal author, from the

Council on Competitiveness.

I recognized a number of Porter`s claims to be
inconsistent with empirical data. After examining the
report, I can confidently state that the report provides
scant evidence that America is benefiting from globalism.

This is not to say that the statements in the report
and the information in the numerous charts are untrue.
It is to say that the data do not support the claim that
America is benefiting from globalism.

The competitiveness report boasts that the United
States "leads all major economies in GDP per capita";
that "household wealth grew strongly, supported by
gains in real estate and stocks"
; and that
"poverty rates improved for all groups over the past two

All of this is true over the time periods that the
report measures.

But it is also true that all of this was happening
prior to globalism. Moreover, in recent years as
globalism becomes more pronounced, the U.S. economy is
performing less well.

The report provides no information that would suggest
that the gains measured over 20 years or more occurred
because of globalism or that the economy is performing
better today than in past periods.

Indeed, the report acknowledges under-performance in
critical areas.

U.S. job creation in the 21st century is below past
performance. Debt payments of Americans as a percent of
their disposable incomes are rising while the savings
rate has collapsed into dis-saving. Poverty rates have
turned back up in the 21st century when the impact of
globalism on Americans has been most pronounced.

A total critique of the competitiveness report would
be as long, or longer, than the report`s 100 pages. As
this is beyond the capacity of the Manufacturing &
Technology News` newsletter and readers` patience, I
will limit my remarks to the most critical issues.

The report mentions many times that the United States
is the driver of global growth without emphasizing that
U.S. growth is debt-driven. Both the U.S. government and
U.S. consumers are accumulating debt at a rapid pace.
Debt-driven consumption is exceeding U.S. output by a
sum in excess of $800 billion annually.

The trade and current account deficits are rapidly
increasing the burden of debt service on Americans and
threatening the dollar`s role as reserve currency. The
competitiveness report makes these negatives sound like
America is leading the world by driving economic growth.

In the middle of the report there is a misleading
chart that shows that "U.S.A. attracts most foreign
direct investment"
—in terms of dollars. The report
asserts that "the United States remains a magnet for
global investment"
because of "America`s high
levels of productivity, strong growth and unparalleled
consumer market."

This is one of the instances in which the report
becomes totally propagandistic.

The report suggests, as do many careless economists,
that foreign direct investment in the U.S. consists of
new plant and equipment, which, in turn, is creating
jobs for Americans. However, foreign direct investment
in the United States consists almost entirely of foreign
acquisitions of existing U.S. assets. Foreign direct
investment is merely the counterpart of the huge
American trade and current account deficits. America
pays for its over-consumption in dollars which
foreigners use to buy up existing U.S. assets. One
result is that the income streams associated with the
change of ownership now accrue to foreigners and,
thereby, worsen the current account deficit.

The charts below on foreign direct investment cannot
be found in the competitiveness report. They are
provided by Charles McMillion of MBG

Information Services in Washington, D.C. The charts
make it completely clear that foreign direct investment
in the United States consists of foreign acquisition of
existing U.S. assets. Foreign acquisition of existing
U.S. assets hurts America by diverting income streams to

Another fantastic error in Porter`s report is the
misleading claims about U.S. productivity growth. There
is no chart in the report, such as the one provided by
McMillion on page 12, that shows the extraordinary and
widening divergence of U.S. productivity from real

Economists maintain that labor is paid according to
its productivity, and historically this has been the
case in the United States. The correlation began to
break down with the advent of offshoring to the Asian
Tigers and deteriorated further with the advent of
offshoring of manufacturing and service jobs to China
and India made possible by the collapse of world
socialism and the advent of the high-speed Internet. The
historical correlation between productivity and wages
has been further eroded by the importation into the
United States of cheap foreign skilled labor on work
visas. Many Americans have been forced to train their
foreign replacements who work for one-third less pay.

The greatest failure in the competitiveness report is
the absence of mention of the labor arbitrage and its
consequences when U.S. firms offshore their production
for U.S. markets. This practice translates into direct
job loss and direct tax base loss, and it transforms
domestic output into imports. This is capital and
technology chasing absolute advantage abroad. This
cannot be considered trade based on resources finding
their comparative advantage in the domestic economy.

It is this replacement of U.S. workforces by foreign
workers that explains the extraordinary rise in CEO
compensation and the flow of most of the income and
wealth gains to the few people at the top. By offshoring
their workforces, CEOs cut their costs and make or
exceed their earnings forecasts, thus receiving bonuses
that are many multiples of their salaries. Shareholders
also benefit. When plants are closed and jobs are
offshored, American employees lose their livelihoods,
but managements and shareholders prosper. Offshoring is
causing an extraordinary increase in American income

The report acknowledges that "for the first time
in history, emerging economies, such as China, are
loaning enormous amounts of money to the world`s richest
Historically, it was rich countries that
lent to underdeveloped countries. The truth of the
matter is that China`s loans to the United States are a
form of forced lending. China is flooded with dollars
from America`s dependency on imports of Chinese
manufactures and advanced technology products. There is
nothing that China can do with the dollars except to
purchase existing U.S. equity assets or lend the dollars
back to the United States by purchasing Treasury debt.
With China`s currency pegged to the dollar, China cannot
dump the dollars into foreign exchange markets without
initiating a run on the dollar and complaints that China
is increasing its competitive advantage over the rest of
the world.

When I was Assistant Secretary of the U.S. Treasury
in the early 1980s, U.S. foreign assets exceeded
foreign-owned assets in the United States. By 2005 this
had changed dramatically, with foreigners owning $2.7
trillion more of the U.S. than the U.S. owns abroad. For
the first time since the United States was a developing
country 90 years ago, the country is paying more to
foreign creditors than it is receiving from its
investments abroad.

The report downplays the extraordinary trade and
current account deficits on the grounds that "foreign
affiliate sales"
do not count against the trade
and "intra-firm trade" is a significant
proportion of the trade deficit and "is due to trade
within American companies."

This argument shows that the report is written from
the standpoint of what is good for global firms, not
what is good for America.

It made some sense when General Motors claimed that
what is good for General Motors is good for America,
because when the claim was made General Motors produced
in America with American labor. It makes no sense to
make this claim today when what is good for a company is
achieved at the expense of the American work force.

"Intra-firm trade" is simply a company`s
products and inputs produced in its offshore plants, and
"foreign affiliate sales" is simply a company`s
overseas earnings from its production in foreign
countries with foreign labor.

Perhaps Porter is arguing that the output of an
American subsidiary in Germany, for example, should be
considered part of U.S. GDP. Such an accounting would
result in a magical increase in U.S. GDP and drop in
German GDP. If success is defined in terms of the
country in which the ownership of the profits of global
firms resides, then a country can be successful with its
labor force unemployed.

The competitiveness report owes much of its failure
to an abstraction—"the global labor supply."
There is no global labor market that equilibrates wages
in the different countries. There are only national
labor markets in which wages reflect cost of living and
labor supply.

For example, in China, the cost of living is low, and
excess supplies of labor suppress manufacturing wages
below the productivity of labor. In the United States,
the cost of living and debt levels are high, and the
labor market (except for those parts hardest hit by
offshoring) is not confronted with large excess supplies
of labor. It is possible for a U.S.-based firm to hire
someone living in China or India to deliver services
over the Internet at a fraction of the cost of hiring an
American employee. Alternatively, foreigners can be
brought in on work visas to replace American employees.
Manufacturing plants can be moved abroad where excess
supplies of labor keep wages far below productivity.
These are all examples of capital seeking absolute
advantage in lowest factor cost.

The report makes the false claim that the future of
U.S. competitiveness depends on education. Although the
United States has 17 of the world`s top 20 best research
universities, Porter sees education as the number-one
weakness of the U.S. economic system. The report
envisions a high-wage service economy based on
imagination and ingenuity. Here the competitiveness
report fails big time, because it fails to comprehend
that all tradable services can be offshored.

In the 21st century, the U.S. economy has been able
to create net new jobs only in non-tradable domestic

The New Face of Class Warfare,
July, 2006

. The vast majority of jobs in the BLS ten-year jobs
projections do not require a college education. The
problem in 21st century America is not a lack of
educated people, but a lack of jobs for educated people.

Many American software engineers and IT professionals
have been forced by jobs offshoring to abandon their
professions. The November 6, 2006, issue of Chemical &
Engineering News reports that "the percentage of
American Chemical Society member chemists in the
domestic workforce who did not have full-time jobs as of
March of this year was 8.7 percent."
There is no
reason for Americans to pursue education in science and
technology when career opportunities in those fields are
declining due to offshoring.

Porter says the future for America cannot be found in
manufacturing or tradable goods, but only in what he
says are high-wage service skills in "expert
and "complex communication." The
report does not identify these jobs, and scant sign of
them can be found in the BLS jobs data.

Princeton University economist Alan Blinder, former
vice chairman of the Federal Reserve, writes that "we
have so far barely seen the tip of the offshoring
iceberg, the eventual dimensions of which may be
Morning News,
January 7, 2007). Elsewhere,
Blinder has estimated that as many as 50 million jobs in
tradable services are at risk of being offshored to
lower-paid foreigners.

Like Porter, Blinder says that America`s future lies
in service jobs. The good service jobs will be those
delivering "creativity and imagination." Blinder
understands that the education solution might be a pipe
dream as such abilities "are notoriously difficult to
teach in schools."
Blinder also understands that
"it is hard to imagine that truly creative positions
will ever constitute anything close to the majority of
Blinder asks: "What will everyone else

Blinder acknowledges that considering the wage
differentials between the United States and India,
Americans will find employment only in services that are
not deliverable electronically, such as janitors and
crane operators. These hands-on service jobs do "not
correspond to traditional distinctions between jobs that
require high levels of education and jobs that do not."

Blinder`s prediction of the future of American
employment is in line with my own and that of the Bureau
of Labor Statistics. Where Blinder falls down is in not
seeing the implication of these trends on the U.S. trade
deficit. A country whose workforce is employed in
domestic non-tradable services is a Third World country
with nothing to export. How will the United States pay
for its heavy dependence on imports of manufactured
goods and energy?

As long as the dollar retains its reserve currency
role, Americans can continue to hand over paper for real
goods and services. But how long can the United States
retain the reserve currency role when its economy does
not make things to export; when its work force is
employed in domestic services; and when its foreign
creditors own its assets?

Blinder, like Porter and almost every other
economist, warns against trying to prevent America`s
descent into a Third World existence. Blinder says
protection would block trade and "probably do a great
deal of harm."
But both Blinder and the
competitiveness report show a great deal of harm being
done to Americans by offshoring the production of goods
and services for American markets. As more and more high
value-added U.S. occupations in tradable services are
undercut by offshoring, the ladders of upward mobility
that made America a land of opportunity are taken down.
As the bulk of domestic service jobs do not require a
university education, the United States will find itself
over-invested in educational institutions and decline
will set in.

For developed economies, offshoring is a reversal of
the development process. As offshoring progresses, the
domestic economy will become less developed and have
less demand for university education.

Economists cannot speak the obvious truth, because
they mistake the operation of absolute advantage for
comparative advantage. The case for free trade rests on
the comparative advantage argument that countries that
specialize in what they do best and trade for goods that
other countries do best share in the gains from trade
and experience higher standards of living.

In 2000, the case for free trade came under powerful
attack when MIT Press published "Global Trade and
Conflicting National Interests"
by Ralph Gomory and
William Baumol. This work shows that the case for free
trade has been incorrect since the day David Ricardo
made it. Economists have not come to terms with this
important work, and they will resist doing so for as
long as they can as it demolishes their human capital.

The challenging work by Gomory and Baumol aside, I
have shown, as has Herman Daly, that the two conditions
on which comparative advantage depends no longer hold in
the present-day world. One condition is that capital
must be immobile internationally and seek its
comparative advantage in the domestic economy, not move
across international borders in search of lowest factor
cost. The other condition is that countries have
different relative cost ratios of producing tradable

Today, capital is as mobile internationally as
tradable goods, and knowledge-based production functions
operate identically regardless of location. Neither of
the conditions upon which the case for free trade rests
exists in the present-day world.

As the necessary conditions for the free-trade case
no longer exist, and if the case for free trade has been
wrong from the beginning as Gomory and Baumol maintain,
then America`s free trade policy

rests in fantastic error.

Economists long ago ceased to think objectively about
free trade. Free trade has become an unexamined article
of faith. As far as I can ascertain, economists no
longer are even aware of the necessary conditions
specified by Ricardo that are the basis for the free
trade case.

Economists have made a number of blunders in their
arguments seeking to

protect offshoring from criticism.
For example,
Matthew Slaughter, a member of President Bush`s Council
of Economic Advisors, penned a study that

: "For every one job that U.S.
multinationals created abroad in their foreign
affiliates, they created nearly two U.S. jobs in their
parent operations."
How did Slaughter arrive at this
conclusion—a conclusion that can find no support in the
BLS jobs data? Slaughter reached his incorrect
conclusion by failing to take into account the two
reasons for the increase in multinational employment.
One is that multinationals acquired many existing
smaller firms, thus raising multinational employment but
not overall employment. The other is that many U.S.
firms established foreign operations for the first time
and thereby became multinationals, thus adding their
existing employment to Slaughter`s number for
multinational employees.

Another problem is that the corruption of the outside
world has found its way into universities. Today,
universities look upon "name" professors as
rainmakers who bring in funds from well-heeled interest
groups. Increasingly, research and reports serve the
interests that finance them and not the truth. Money
rules, and professors who bring money to universities
find it increasingly difficult to avoid serving the
agendas of donors.

When a country gives up producing tradable goods, it
gives up the occupations associated with manufacturing.
Engineering and R&D move away with the manufacturing. It
is impossible to innovate independently of the
manufacturing and R&D base. Innovation is based on
state-of-the-art knowledge of what is being done, and if
the doing is done elsewhere, the innovator will find
himself at a disadvantage.

Offshoring is causing dire problems for the United
States. I have suggested that one necessary reform will
be to break the connection between CEO pay and short-run
profit performance. As long as CEOs can get filthy rich
in a few years by dumping their U.S. workforce, the
trade deficit will continue to rise, and more college
graduates will be employed as waitresses and bartenders.

The short-run time horizon of U.S. management
endangers the long-term viability of U.S. firms. This
short-run time horizon is the result of a "reform"
that sought to give investors the most up-to-date
financial information. The reformers did not consider
the unintended consequences.

Economists need to inject some realism into their
dogmas. The U.S. economy did not develop on the basis of
free trade. Whatever the costs of protection, the costs
did not prevent America`s economic rise.

Much American economic thinking is grounded in the
fact of America`s past success. Many economists take it
for granted that as long as the U.S. has free markets,
it will continue to be successful. However, much of
America`s success is due to World War I and World War
II, which bankrupted rivals and destroyed their
industrial capacity. It was easy for the United States
to dominate world trade after World War II as America
was the only country with an intact economy.

Many economists dismiss the problems with which
offshoring confronts developed economies with the
argument that it is just a question of wage
equilibration. As wages rise in China and India, the
labor cost differential will disappear and wages will be
the same everywhere. This argument overlooks the lengthy
period required for the hundreds of millions of workers,
who overhang labor markets in India and China to be
absorbed into the workforce. During this time, hardships
in currently high-wage countries will be severe.
Moreover, once the wage adjustment is complete, the new
developed countries will have the upper hand. Will they
give up their competitive and strategic advantages?

In the July 2006 issue of CounterPunch, I

that jobs offshoring was the new form of class
warfare and that it was bringing political instability
and social strife to the United States. There is nothing
in the Council on Competitiveness` latest report to
cause me to alter my view.

— Dr. Roberts held the William E. Simon Chair
in Political Economy at the Center for Strategic and
International Studies at Georgetown University and was
Senior Research Fellow in the Hoover Institution at
Stanford University. He served as Assistant Secretary of
the U.S. Treasury in the Reagan administration.

Paul Craig Roberts

] was Assistant
Secretary of the Treasury in the Reagan Administration.
He is the author of

Supply-Side Revolution : An Insider`s Account of
Policymaking in Washington
and the Soviet Economy

Meltdown: Inside the Soviet Economy
and is the co-author with Lawrence M. Stratton of

The Tyranny of Good Intentions : How Prosecutors and
Bureaucrats Are Trampling the Constitution in the Name
of Justice
. Click

for Peter
Forbes Magazine interview with Roberts
about the recent epidemic of prosecutorial misconduct.