Wednesday, May 23, 2007

Lou Dobbs defies economic fundamentals

Lou Dobbs has long been a critic of free trade and outsourcing as can be read here. He has cried about manufacturing jobs moving overseas and now a new generation of white collar jobs moving to third world countries. Well he's right. Manufacturing jobs and many white collar jobs are leaving the US but Dobbs, being a bit of a soap box proselytizer only talks about one side. He has completely missed a titanic shift in the US economy; namely, that manufacturing is simply not as important as it once was. Compare Singapore and Hong Kong with little to no manufacturing to Italy that is hell bent on protecting it's manufacturing industry (mostly over-priced shoes) then ask how relevant manufacturing is again. Simply said, about 70% of the US economy is now services; services such as serving you at the local supermarket, styling your hair, doing your accounts, or reporting the news are what make up the US economy today.

David Ricardo was the first economist to formalize the theory of comparative advantage. At it's most simplified level, what comparative advantage says is that countries will naturally shift their economies to where they are most skilled. When countries do that, they benefit because they are able to use scarce resources more efficiently - and don't forget economics is all about the study of how we use allocate resources to do something useful (like feeding and clothing ourselves).

We intuitively do this in society - none of us tries to grow our own wheat, milk our own cow and then try and write advanced software to write our blogs in the evenings. We specialize in what we're good at and this enables us to use our resources (the most precious of which is time) more efficiently. This is only one part of the theory of comparative advantage. The other is that we don't have to be absolutely the best in the world in order to specialize. We only have to do one thing better than we do other things. On a global scale as there are so many products and services, it is extremely unlikely that two countries would happen to have the same speciality. And, anyway, typically the response to competition is that either you do better or you move into a market where there is no competition.

So coming down to Earth, what does this say for Dobbs' arguments. Well it says that the US is better off when it shifts its resources to areas where it is more productive. In fact studies have shown that for every $1 worth of work that has been outsourced, the US gains $1.12 - $1.14. Higher productivity means higher earnings, and lower prices and lower unemployment. So it is no tragedy when lower productivity jobs leave the US. The only thing politicians can and should do is to help those who have been displaced. In other words instead of trying to keep those factories in the US through subsidies or tariffs (which has the perverse effect of encouraging young people to go into dying job markets) and thus helping only a tiny minority of workers (and the factory owners who usually are the ones to lobby for such protection), it is better to allocate those resources to retraining and possibly helping people relocate to areas that are growing.

Everyone can benefit from free-trade if only politicians would let them. As for Lou Dobbs, who studied economics at Harvard, he should know better or maybe he should have been paying more attention during classes.

(posted by Rajeev)

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