Intl Micro ECN 160A
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Date Created: 09/08/15
Lecture 6 ch 6 One facet of increased services trade is the increased use of offshore outsourcing in which a company relocates laborintensive serviceindustry functions to another country When a good or service is produced more cheaply abroad it makes more sense to import it rather than to make or provide it domestically Economic Report of the President 2004 Foreign Outsourcing of Goods and Services The provision of a service or the production of various parts of a good in different countries that are then used or assembled into a final good in another location is called foreign outsourcing or more simply Outsourcing 39 is trade in intermediate inputs which can sometimes cross borders several times before being incorporated into a final good that can be sold domestically or abroad Is outsourcing different from the type of trade examined in the Ricardian and Heckscher Ohlin models From one point of view the answer is no outsourcing allows a company to purchase inexpensive goods or services abroad just as consumers can purchase lower priced goods from abroad in the Ricardian and HeckscherOhlin models This is what the above quote from the Economic Report of the President suggests w outsourcing we import those goods and services that are cheaper to produce abroad From another point of view however outsourcing is different Companies now have the opportunity to send a portion of their activities to other countries The jobs associated with that portion leave the United States and by paying lower wages abroad US firms lower their costs and pass on these savings to consumers Outsourcing results in lower prices but changes the mix ofiobs located in the US higher skilled workers in the US engaged in activities like marketing and research will be combined with lessskilled workers abroad engaged in assembling products In a sense outsourcing is similar to immigration in that US firms are able to employ foreign workers even though those workers do not have to leave their home countries Three goals of this chapter 1 See how outsourcing affects the demand for skilled and unskilled labor and their wages Discuss the gains from outsourcing Examine the newest form of outsourcing the outsourcing of business services to foreign countries This involves the movement overseas of skillintensive activities rather than unskilled activities 9 Wage Patterns in the Uni ed States Skilled and Unskilled workers Two methods for classification 1 Edncztinn sehool dropout hlgh sehool graduates 16 orrnore years ofeducatlon 27 Type nrwnrk produetlonquot and nonproducn onquot workers Froduetlon workers are lnvolved in the manufacture and assernbly ofgoods hereas nonprodueuon wor are mvolvedm supporung servlce aetwltles Generally nonprodueuon workers regulre rnore edueatlon and so we wlll taeat these workers as skllled whlle the produeuon workers are taeated here as unskllled workers Earningspatterns By queauon Real wages of fulletlme U 5 workers between1979 and 1995 Fell by 20 forhlgh sehool dropouts Fell by 13 for hlgh sehool graduates with no further edueauon Rlse by 3 forworkers with 16 or more ears of edueauon Rlse by 14 for those with 18 orrnore years ofeducatlon o you ean see at a wage gapquot deyelopedbetween the earnings of the r Thls dagrarn shows the average wage ofnonrproductlon workers dylded by the average wage ofproducuon workers analogous to the rauo ofskllledto unskllled wages Whl eh we de ne later as WsWL in U s rnanufaetunng o The gure shows the relauye wage of produetlon or unskllled workers fell dunng the 19805 and 19905 f f f e s quot t Figure 52 Relative Wage or Nnnrprndnc nnPrndnctinn Workers us DIanufzctnring Why the relative wages of unskilled workers fall two possrbrlrtres 1 mto the U s lowerwages sklll are no longerpel39formedln the Umteol States skllled workers leadlng to hlgher wages and employment of skllled workers Rzlalwe Emploan i f f f Relative Employment of Nonproduction Workers From 1968 to the early 1983 relataye supply of eollege graduates mereaseol seeFlg o 2 But after 1983 the slog ehanges The nsmg relataye wage ofnonproductlon workers shouldhave leolto a shrltm employment awayfrom nonprooluetron workers butrt deal not mld198039s Thls eoneluslon ls lllustxatedm Flgure 6 4 dunng the 1980s The only way that th5 pattern ean be eonsrstent wth a olemanol and supply dlagram ls lthe relatwe olemanol eurye for skllledlabor has mereaseol as rllustrateol Thxs wouldleadto an mcrease m the relauve wage for shlledlabor and an mcrease m us relative employment the pattem seen m the data for me Umted States 39 W Drumm 1953 NnnpraductmnPmduninn Wage Demand x979 rrr gn Rnyrly romp mm H2 ME e 035 M pea up 5 Iu NonpmduchonProductmn Empmymem Figure 54 Supply and Demand fur Nnnprnduc nnPrnductinn Wnrkers we g Himm Demand 3 Sh lm39U uk ladLabm 5 2 Emm mmrn m Relative Demand and Supply m Skilledunskilled L shuedmmlled wacr m Foreign mumv ah nr Figure 57 e WsWL labor m Forexgn sL dependmg on me relauve wage wwwr The equmbuum 15 at pomt Aquot Forexgn Home Supply g Eomgn Supply B 5 5 f A i l 4v 39 Hume Demand FDKclgn Demand Sk ue lt mc m Lab 5 7 Sleled Unskllled Labor 5 L l a Hume munm 1 foreign rollnrry Figure 69 Change in the Relative Demand for SkilledquotUnskilled Lab or uh I I39ll A s u t t t e t t t t A I In In to t t t relative wage for skilled labor in Foreign also nses from point m to point 13 TWO Explanations 1 ahttehmaed technalaglml change 39 1980 II skilled workers 2 International Trade The 19805 was also a time ofincreasing imports into the United States I quot A I these factors will he employed elsewhere in an eeonomy 1n othe wonls H0 predicts betweennndnatyy movements in factors of quotv in 0quot n 39 39 39 39 L are gaining comparative advantage a L a I US manufacturing indusm39es and even withinindividual rms rms have been quot39 39 quotquotquot39 quota lama labor is becoming relatively more expensive There is no explanation in the HeckscherOhlin model or the Ricardian model formis kind withinindustry shaltln labor demand Outsourcing There may be other reasons re1atedto rhtematroha1 trade that ear explam thrs ohe sueh reasoh quot produehoh proeess and do the uhsmuedahtehsrve outsourerhg allows frrrhs t ther explahahoh for sk lledlabor m the Uhrte tates and uhthes det whr eh aehvrtres are hkely to be transferred abroad to do the hang relatrve wage of E 5quot q 539 E A Model of Outsourcing Order nfprndllctinn aetrvrhes m the order m whreh they are performed m Cempon em Assemhlv Marketmg Produchun a Sales Panel a Order of Prnducrinu usedm eaeh Dene at Home Done m Foray A Asscmhly ompon Marketmg mu Producuon 5 Sale Ymnel b Ranked by Skilledfusk lell Lahnx39 Figure 66 The ValuEChain nf z Prndnct Assumptions On wages WLlt WL Wslt W3 and WLquotWSquotlt wuw relative wage ofunsk lled labor rs lower m Forergh that at Home On Cagttat and Trade costs value ehath thatrs these extra eosts add say 10 to eaeh and every eorhpoheht of operation m Forergh as eorhpared to Home Extra cost of capital like higher prices to build a factory or higher prices for utilities such as electricity and fuel in foreign country Extra cost of trade like extra costs involved in transportation and communication which will be especially high if Foreign is still developing roads ports and telephone capabilities and the extra costs due to tariffs if Foreign imposes taxes on goods such as component parts when they come into the country We will lump together the last two factors together into what we call trade costs Which activities will be transferred Home firms send the most unskilledlabor intensive activities abroad and to keep the more skilledlabor intensive activities at Home In Figure 66 all activities to the left of the vertical line A might be done in Foreign We can refer to this transfer of activities as slicing the value chain Relative Demand and Supply of Skilled Labor For home country add up the demand for skilled labor S and unskilled labor L for all the activities to the right of line AA for Home Taking the ratio of these we graph the relative demand for skilled labor at Home S L against the relative wage WsWL This relative demand curve slopes downward because a higher relative wage for skilled labor would cause Home firms to substitute toward lessskilled labor in some activities Similarly for Foreign country In each country we can add a relative supply curve to the diagram Relative supply curve is upward sloping because a higher relative wage for skilled labor will cause more skilled individuals to enter this industry individuals will invest more in equipping themselves with the skills necessary to earn the higher relative wage A and A are the equilibrium relative wage in this industry in each country and the equilibrium relative employment of skilledunskilled workers Starting at these points we will next study how the equilibrium changes as Home outsources more activities to the Foreign country Changing the Costs of Trade Suppose now that the costs of capital or trade in Foreign o eg NAFTA lowered tariffs charged on goods crossing the USMexico border gt lower trade costs gt makes e it easier for US firms to outsource to Mexico 0 Another example is India which in 1991 eliminated many regulations that had been hindering both businesses and communications and also allowed more foreign investment These changes made India more attractive to foreign investors and firms interested in outsourcing Wlth lower trade eosts rtrs now desirable to shlftmore aetwrues m tlne Valuer chain from Home to Forelgn o slult othe dividing line from Ato B m Flgure o 8 0 move aeumtres lnrbetween A andB from Home to Forelgn o gt lncrease demand for relauve skilledlabonn botln eo ntnes beeause Ho does less of tlne lower skill end oflts aetwrtres and Foreign picks up ose o Aeumues no longerperformed atHome r e tlnose lnrbetween A and B are 1255 slullantenswe than tlne aeumues strll done tlnere those to tlne rrglnt Tlus means tlnat tlne range of aetwrues now done at Home are more skilledrlabonntenslve on average than tlne set of aeumtres formerly done at Home Tlus model of outsouremg generates tlne same kind ofslultm relauve demand o US Done mForclgn Dune at Home A E Assembly Cuuumnenl lvlarkeung Rva Pmducnon dr Sales Figure 58 Outanureing an the ValueClnain demand for skilled labor m both countries Case Study Is it outsourcing skilled biased technological change or both 0 Have two ways ofmeasunng high techrequlpment t t t skllled workers m US dunng 197971990 0 L 1 r lmponant explanauons for tlne lncrease m tlne relauve wage of nonproduetron produetron laborln U 5 manufacturing but it ls ddfflcultto udge which ls more equipment ram Luau nmexennn asenmnnmnnennn LahmInL hnulnnnrmglg39EJSW Onesnus senquot hencFaallzude an mum 0 used Tedunlagvsz amuse a 3 my 90 QIMIHE Ioumn 5mm Mums H401 ya no a It is both 63 The Gains from Outsourcing a Sawuutsuurnng canleadtu ansem theralanvewggerates nmne slnuealabne se sxnuea 1am gans and unslnuea laburluses m relative terms a On the uLha39 hand me ammy af rms tn relucate senne pruduchun aenvmes abmad means that men Busts are reduce luwerpnces bene ts tn cunsumers Our gual mths seennn 15 D try and balance the gutenual 1nsses faced by senne guups unslnuea 1am wmn une gans Enjuyed by nunen sxnuea 1am and cunsuma39s Simplified Outsourcing Model 0 undersfand Samuelsun pom a Instead ufhavmgmzny ae muesmvulvedmthepruducuun ufaguud suppusethat are are Duly two aenmnes cumpunents prudu lun Q5 and research and develupment Men QR o Sugguse there are twu facturmputs unsxnuea 1am L sxnuea labur 5 used m pruduce une tvm mta med ate guuds o ngs anuns1n11e unmanle x e maxnngnans and cumpunmts and o Qxxs askllledrlaburrmtensxve nunrpmdumunmpu such as RampD marketing and aaensa1e semees The QE a e are bundled tuge qa tu pruduce a nal guud Y labururcsztal are nutused m the nal guud o All aemmes take plaee wme a smgle manufaemnng industry 0 Allthreepmduds canbexnmmauunally traded a We assunneunamne Busts nfeannal are equal m Lhatvm aenmnes o eornpare nortrade situauon to an equilibrium with trade through outsouremg to determme whether ornot there are overall gams from trade aetlvmes 0 Given the amount ofskllled and unskilledlaborusedm total we can graph a aetwmes as shown m Figure 6 11 n m V now we apply it to a smgle firm MD Slope 1 i14 Cornpouems Figure 511 Nanrzrle Equilibrium at Hume produees atA with the quanuues ch ofeornponents and Qiu ofRampD The amount Y the value that the rm puts on eornponents relatwe to 12521 or therrrelatwe pnee P RA The amount 12 ofthe final good eannot be produeedm the absenee of outsouremg beeause it lies outside the PPF for the rm Equilibrium with Outsourcing Suppose PcPRW lt PcPR The worldrelatwe pnee onc is eheaper than Horne39s nortrade relauve pnee gt the Home rm ean rrnport eornponents at alower relatwe pnee than it ean produee thern itself wage ofunslulledlabor is lower m Foreignw1ws lt wuw F r l w also be eheaper there It follow thatHorne wrll wantto outsouree eornponents whreh rs eheaper abroad whrle Forelgn rms wrll outsouree the skllledrlntenslve aehvrty RampD h h rs eheaper atHorne Then aeeordrng to H0 rnodel we errpeetthatHorne eountry to export QR sleledrlaborrlntenslle rnterrnedrate rnput and lmgon Qc unskllledlaborrlntenslve rnterrnedrate rnput Gains from Outsourcing Within the Firm Increasel from lto yzers arneasure ofthe gams from trade to the Horne rm ough outsou ng sarne total ount ofresources outsourerng rn ore flnal good gt hlgher produetrvrty gt lower produetron eosts gt lower prree of Y gtconsumergan Thus When agood or servlce rs produee rnore eheaply abroad rt makes sense to rrnport rt than to make or provlde rt dornestreally quot In our example eornponentproduetron rs eheaper rn Forelgn than rn Horne so Horne rrnports eornponents from Forelgn There are overall gams from outsourerng Ihatrs ourflrst eonelusron when Dutsaurclng eountry39 s terms dtmde 3913 slepe prtm v Slaps MW Y1 Compouems Figure 612 International Trade Equilibrium at Home In the presence of outsourcing the rm will do more RampD and less component production producing at point B The Home rm then exports RampD and imports components moving to point C At point C the amount Y2 of the nal good is produced The difference between Y1 and Y2 represents the gains to the Home rm from outsourcing If the price of components falls then the Home rms will shift to B and C with even greater gains Possibility of making a loss 0 The Nobel laureate Paul Samuelson 0 Most noneconomists are fearful when an emerging China or India helped by their still low real wages outsourcing and miracle exportled developments cause layoffs from good American jobs This is a hot issue now and in the coming decade it will not go away Prominent and competent mainstream economists enter in the debate to educate and correct warmhearted protestors who are against globalization Here is a fair paraphrase of the argumentation that has been used recently Yes good jobs may be lost here in the short run But still total US net national product must by the economic laws of comparative advantage be raised in the long run and in China too The gains of the winners from free trade properly measured work out to exceed the losses of the losers Correct economic law 39 that some American groups can be hurt bv dvnamic free trade But correct economic law vindicates the word creative destruction by its proof that the gains of the American winners are big enough to more than the losers Does this paraphrase by Samuelson sound familiar You can nd passages much like it in this chapter and earlier ones saying that the gains from trade exceed the losses But listen to what Samuelson says next The last paragraph can be only an innuendo For it is dead wrong about the necessary surplus of winnings over losings So Samuelson seems to be saying that the winnings for those who gain from trade do not necessarily exceed the losses for those who lose How can this be His last statement seems to contradict much of what we have learned in this book Or does it Fall in the Price of RampD Starting at point B a fall in relative world price of RampD PCFRY igt steeper price line PRPaw At the new prices Home shifts production to point B and by exporting RampD and importing components moves to point C39 Notice that nal output has fallen from Y2 to Y3 Therefore the fall in the price of RampD services leads to losses for the Home rm Samuelson s point is that US could be worse off if China or India becomes more competitive in and lowers the prices of the products that the US itself is exporting RampD Slope en no Componems Figure 513 Fall in the Price nfRzS zD Starting atpomt c mu tn the relattve pnee of RampD Wm lead to a steeper pnee lme The x and YZLO Y3 39T h r F r leads to losses forHome Nonee thatfmal output at Home is snu higherthan 11 which is the equmbnunn Without any outsourcing So there are gams from trade at c as compared L huH V C equmbnunn with outsourcing atpomt c US Terms of Trade and Service Exports Examine the emdenee forthe United States Foreign competition tn MD gt expeetO Rngwl Conversely 1the U s has been outsourcing tn manufaetunng then the opportuan 9 11939 fi miw i ffff Figure 515 Impact of Outsourcing on US Productivity Productivity In Table 6 3 we showthe 1mpact ofservme outsourcmg and hxgh perworker Overthe exght years 1992 e 2000 semee outsourcmg can explam between 12 and 17 of the m1 mcrease m groducuvxty Despxte the small amount ofservme 1mpons1t explams a sxgmfmant pomon ofproducnvxty growth Table 53 Im an nf Outsnurcing nn Prndnctivity and Emplnymem in US DIanufzcturing 199272000 110541 hnnzlthulauniu Wm M meme 1 139 Ahnuhrmnuslwi 7n 64 Outsourcing in Services The outsourcing of skilled service activities seems to violate the prediction of our outsourcing model Why does the model fail when skilled services are outsourced The brief answer is that the assumptions we made in the outsourcing model are not satis ed when comparing the US and India Let us examine these assumptions one at a time 1 Our rst assumption was that Foreign wages are less than those at Home and in addition that the relative wage of unskilled labor is lower in Foreign that at Home That assumption holds true for the US and India Certi ed public accountants earn 15000 in India and 75000 annually in the US so the highskill US wage is ve times higher But the gap for less skilled workers is much greater Indian wages for entry level call center employees in urban areas is 2400 per year whereas in the US entry level call center employees earn at least 24000 per year a wage that is 10 times higher 2 Our second assumption in the outsourcing model was that the extra costs of capital and of trade in Foreign were spread uniformly over all the activities on the value chain But this second assumption does not hold in India The costs of outsourcing relatively unskilled manufacturing activities to India are much greater than the costs of outsourcing skilled service activities That is in part because manufacturing requires transporting component parts to India which has a poor transportation infrastructure ships are frequently delayed at ports and roads are clogged Policy makers in India are well aware of these dif culties which have limited their ability to engage in manufacturing outsourcing as their neighbor China has done Indeed in an attempt to encourage other countries to outsource their manufacturing there India is now proposing free trade zones ie government subsidized areas not subject to regular customs restrictions which encourage foreign rms to outsource with Indian manufacturing We can view the creation of free trade zones as decreasin the trade costs 39 t A with f outsourcing These zones have been very successful in China at promoting manufacturing exports particularly in the coastal regions which have better access to shipping routes Service activities on the other hand do not rely as much on transportation but instead require reliable and cheap 39 quot The communication infrastructure is very good in India where cell phone charges are less than in the Us and Europe In addition India has a large number of welleducated individuals who speak English and is in a time zone that is 12 hours different from the Eastern time zone in the US which can be an advantage for performing some service activities iIIQ All these aspects create a compelling logic for rms in the Us and Europe to engage in service outsourcing with India where India has a comparative advantage Until trade and capital costs across industries are similar as assumed by our outsourcing model India will continue to have a comparative advantage in performing service activities not manufacturing activities Appendix What can explain increasing wage inequality in US Since the early 1980 s the wage of skilled relative to unskilled workers in US has increased Is this because of Trade with NIC s Is this related to the growth of exports of manufacturing goods of NIC s and a move toward FPE WLWS 1 WIWSW WWsf ss 7 4 PCP5 PCPSW PCPsf PcPs There is skepticism based on 4 observations 1 According to HO a Kabundant country such as US is expected to export K intensive goods This would increase r and decrease w If so then we should observe R KGDPT and WLGDPi But there has been no change in the distribution of income of K and L 2 According to SSTheorem an increase in the price of skilled intensive good leads to an increase in the wage rate of skilled labor PSINTT gtWST But there is m clear evidence of a rise in the relative price of skilled intensive goods LA If increase in the price of skilled intensive good was the reason for an increase in the skilledunskilled wage gap in Us then we should have observe the reverse in unskilled labor abundant countries such as China PSJNTT gtWsi That is with an increase in the price of unskilled intensive goods the skilledunskilled wage gap in China should have A A but this in fact has increased in NIC s 4 Trade of advanced countries with NIC s is a small share of total spending in advanced countries Nontraded goods and the Harrigan empirical observation Movement in wages over 1980s and 1990s are 7 not correlated with trade prices PT or outsourcing 7 but rather with nontraded goods PNT 7 ie there is a sharp increase in the pri of skilled intensive nontraded goods in the US WST as PSNTT 7 as well as a decrease in the price of unskilledintensive nontraded goods WLl as PLiNTl This nding poses a challenge to the idea that either trade or technology is responsible for the changes in wages Price of NT Skilledintensive goods T Price of NT Unskilledintensive goods i gt this cannot be because of trade or technology because AW is correlated with PM and not with PT gt something else is going on unrelated to international trade
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