Sunday, January 2, 2011

Outsourcing Destroying Jobs? Not Quite...

One economic misunderstanding that I've heard often, especially lately, expresses concern over foreign outsourcing destroying jobs domestically. The argument goes like this: Foreign workers are willing to work for lower wages due to lower demand in their respective countries (specifically India and East Asia). American companies outsource work, often via the internet, to these foreign workers in order to take advantage of the low wages. The American workers that were formerly performing these duties lose their jobs and can't find anything useful to do, and our money ends up in foreign hands.

This view is somewhat flawed because it fails to account for the economy as a whole; it only focuses on a specific group of people, the American workers whose jobs are being outsourced. As with any economic advancement, this outsourcing trend does harm some people but increases the overall welfare. When the automobile was invented, the horse-drawn carriage manufacturers went out of business. When the light bulb was invented, candle makers saw a drop in demand. You get the idea.

When a company takes advantage of cheaper foreign labor via outsourcing, it is able to produce goods cheaper and more efficiently. This means more wealth for the shareholders of the company, who then proceed to buy more stuff. Let's say, for simplicity's sake, that these shareholders spend all of this newly gained wealth on furniture. Since there is now a greater demand for furniture, more craftsmen are required to build furniture. More clerks are needed to staff furniture stores. More Americans are hired to oversee shipping of imported furniture and sell it domestically. While jobs are lost in those sectors whose work is being outsourced, they are simultaneously being created in other sectors (not just in furniture production, but all over the economy, in a more realistic example).

Now let's simplify things again: Let's say all of the outsourced jobs are in the field of computer programming. Microsoft, Apple, etc. outsource all of their computer programmers to India for better prices on labor. Since these companies have now minimized their costs of production, they lower the prices of their products accordingly in order to remain competitive. This means that every consumer pays less for his computer products, and thus is a little bit wealthier. These consumers won't just hoard this excess wealth; they either spend it or invest it. Investment is used to fund projects, such as new businesses, new buildings, new offices, and new capital infrastructure that support the American economy. Consumer spending creates demand which requires more workers (as per the furniture example above) in whatever industry they decide to spend. If they decide to buy houses, it creates jobs for construction workers. If they decide to buy clothes, it creates jobs for tailors. If they buy more food, it creates jobs for farmers. And so on.

Thus outsourcing does not cause any net loss of jobs in the country, only a realignment of demand for domestic labor. It makes the whole country wealthier, albeit at the expense of a select group of workers who then have to adapt to economic progress by taking up a new career field. Every economic advancement in history has been decried for destroying jobs, but total unemployment has never been permanently reduced, because the market doesn't allow able workers to go unused for long.

I also want to address the issue of money flowing out of the country. This might sound like a bad thing, but it really isn't at all. The main fallacy behind this line of reasoning is the idea that wealth is measured solely in monetary terms. This, unfortunately, is a common understanding, even though in economics, the idea is some 500 years out of date.

Money is not wealth. Wealth is something that does you some good. Food is wealth, because it provides sustenance; televisions are wealth because they provide entertainment; etc. Money is only valuable as a medium of exchange; it carries no inherent value. It is essentially a promise of future wealth. Therefore, if you buy your neighbor's car for a sum of money, he has transferred some of his wealth (the car) to you, in return for the expectation of some future acquisition of wealth (the money). From the very fact that you saw fit to exchange your money for his car demonstrates that the car is more valuable to you than the some of money you used to buy it. Thus you become more wealthy.

This applies on a national scale as well. If Microsoft gives its money to workers in India in exchange for better-value products, it has received a form of wealth (the products created by the Indian workers) in exchange for a promise of future wealth (the money). Thus the actual wealth has flowed into the country, while the promise of future wealth has flowed out. And the scenario doesn't stop there. What do these Indian workers do with all their new American money? They essentially have two choices: either buy American products or invest in American companies, both of which send the money back home. This cycle continues endlessly, with money and wealth constantly changing hands.

And there is always a balance of money to wealth, as can be concluded intuitively. If you have a million dollars, but are living on the street, what will you do? Obviously, you will spend some of that money to buy or rent a place to live. On the other hand, if you have a million-dollar mansion, but no money for food, you will obviously sell the house in return for some food money. The same is true on an aggregate level; every country benefits by maintaining a balance of wealth and liquidity in the form of money. The free market naturally determines this balance, and, as is supported by thousands of years of historical evidence, there is no need to worry about a free-market-determined balance of money and wealth.