Driving the Next Wave of Job Creation

Stephen Roach has a very important post today. Really here he gets hold of the central question for the future of the US economy. All the deficits in the world are supportable, if you can pay your way. But it is precisely this capacity to make the pay back which is put in question by the existence of IT-enabled outsourcing. As Roach continually reminds us, the US has a standard of living 'differential' with the rest of the planet. In part this is a 'positive feedback' consequence of the fact that the dollar is the world's reserve currency, and hence people are prepared to hold dollars. But the reason the US can 'enjoy' this possibility is, in the final analysis, a by-product of the high productivity and earning capacity of the US enterprise and the US workforce. It is this latter which is put in doubt by the new global competition. No-one doubts that the US worker is highly productive, but are they as productive as the per capita income differentials suggest? This is the question, and this is the new challenge facing the US.

A US-centric global economy is waiting with baited breath for sustained cyclical revival. Central to such a growth spark is the time-honored vigor of the great American job machine. That’s been missing up until now but there are hopes this piece of the macro puzzle is finally falling into place. Those hopes are not likely to be realized, in my view. At work is a new “global labor arbitrage” -- a by-product of IT-enabled globalization that is now acting as a powerful structural depressant on traditional sources of job creation in high-wage developed countries such as the United States. America’s jobless recovery could well be here to stay.

There is a critical dichotomy between those who accept this premise and those who don’t. At one end of the spectrum is the angst of the American body politic. Consumers and their elected political representatives remain deeply concerned about the persistent perils of a jobless recovery. As a result, the very real and worrisome risks of a protectionist backlash are mounting in the US Congress. At the other end of the spectrum are increasingly frothy financial markets that believe the worst is over and that hiring is now set to resume. The theory is simple: A policy-induced stimulus to aggregate demand will eventually require the supply of new labor. The September labor market survey has given investors great encouragement that such magic is back in the US business cycle and that the carnage on the job front has finally run its course. I couldn’t disagree more. Employment growth of 57,000 is puny when compared with hiring spurts of the typical cyclical recovery that often run in the 200,000 to 300,000 range. Moreover, with nearly 60% of the September gain in payrolls traceable to increases in temporary staffing -- the fifth month in a row of solid hiring in this industry -- it’s a real stretch, in my view, to conclude that the days of this jobless recovery are now nearing an end. Instead, I would argue that America’s increased emphasis on a relatively low-cost contingent workforce is emblematic of a new relationship between aggregate demand and domestic employment that lies at the heart of the global labor arbitrage.

A powerful confluence of three mega-trends is driving the global labor arbitrage -- the first being the maturation of offshore outsourcing platforms. China personifies the critical mass that has now been attained in new manufacturing outsourcing platforms. Built on a foundation of massive inflows of foreign direct investment -- China is now the world’s largest recipient of FDI -- and domestically funded infrastructure, the Chinese factory sector has become a critical ingredient in the global supply chain. Fully 65% of the tripling of Chinese exports over the past decade -- from US$121 billion in 1994 to US$365 billion in mid-2003 -- is traceable to the outsourcing dynamic of Chinese subsidiaries of multinational corporations and joint ventures. Of course, China is hardly alone in the outsourcing business. Similar patterns are evident elsewhere in Asia, as well as in Mexico, Canada, South America, and Eastern and Central Europe. Outsourcing is hardly a new phenomenon. But today’s offshore outsourcing platforms now offer low-cost, high-quality alternatives to goods production and employment on a scale and scope the world has never before seen.

A comparable trend is now emerging in the labor-intensive services providing sector. Long dubbed as “non-tradables,” services are typically perceived as having to be delivered in person, on site. That’s no longer the case. Rapid growth is also occurring in the offshore outsourcing of services. Such activities span the value chain -- from low-value added functions such as transactions processing and call centers to high-value added activities such as software programming, engineering, design, accounting, actuarial expertise, legal and medical advice, and a wide array of business consulting activities. Increasingly, service sector outsourcing is shifting to intellectual capital -- heretofore thought to be the sheltered mainstay of economic activity in the wealthy developed world. India personifies the critical mass that has now been attained in offshore services outsourcing. One study estimates that India’s IT-enabled services exports will increase by ten-fold between now and 2007 -- rising from US$1.5 billion in 2001-02 to US $17 billion by 2008, making it one of the fastest-growing major industries in the world (see The IT Industry in India: Strategic Review 2002, published by India’s National Association of Software and Service Companies in conjunction with McKinsey & Co.). Nor is India alone. Services outsourcing is increasingly prevalent in places like China, Ireland, and even Australia.

E-based connectivity is the second new mega-trend behind the global labor arbitrage. This is the first business cycle since the advent of the Internet. Say what you want about the Web, but I believe it has been a transforming event on the supply side of the global macro equation. For manufacturing, it puts new meaning into the real-time monitoring of sales, inventory, production, and delivery trends that drive the logistics of global supply chain management. And it provides a new transparency to the price discovery of factor inputs and upstream materials and supplies -- offering efficiency breakthroughs never before attainable. For services, the Internet enables outsourcing to penetrate an entirely new realm of economic activity. The intellectual capital of research, analysis, and consulting can now be transmitted anywhere in the world with the click of a mouse. For example, a systems problem in New York can be fixed by a software “patch” written in Bangalore. The results of processing and analysis functions can be fed into real-time information systems from anywhere in the world. The instantaneous connectivity of the Internet has become the new pipeline for the global information flows that drive the service sector supply chain. It allows the knowledge-based output of information workers to be exported instantaneously around the world. That permits well-educated, hard-working, relatively low-wage offshore knowledge workers to be seamlessly integrated into global service businesses, heretofore the exclusive domain of knowledge workers in the developed world.

Outsourcing and globalization go hand in hand. But in an e-based world with instant diffusion of new technological breakthroughs, the rules and role of outsourcing quickly get re-written. Increasingly educated, low-wage work forces in developing nations only enhance the globalization of supply chains. Nor are prices and costs the only considerations in shifting to offshore production. The textbook analysis of outsourcing also stresses a variety of additional factors such as quality, supply flexibility, on-time performance, replenishment lead time, inbound transportation costs, design collaboration capabilities, information coordination resources, supplier viability, as well as exchange rates, taxes, and duties (see S. Chopra and P. Meindl, Supply Chain Management: Strategy, Planning, and Operation, Pearson Prentice Hall, Second Edition, 2004). In my view, enabled by the Internet, the Chinas and Indias of the world can now compete favorably on all of those terms. The result is an accelerated pace of globalization on the supply side of the macro equation -- the essence of the global labor arbitrage.

The asymmetrical impacts of the global labor arbitrage lie at the heart of the great political debate now swirling in the United States and elsewhere in the developed world. The resulting tensions underscore the distinct possibility that jobless recoveries may remain the norm in high-cost developed economies for some time to come. That’s not something to take lightly. The threat to traditional sources of job creation strikes right at the heart of economic security. That has given rise to a political backlash in the US Congress that could prove quite destabilizing for the global economy.

In the end, the choices are stark -- to look inward and protect the “old way” or to look outward and encourage the “new way.” I would dare say this dilemma is quite comparable to what farmers faced in the late 1800s as the Industrial Revolution blossomed. The same would have probably been true of sweatshop workers when confronted with the assembly lines of mass production in the early 1900s. The “rusting” of Smokestack America in the early 1980s is a more recent example. At each of these earlier critical junctures, there were no clear answers at what would drive the next wave of job creation. America’s model -- one that fosters flexibility, entrepreneurialism, innovation, technological change, and investment in human capital -- always found that answer. The global labor arbitrage forces the US and the rest of the developed world to rise to the occasion once again.
Source: Morgan Stanley Global Economic Forum
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