Offshoring and Directed Technical Change

by on December 11, 2012 at 3:30 am in Economics | Permalink

That will have been one of the most important papers of this year and it is by Daron Acemoglu, Gino Gancia, and Fabrizio Zilibotti.  Read every sentence of the abstract carefully because each one matters!:

To study the short-run and long-run implications on wage inequality, we introduce directed technical change into a Ricardian model of offshoring. A unique final good is produced by combining a skilled and an unskilled product, each produced from a continuum of intermediates (tasks). Some of these tasks can be transferred from a skill-abundant West to a skill-scarce East. Profit maximization determines both the extent of offshoring and technological progress. Offshoring induces skill-biased technical change because it increases the relative price of skill intensive products and induces technical change favoring unskilled workers because it expands the market size for technologies complementing unskilled labor. In the empirically more relevant case, starting from low levels, an increase in offshoring opportunities triggers a transition with falling real wages for unskilled workers in the West, skill-biased technical change and rising skill premia worldwide. However, when the extent of offshoring becomes sufficiently large, further increases in offshoring induce technical change now biased in favor of unskilled labor because offshoring closes the gap between unskilled wages in the West and the East, thus limiting the power of the price effect fueling skill-biased technical change. The unequalizing impact of offshoring is thus greatest at the beginning. Transitional dynamics reveal that offshoring and technical change are substitutes in the short run but complements in the long run. Finally, though offshoring improves the welfare of workers in the East, it may benefit or harm unskilled workers in the West depending on elasticities and the equilibrium growth rate.

In this paper you will find a ray of hope, namely “…when the extent of offshoring becomes sufficiently large, further increases in offshoring induce technical change now biased in favor of unskilled labor because offshoring closes the gap between unskilled wages in the West and the East, thus limiting the power of the price effect fueling skill-biased technical change.”

And this:

The unequalizing impact of offshoring is thus greatest at the beginning. Transitional dynamics reveal that offshoring and technical change are substitutes in the short run but complements in the long run.

Of course we will see, but if you wish to be ahead of the game, spend your time pondering those propositions.  Ungated copies are here.

The truly clever will solve this model for some analogous propositions about robots.

Steve Sailer December 11, 2012 at 4:55 am

“further increases in offshoring induce technical change now biased in favor of unskilled labor because offshoring closes the gap between unskilled wages in the West and the East”

How many billions of people are there in “the East”?

“once the Invisible Hand has taken away all those historical inequities and smeared them out into a broad global layer of what a Pakistani brickmaker would consider to be prosperity …”

“Snow Crash” isn’t really a utopian novel.

Slocum December 11, 2012 at 8:48 am

That bit from ‘Snowcrash’ is pithy, memorable….but wrong. Had Stephenson been writing the novel in the 50′s he might have used a Japanese laborer as his example rather than a Pakistani. And decades later, poor laborers from Taiwan or South Korea would still have served. But ‘smearing the inequities downward to the level of a day laborer in a poor country’ is not what happened in those cases, is it? And clearly it’s not what’s been happening in China.

john personna December 11, 2012 at 9:10 am

Oh, I’m sure that some of us might live long enough to see rural Chinese wages reach rural American levels … of course, workers need to meet the rent in the shorter term. “Just give it another decade or two” is little solace.

Brian Donohue December 11, 2012 at 10:00 am

solace to whom? The idea that we live on a planet with billions of very poor people is one of the outstanding facts of the past couple centuries. It gave Marx all his raw material, for example. The fact that most people in rich countries live lives beyond the imagination of these billions of poor people should give all of us pause from time to time.

The fact that, in the last fifty years, something like a billion people have become “unpoor” on this planet, this is very good news.

john personna December 11, 2012 at 10:33 am

Have politicians ever made that choice clear? “sure some American jobs will be lost in the coming decades, but others overseas will benefit.”

Of course they have not. They’ve made a “rising tide raises all ships” argument. The “ah, but the world is better” thing is only offered by … back-thread kibitzers? It would be one thing if US workers directly “took the deal” and by that I mean to “take one for the team.”

Brian Donohue December 11, 2012 at 11:21 am

@john,

I never said anything about politicians or deals that are on offer, just some background facts.

Do you have a solution that raises all boats? I’m skeptical. I don’t get the idea that it’s more important to help some guy nearby fix up his dinghy than it is to see that the folks treading deep water get a shot at a life preserver.

But then, I’m not much on birthrights. I always thought that was the American deal.

albatross December 11, 2012 at 12:07 pm

Brian:

If the choice comes down to whether the US government should work for the benefit of American citizens or foreigners, it seems pretty clear to me that the job of the government is to work for the benefit of citizens, and that governments of the kind we know how to build and maintain actually work a lot better at that task than at some global maximization-of-welfare task. It certainly doesn’t look too promising to run for political office on a platform of “I’ll make you poorer, but in so doing, I’ll make much poorer people better off, and the net benefit to mankind will be substantial.” You can get some acceptance of that around the edges, with disaster relief or subsidies to countries with politically important voting blocs in the US, but I don’t think you can (or should) be able to get support for doing that on a large scale.

If I hire a property manager to run my rental property in a faraway city, it’s not okay for him to turn my property into a homeless shelter at my expense, even if it may be the welfare-maximizing thing to do in a global sense. That’s not his job. I see the role of government in a similar way–like a property manager, or the manager of a sick relative’s estate on behalf of her far-flung family. Those managers are hired to work on the behalf of their employers, and the world works a lot better when they make some effort to do that, rather than to feel free to use their employers’ resources for charity. And I think the same is true of elected governments. The president isn’t on Pennsylvania Avenue to play Santa Claus or Mother Teresa, he’s a manager hired by the voters to, as much as possible, manage their many conflicting interests.

Brian Donohue December 11, 2012 at 12:34 pm

All right, I get that. Perhaps ‘giving life preservers out’ is a poor metaphor- I’m not talking about charity here- much more interested in good-doers than do-gooders.. How about allowing people from poor countries to sell me their wares at market prices?

I don’t think protectionism “works for the benefit of American citizens”- it works, in the short-term, for the protected job. It works less well for me, forced to pay higher prices or settle for inferior goods than I might. It doesn’t help the poverty-stricken Asian, African, or South American. In the long run, the only safety is being able to compete successfully. I think economic nationalism is silly and misguided and falsely casts decisions as zero sum.

msgkings December 11, 2012 at 1:18 pm

Brian is rocking this thread. Bravo.

doctorpat December 11, 2012 at 7:25 pm

So I can choose to have a better life (cheaper products) and at the same time benefit many poor people I’ve never met. OR I can choose to have a poorer life (more expensive, restricted products) and at the same time benefit some medium-to-well off people I’ve never met.
Decisions, decisions….

prior_approval December 11, 2012 at 4:59 am

‘Some of these tasks can be transferred from a skill-abundant West to a skill-scarce East.’

Hilarious – at this point, when it comes to the manufacture and assembly of electronics, it is the West which is scarce on skills, not the East.

‘Profit maximization determines both the extent of offshoring and technological progress.’

At this point, I don’t think that the relationship is what the authors assume, at least in the broad area which one could describe as ‘electronics.’ Certainly there are global companies, such as Intel, which care nothing about offshoring (the entire world is their offshore, so to speak), but to imagine that companies like Apple, Dell, or HP are the ones doing the ‘offshoring’ ignores the fact that a company like Foxconn is the one doing the work – and does the work for any customer able to pay them. Lenovo comes to mind in this regard (a Chinese company which is poised to overtake HP as the world’s largest PC manufacturer). Or Acer, who has a finger in every pie, it seems.

‘The unequalizing impact of offshoring is thus greatest at the beginning.’
And yet, in the long run, the ‘unequalizing’ impact is most enduring for the society which loses the ability to manufacture the goods it consumes. This is not about comparative advantage – this is about something which was called ‘decadence’ in another age. The U.S. believes it retains a pre-eminent position in electronics. The reality being something considerably different, though American self-deception is still an option. Maybe even for another 10 years, though America’s ability to market itself to itself is still exceptional.

I can already hear those objecting about how the U.S. is a manufacturing powerhouse, using American definitions of ‘manufacturing.’ Like this one – ‘The Petroleum and Coal Products Manufacturing subsector is based on the transformation of crude petroleum and coal into usable products. The dominant process is petroleum refining that involves the separation of crude petroleum into component products through such techniques as cracking and distillation.’ http://www.bls.gov/iag/tgs/iag324.htm

In other words, the world’s largest consumer of petroleum considers itself a manufacturer of gasoline. But who builds the tankers that crude is carried in? (Hint – not the U.S.) Actually, the U.S. doesn’t really build anything but tax payer funded ships at this point, but why care about shipyards when manufacturing gasoline is such a major industrial activity.

derek December 11, 2012 at 11:35 am

You pretty well described my reaction. The Japanese auto manufacturers off-shored production to somewhere cheaper when they set up Honda and Toyota plants in southern states. A few years ago an asian air conditioning manufacturer bought up a US company to have access to it’s distribution networks. They weren’t buying the brains, they had them already. They wanted to sell new and innovative technologies that any US manufacturers have yet to produce. There is no stagnation, the innovation is happening elsewhere.

The US has become a consumer society almost entirely, about 3/4 of the economy being such. This paper seems to encapsulate the delusion among US policy thinkers.

Kevin Burke December 11, 2012 at 5:03 am

Does the model account for the ability of workers to acquire skills? What is the evidence for/against workers acquiring skills?

(I don’t know either way but it seems rational to try and acquire skills in the face of rising relative wages for skilled labor).

Steve Sailer December 11, 2012 at 5:33 am

I’m all in favor of Daron Acemoglu writing extremely abstract abstracts like this, because when he tries to deal with facts the results aren’t pretty:

http://isteve.blogspot.com/2012/10/daron-acemoglu-is-kryptonite-to-clear.html

Ray Lopez December 11, 2012 at 6:08 am

Are you Peter Brimelow? lol. Seems you have extraordinary knowledge about economics. So please take a stab at deciphering this handwaving (seemingly): “Transitional dynamics reveal that offshoring and technical change are substitutes in the short run but complements in the long run.” How so in the long run? Except for the trivial observation that over time the economic pie gets bigger for everybody?

Engineer December 11, 2012 at 7:03 am

I am not an economist, but the gist of this paper as I understand it sounds obvious: when offshoring is feasible, the offshorable skills become cheaper in the West.

This would be a good time to ask the following question: is there such thing as a “serious” economic argument in favor of protectionism?

C December 11, 2012 at 7:33 am

Yes. For example, industries that produce positive externalities. Or probably more salient, industries that require learning-by-doing. Suppose country A and B can both produce a commodity, but country A receives a new technology that allows it to be the lowest cost producer. Country B can implement the technology, and will actually be the lowest cost producer in the long-run, but the start-up costs required for implementation prevent it from adopting. Protectionist policies, therefore, would give B the mechanism to implement the technology. In the short-run the economy is worse off but because of B’s long-run competitive advantage overall welfare is increased.

Of course, the problem arises where B’s lobbyists contend that they perpetually need the protectionist policies, entrenching an obsolete institution. For instance, the US textile industry. http://www.rushfordreport.com/2003/6_2003_Yankee_trader.htm#Top

kebko December 11, 2012 at 9:32 am

In this scenario, wouldn’t country B attract investment in the technology without protectionism? Surely capital would be attracted to the place with the long term advantage.

Dana December 11, 2012 at 10:43 am

“Assume capital” is a big assumption. “Assume capitalists who are OK with a 30-year return-on-investment horizon” is an even bigger assumption.

doctorpat December 11, 2012 at 7:29 pm

Of course assuming that governments have coherent planning over 30 year horizons is also an assumption.

kebko December 11, 2012 at 7:55 pm

NASDAQ at 5000?

C December 11, 2012 at 10:50 am

Without protection, the short-run opportunity cost will not be compensated by the long-run advantages that country B gains.

The literature is filled with papers that show tariffs are associated with growth. More recently economists have explored whether the structure of tariffs (i.e. protecting industries that have externalities v.s. rent-seeking) can explain the counter-intuitive findings.

Dismalist December 11, 2012 at 9:40 am

And an example, ex ante, would be… ?

Dana December 11, 2012 at 10:45 am

American manufacturing, 1790 to ~1870?

DRDR December 11, 2012 at 9:23 am

No, that’s not the gist of the paper. What’s important is how offshoring impacts the dynamics of real wages for unskilled workers, which initially fall but eventually stabilize and rise. The authors claim this is what has already happened over the last 30 years in the U.S.

derek December 11, 2012 at 11:43 am

Sure. Seriously we need to maintain a cost of government that is going parabolic or we will be kicked out of power. Seriously the sinecures and rents are necessary to maintain the standards of living of those who benefit from them.

Competition does it’s work by forcing failure. The US was once able to produce better quality goods at a better price than elsewhere, it was a place defined by economic opportunity. It is now a high cost jurisdiction, getting more expensive all the time. Oddly, those conditions lose in a competitive environment. The reaction is always to prevent competition, but it always makes it worse.

Get US total government expenditures down to the 32% range and the situation would change quite dramatically. And make sure that regulatory costs are included in that number. And if you say that it is impossible, well, frankly, it is time for an ambitious young person to move elsewhere for opportunity, because it won’t be in the US.

The D-man December 11, 2012 at 4:32 pm

Perhaps strategic stuff related to security? Probably not a good idea to outsource encryption electronics to China.

doctorpat December 11, 2012 at 7:36 pm

Yes. The USA has a good defense based argument for maintaining the ability to construct things like ships, tanks, guns, aircraft etc. in a locality that can’t be cut off in the case of war.
Though you can argue where such a cutoff is located. Is Japan a safe location? Hawaii? Alaska?

Chris December 11, 2012 at 8:53 am

Tyler, regarding your last sentence, this paper may be of interest to you: http://economics.mit.edu/files/1474

One interesting finding, from page 12: “If goods and services are at least weakly complementary, inequality between high and low skill labor either asymptotes to a constant or reverses course.”

DRDR December 11, 2012 at 8:54 am

“The truly clever will solve this model for some analogous propositions about robots.”

Just relabel the skilled workers as capital and the unskilled workers as labor, and the same results go through. Any objections?

Master of None December 11, 2012 at 9:43 am

Inequality and unemployment explained in one go! VERY productive!

R Richard Schweitzer December 11, 2012 at 10:38 am

Perhaps it may be of minimal significance, but then again it may not be:

in addition to the matters of pricing and technology there are the operating conditions that impact productivity and profitability, as well as the margins available from all activities. These can be adversely affected by what is loosely referred to as the “regulatory environment,” the issues of “political stability” and and market prejudices with respect to outsourced production or services. Pricing and technology may carry the main weights, but they are not exclusive factors.

Harun December 12, 2012 at 12:41 am

Yes, its much, much easier to place orders with Foxconn then to run your own factories in the US or China.

Ignore wages. Just take into account compliance and regulations. Far easier to import than to produce here. What was Andy Grove’s complaint about California? A billion more to open a plant disregarding labor costs.

Now, Apple could open its own factories. Which would become bribe magnets for China’s officialdom. Foxconn also handle that. What’s not to love?

Maybe the IP protection for smaller players than Apple or the QC. As long as labor’s really cheap even that might look okay. But labor is going up in China and bribes always follow. That may mess with the equation.

Dave December 11, 2012 at 10:57 am

The big assumption is that the skill composition of the East remains constant in the long run, there is no historical justification for this. With more income, individuals in the East will upgrade their skills which only reinforces skill-biased technical change.

DRDR December 11, 2012 at 12:49 pm

Based on what they’ve said in the introduction, they think the short run is about a decade and the long run is three decades and it’s already happened. Skill-upgrading in the East may not be large enough to put a dent in their theory.

Dredd December 11, 2012 at 11:04 am

The use of “offshore” means foreign locations in the geographical sense. But there are issues like “be true to your school” (Beach Boys) and be true to your own nation.

There seems to be a flavor of epigovernment in the economic notions of the paper.

The current nature of epigovernment is not properly disposed toward the long term betterment of citizens of nations.

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