This post first appeared in the St. Louis Beacon: July 27, 2008 - In "The Accidental Theorist," Paul Krugman describes a fictional economy that produces two items: hot dogs and buns. The Princeton economist and New York Times columnist uses the playful idea as an analogy to dispel the belief that productivity growth in the world economy reduces overall employment and creates an excess supply of products that cannot be consumed.
If it takes two person-days to create either a hot dog or a bun, and labor is the only input to production, then technological improvements that double productivity in the hot dog sector will eliminate jobs in the hot dog sector if consumption remains level. After all, it now takes half as many workers to create the same number of hot dogs.
However, when consumption rises to meet the increased productivity, new jobs are created in the bun sector. Substitute hot dogs for "manufacturing" and buns for "services," and, Krugman argues, you've described the history of the U.S. economy over the past 30 years.
That consumption automatically increases as a result of higher productivity is a bold assumption. But as Washington University Economics Professor James Morley explains, "... productivity growth increases consumption ... even if we don't see it at a microeconomic level, there is a necessary connection between productivity and income at the macroeconomic level.
"If more goods in total are being produced, it must correspond to more income in payment for the increased production of goods," Morley writes. "The amount that firms are willing to pay workers depends on the productivity of those workers ... [thus] the more productive are workers, the more they will be paid. Furthermore, because labor markets are linked across industries, an increase in the productivity of some workers will generally increase wages throughout the economy."
Krugman's economy, therefore, is not so fictitious. Since 1970, output of manufacturing in the United States has roughly doubled due to productivity gains, while employment in that sector has declined slightly. Over the same period, production of services also roughly doubled, but with little productivity improvement. This fact caused employment to grow by 90 percent and created more than 45 million jobs between 1970 and 2000. In short, productivity gains in one sector led to job gains in another.
It is easy to be swayed by the economic hysteria created by reflexive commentary.
Chrysler is closing a plant. Jobs will be lost, and Fenton will suffer. But might this pain be integral to the long term viability of the company and potentially create new opportunities?
Our beloved Anheuser-Busch will soon be owned by a company based in Belgium. Hundreds may lose their jobs and the brewery's local philanthropy is likely to disappear. But won't this open a world of distribution channels for A-B products and bring new jobs in tangent industries?
Domestic firms are outsourcing business services to foreign countries at an increasing rate. But even this phenomenon has hidden economic benefits.
Labor arbitrage (taking advantage of the wage differences between industrialized and developing nations) has driven much of the manufacturing industry from the United States to East Asia over the past three decades. U.S. companies have increased margins by using the cheap plentiful labor available in Asian countries. Traditionally this occurred in the manufacturing sector, but in the last decade, improvements in communication technology have opened more possibilities for service outsourcing. On its face, this trend has frightening long-term implications: Highly educated Americans receiving wage premiums for their skills could see the demand for their work evaporate as firms use cheaper foreign labor to cut costs.
Whether the fear is justified is up for debate. Research by Mary Amiti and Shang-Jin Wei, both formerly of the International Monetary Fund, provides evidence to quell anxiety. In 2007, the United States outsourced $52 billion worth of "business services," making it the top absolute outsourcer of business services in the world. However, the U.S. also insourced $76 billion worth of business services, resulting in a net surplus of $24 billion that year. This means that other countries actually created $24 billion more worth of work for Americans employed in business services than the U.S. sent to other countries.
While examining the net effect of business services in/out-sourcing, Amiti and Wei note that the U.S.'s $24 billion balance of payments surplus ranks number three in the world behind the United Kingdom ($32 billion) and India ($28 billion). China's surplus is fourth largest at $22 billion.
Clearly, a disproportionate amount of service work is not being sent from the United States to developing nations. In fact, the $52 billion of outsourcing represented just 0.53 percent of U.S. GDP in 2007. For smaller developing nations such as Angola and Lebanon, business services outsourcing represented 16 and 12 percent of GDP, respectively.
But absolute figures do not tell the entire story. Service outsourcing in the United States has roughly doubled each decade since the 1980s. While this sounds alarming, a more important question is how has this affected domestic employment? The answer varies upon the number of sectors into which one divides the economy.
In a separate case study, Amiti and Wei analyzed how outsourcing service inputs has affected employment across the U.S. manufacturing industry. A "service input" is a non-material input that is essential to running a business, such as accounting or finance, no matter what "widgets" are the final product. The research focused on business services, which represent the largest component of service inputs on average.
Using data from 1992 to 2000, when defining industries very narrowly (450 total manufacturing industries), Amiti and Wei's analysis found that service outsourcing has had a significant, but small, negative effect on employment: a decline in total employment by 0.40 percent. When viewed more broadly and these 450 industries are grouped and redefined as 96 entities, service outsourcing has an insignificant effect on total employment due to growth in labor demand within other industries. In other words, productivity gains in certain sectors are leading to job growth in others. Sound familiar?
So why is it, then, that sending service jobs abroad has had an insignificant effect on total employment? For one, the United States has a relatively flexible workforce. When productivity growth creates opportunities in adjacent sectors, labor is easily reallocated.
Americans tend to be educated, possess the skills necessary, and have access to the training that allows for employment across a range of industries. The United States' high degree of "intangible capital" makes this possible.
In a 2005 study, "Where is the Wealth of Nations?" the World Bank demonstrated that the largest proportion of wealth (defined as the net present value of sustainable consumption) in most countries comes from intangible capital, not from natural or produced capital. In high-income Organization for Economic Cooperation and Development countries, it accounts for 80 percent of the wealth on average.
Intangible capital -- loosely defined as human capital, social capital and the quality of institutions -- is the key in creating a flexible, productive and healthy economy. In the United States, intangible capital comprises 82 percent of total wealth. This demonstrates the impact of education on human capital, the value of effective governmental institutions in protecting property, and the importance of trust and cooperation in boosting social capital.
So fear not, Anheuser-Busch employees. Even though a job loss is devastating, take solace in the very reason you were employed: the high value of your skills and knowledge. These qualities are what make you so employable in the future. Americans fortunately have access to exceptional education and a functioning government that protects property rights and promotes economic development. These elements have created one of the wealthiest nations on the planet and foster an environment for job creation even amid outsourcing, layoffs, mergers and acquisitions.
Ryan Harris is a financial adviser with Equity Financial Services Inc. (EFS), an independent financial planning firm, Sappington. (Securities offered through First Allied Securities, Inc., a registered Broker/Dealer, member FINRA/SIPC. Investment Advisory Agent offering services through First Allied Advisory Services Inc.)