The rise of China as an economic power that could overtake the U.S. in two decades as the world’s largest economy often arouses anxiety. Among the most pervasive fears among U.S. workers is that China could become a magnet attracting not just manufacturing jobs but also those that require other kinds of knowledge-intensive work. How valid are these fears? In this excerpt from his new book, The Chinese Century: The Rising Chinese Economy and Its Impact on the Global Economy, the Balance of Power, and Your Job, (Wharton School Publishing), author Oded Shenkar examines the economic forces driving job migration. The following excerpt is from Chapter 7: “East, East, and Away: Where the Jobs Are.”
The migration of jobs to foreign destinations, China included, has become a hotly debated topic in the United States and in other nations, mostly – but not only – in the industrialized world. Job migration has been blamed for a “jobless recovery” in America, with new job creation lagging behind economic recovery further than at any time since the aftermath of World War II, as well as for stalled employment growth in Mexico and in other developing economies. In fairness, job migration is not the only or even primary factor behind job losses: Productivity gains induced by technology (for example, automation), capital investment, process improvements, and enhanced skills; cyclical and nontrade-related structural shifts; alternate employment in the service sector; and regulatory and tax burden are among the factors that influence the employment picture. Still, job migration in its various forms accounts for a significant portion of job losses in the U.S., as well as in other economies, and its impact will continue to loom large in the years to come.
Based on Trade Adjustment Assistance (TAA) data, 6.4 million American jobs were lost to foreign competition between 1979 and 1990 – or, approximately one-third of the 17 million manufacturing jobs lost during that period, according to Lori Kletzer, a University of California–Santa Cruz economist. (Editor’s note: This excerpt excludes footnotes; they can be found in the original book.) Analyzing Department of Labor data, Bardhan and Kroll found that between 2001 and 2003, the U.S. manufacturing sector suffered a 12.8% decline in employment (versus a 1.4% addition in the service sector), but industries at risk of outsourcing experienced a steeper decline, with computer and electronic products and semiconductor and electronic components (sectors in which Chinese imports are prominent) falling at 24% and 22.9% below their prior staffing levels, respectively. Goldman Sachs and Company estimates that 20% of U.S. manufacturing employment, representing one-half a million jobs and including those involving sophisticated design and technology, have moved overseas.
China is not solely responsible for jobs lost to foreign competition, and – in the service sector – it is not even the primary culprit. If you are an information technology or call center worker, India would place higher than China. If you are an insurance claim processor, Irish workers may have already replaced you, only to face their own competition in the form of Polish recruits. If you are an aircraft designer, Russian replacements may be more of a concern. China is not yet a major player in services although it is already a destination for embedded software and for financial firm back-office business processes and application development, and a competitor in call centers for Japanese and Korean firms. Figures compiled by McKinsey Global Institute show China to be a destination for only $1.1 billion in services versus $7.7 billion destined for India and $8.3 billion destined for Ireland (though the Chinese figures are still higher than those for Australia and Russia, among others).
If you are in manufacturing, however, or are in one of the many sectors that support it directly (such as product design) and indirectly (such as engineering and consulting services), a 750 million strong Chinese workforce is not something you would want to discount in a global economy where production factors are ever more mobile. Historically more susceptible to employment shifts (for example, productivity in industry has risen much faster than in services), manufacturing has shed close to three million jobs in the U.S. in a mere three-year period. Many of those losses have little to do with foreign competition or are in sectors where employment has been declining for years. Nevertheless, job losses attributed to developing economies in general, and to China in particular, have stirred political backlash in the U.S., the European Union (EU), and Japan. China has also been blamed for job losses in developing economies like Mexico, which holds China responsible for fleeing foreign investors and for the country’s shrinking share in lucrative export markets.
Job Migration: Myth and Fact
The vocabulary surrounding job migration can get confusing. Briefly, outsourcing is the farming out of portions of a company’s value chain (such as an appliance motor) to other companies, divisions, or affiliates. Foreign outsourcing, or off-shoring (a term that may not only acquire virtual connotation but also involve the physical movement of value chain elements), is similar to outsourcing except that the work is farmed out overseas. Trade displacement is job loss due to foreign imports driving domestic producers out of the market. Trade displacement is defined and measured in terms of import competition in a focal market, but domestic workers also lose when the foreign markets to which they export shrink; additionally, they miss out on future demand at home and abroad. Outward foreign investment, another source of job loss, is when domestic manufacturers shift production to an overseas location or when a new plant is placed abroad and home country employees are not hired as a result.
There are no overarching statistics for job migration. The numbers that appear in the media typically refer only to one type of migration, (such as off-shoring or trade displacement, a usage which tends to discount the overall impact of job migration). For example, foreign outsourcing proponents point out that the phenomenon represents a very small portion of overall job loss, but rarely mention that it is only one aspect of foreign competition for jobs. In addition, some of the oft-cited estimates entail a clear downward bias. For instance, TAA statistics are based on the U.S. government program by that name, which, as Jon Honeck of Policy Matters Ohio notes, greatly undercounts job losses – to be counted, you must apply, but many workers are unaware of the program’s existence and TAA does not cover service providers (even when related to manufacturing), (upstream or downstream) suppliers, or (until recently) jobs relocated to any country other than Mexico or Canada. As to outward foreign investment, because its impact is difficult to gauge, it is almost never included in job loss estimates; in contrast, inward investment often is, which amplifies the undercounting. The confusion surrounding the numbers makes them ripe for political hijacking by proponents, opponents, and other job migration constituencies.
Job Migration and Job Losses
What it clear is that the production flows underlying the various forms of job migration are on the rise. For instance, from 1987 to 1997, the share of foreign inputs in American manufacturing (an outsourcing measure) rose from 10.5% to 16.2% and in American high tech rose from 26 to 38%. There is a general consensus that the U.S. is the leader in off-shoring with more than two-thirds of the global market, and that the flow will only grow; a recent survey of financial officers of U.S. firms found that 27% planned foreign outsourcing while 61% of those already engaged in the activity planned to expand outsourcing activities. In 2004, 86% of the companies DiamondCluster International polled expected to increase foreign technology outsourcing, compared to 32% just two years earlier.
Given the above trends, the job impact cannot be far behind. Forrester Research projects that by 2015, off-shoring will have generated a loss of 3.3 million U.S. jobs, especially in the service sector, representing more than $130 billion in wages (keep in mind that most of the impact is projected to occur in later years and that the yearly loss seems minute in a work force of 150 million). McKinsey Global Institute sees a loss of about 200,000 jobs a year through off-shoring, while Economy.com projects that the 300,000 jobs currently lost every year will double by the end of the decade. By 2010, 277,000 jobs in computer science, 162,000 in business operations, and 83,000 in architecture will have moved from the U.S. to low wage countries like India and China. Trade displacement – somewhat forgotten in the uproar surrounding off-shoring – continues to be a significant contributor to employment losses, averaging 270,000 jobs annually between 1989 and 2000 according to the Department of Labor Statistics. A study by Policy Matters Ohio calculated that U.S. trade deficits between 1994 and 2000 removed 135,000 actual and potential jobs in Ohio alone, 100,000 of which where in the manufacturing sector. Finally, the U.S. has the largest outstanding stock of foreign direct investment, and its foreign affiliates – like those of other nations – compete with domestic jobs twice: first, by shifting company employment that would have taken place domestically; second, by exporting back to the U.S. market thereby displacing American workers employed by their domestic competitors.
To put things in context, economies shed and create numerous jobs regardless of trade; this is especially true of the American economy that is more flexible than most others. Every year, millions of Americans separate from their workplace – voluntarily or otherwise – and millions of jobs are lost (many, like those of typists, never return) while millions of new jobs are created in a so-called “creative destruction” process. Job migration itself is not a one-way street; one country’s outsourcing is another country’s insourcing. The U.S. runs a huge deficit in merchandise trade, which destroys jobs via trade displacement but enjoys a considerable surplus in commercial services – a form of insourcing for the American economy – such as consulting or engineering services. The Institute for International Investment claims that, over the last fifteen years, insourced jobs have grown by an annual rate of 7.8% while outsourced jobs have grown at a rate of 3.8%. In 2001, according to Department of Commerce figures, U.S. companies exported $280 billion worth of services directly and $432 billion more through their affiliates; at the same time, foreign companies sold to the U.S. services in the amounts of $202 and $367 billion, respectively. U.S. exports of private services such as consulting, banking, and engineering exceeded $130 billion in 2003 while imports were lower at about $78 billion.
Although outsourcing eliminates many jobs, it also creates employment. It does so directly by creating demand for employment in sectors associated with the mobility of production inputs and finished goods (such as logistics, shipping and retail) and indirectly by enhancing the competitiveness of the local firm. Outsourcing permits a company to focus on what it does best (for example, designing and developing new products) and allows for the deployment of resources into areas of comparative advantage that, at least in developed economies, produce more value added and better paying jobs. President Bush’s chief economic advisor was alluding to those benefits when he suggested that outsourcing was good for the U.S. economy, though he neglected to consider its downside potential or show sympathy for the workers displaced. In addition, workers in outsourcing destinations are often more motivated to do jobs viewed by those in an industrialized nation as less attractive. Global Insight, a consultancy, argues that off-shoring lowers inflation and interest rates and raises productivity. According to Global Insight, off-shoring added a net of 90,000 jobs by the end of 2003 and will yield more than 300,000 jobs by the end of 2008 by making U.S. producers better competitors and exporters.
Imports need not result in job losses if the foreign producer decides to manufacture in the host market. While the U.S. has the largest foreign investment stock, it is also the primary destination for inward investment and was the second ranked recipient (following China) in 2003. Close to 6.5 million Americans are employed by the affiliates of foreign companies in the U.S. and, as the Organization for International Investment notes, foreign firms tend to pay more – on average – than their U.S. counterparts. Also, without imports, there would be no exports, which typically provide better than average compensation. Still, exports tend to create jobs while imports tend to destroy them, and the problem for the U.S. is that it runs an enormous trade deficit; in other words, the downside employment potential of imports outweighs the upside employment potential of exports.
Economic models such as that of the Economic Policy Institute (EPI), which capture the employment impact of both imports and exports, show a loss of three million U.S. jobs and job opportunities between 1994 and 2000 – the difference between 2.77 million jobs created through exports and 5.8 million lost via imports. Additionally, the jobs gained are not necessarily better than the jobs lost. Past wisdom was that the U.S. exported simple, low-paying jobs and imported high-skilled jobs. No more. Knowledge intensive jobs are now on the line. Finally, the people who lose jobs and those who gain jobs as a result of job migration are not the same people, do not work in the same industries, and do not live in the same regions. Thus, even if job migration were beneficial at the macro level, there remains the problem of those who pay the price for the supposedly common good.
The McKinsey Global Institute argues that off-shoring creates net additional value for the exporting economy. According to the McKinsey analysis (using off-shoring to India as an example), for every dollar off-shored, the U.S. economy accrues between $1.12 and $1.14 while the receiving country captures just 33 cents. The U.S. benefit comes from a combination of reduced costs (58 cents), purchases from U.S. providers (5 cents), and repatriated earnings (4 cents) for a current and directly retained benefit of 67 cents; an additional 45 to 47 cents is supposed to come from the redeployment of labor into higher value-added (and better-paying) jobs.
Since the McKinsey report does not provide the actual analysis on which the final numbers are based (McKinsey states that they are based on a conservative interpretation of historical patterns), it is impossible to pass judgment on their validity. Nonetheless, the report seems to make a number of optimistic assumptions that may not materialize. For instance, the profit repatriation component in the formula is suspect not only because foreign investment contracts in developing economies often limit profit repatriation but also because companies increasingly choose to retain earnings in higher growth markets such as China and India in order to fund further expansion.
The McKinsey analysis also fails to capture the value of the capabilities that the receiving countries obtain as a result of outsourcing and that will eventually enhance their ability to compete with the origin-country producers. This benefit to the receiving country (which will eventually show up as trade displacement) challenges the largest benefit for the origin country, namely savings accrued to U.S. investors and/or consumers. McKinsey’s calculation does not take into account the losses associated with loss of purchasing power by laid off workers (including loss of tax revenues), possibly because the assumption is that the gap will be more than made up by higher-paying jobs. It is not clear that this compensation will happen. And, if foreign producers end up in an oligopoly position (quite possible, given China’s dominance in some product lines and ongoing consolidation of its industry), the savings to consumers may disappear. Finally, if indeed most benefits are accrued to investors and customers while most costs are born by employees, there might be a substantial social cost that is not factored into the McKinsey formula.
Macro Promise, Micro Reality
If – like the chairman of the Federal Reserve – you have an unfailing faith in the vibrancy of the U.S. economy, you are still left wondering about the prospects for your industry, firm, and job. The redeployment of resources that may be beneficial in the long run to the public at large presents immediate challenges to certain industries and job categories and – as a result – to individuals, families, and communities. Those affected will find little comfort in a common benefit that will not be shared by all or in the fact that (according to demographers’ predictions) the U.S. will eventually be facing a shortage of employees as its population, like that of other industrialized countries, ages. Those adversely affected will also find little solace in the thought that the U.S. is not the only country to be affected or in the belief that all of this has happened before.
From the perspective of individual employees, redeployment is easier said than done. As Ron Hira of the Institute of Electrical and Electronic Engineers (IEEE) asks, how realistic is it to expect a twenty-year engineering veteran to find employment as a nurse? And how many of the 32,000 workers displaced by U.S. furniture makers over the last two and one-half years – some with highly specialized skills – are likely to find employment, and where? It is true that exports create jobs, but the U.S. happens to run an enormous merchandise trade deficit. Some say this deficit does not matter but others, including this author, disagree. Furthermore, as numerous studies have shown, the jobs created by exports seldom go to those workers displaced by imports; close to one-third of the manufacturing employees displaced by foreign competition were unable to find a job. Two-thirds of those able to find work made less than in their old jobs, and while the average earnings loss was 13%, one-quarter suffered earning losses in excess of 30%. Those who found employment in the service sector, where average wages are barely more than half the manufacturing wages and where newcomers lack know-how and seniority, suffered an especially steep drop.
States like Ohio, with a high concentration of manufacturing, are especially vulnerable to job loss. Policy Matters Ohio, a nonprofit and nonpartisan research institute, input data from the TAA and the former North American Free Trade Agreement (NAFTA) TAA program into an EPI economic model that takes into account exports as well as imports. The institute’s study identified more than 45,000 jobs that were lost to trade competition between January 1995 and October 2003. More than three-quarters of the losses occurred in the 1999 to 2003 period, with the manufacturing wage bill in the second quarter of 2003 down $1.21 billion from three years earlier. While China’s (like any other country except Canada and Mexico) generated trade displacement was not included in the study, the Federal Reserve Bank of Chicago notes that the key sectors in the Midwest economy (such as automotive) have recently become exposed to Chinese competition, with companies like Nippert hard hit. Job losses vary widely within the state; they were especially high in urban counties such as Cuyahoga (5,460 job losses) and almost nonexistent in Geauga and Seneca (10 job losses each). Still, only three of Ohio’s congressional districts experienced less than 1,000 job losses. While those numbers should be counted against trade and investment related job gains, the comparison is not necessarily comforting: Bureau of Economic Analysis data cited by the Organization for International Investment suggests that 242,000 Ohioans are employed by foreign subsidiaries, but this number should be evaluated against outward foreign investment by Ohio companies for which domestic displacement numbers are unavailable. Global Insight sees Ohio gaining almost 4,000 jobs through outsourcing in 2003 and more than 13,000 by 2008, but this is a drop in the bucket given the overall job losses in the state.