Long-term unemployment soars

The Wall St. Journal links to a scary chart at George Mason University’s Mercatus Center.

Veronique de Rugy explains the chart.

[...] According to seasonally adjusted data from the Bureau of Labor Statistics, last month, over 44.1% of unemployed workers (6.5 million workers) had been unemployed for 27 weeks or more; at the start of 2008, 18.3% of unemployed workers fell into this category. Importantly, these measures of unemployment exclude workers who want employment but were, for various reasons, not included in BLS’s unemployment calculations – an estimated 5.8 million workers [...]

Consider also the rate of underemployment.

Over 40% of Americans have lost their careers. Half of these dispossessed citizens have no prospect for future employment.

Yet, it’s easy to find empirically blind, faith-based economic assessments like this from Georg Riesman.

Contrary to the negative associations it has, outsourcing serves to reduce the prices that Americans pay by more than it reduces their incomes. In fact, on overall, net balance, under today’s monetary conditions, it does not even reduce the money income of the average American worker at all, while it does reduce the cost of production and price of some of the things that he buys. The reason for these results is that the reduction in cost of production, and ultimately in the price of a service that is outsourced, corresponds to the extent to which the relevant wage rates in India, or wherever else, are lower than those in the United States. At the same time, however, the fall in income of the American workers whose jobs have been outsourced is much less than this, and in the economic system as a whole, a fall in income is non-existent.

Reisman goes on to argue,

Thus, for example, assume that workers who provide telephone support to software buyers or credit-card holders must be paid $15 per hour in the United States, while comparably good workers can be employed in India at $1 per hour. The cost saving will probably not be as great as a reduction to one-fifteenth of its original amount, because now there is the cost of setting up and maintaining a longer-distance and probably more elaborate communications network. So let’s say that when allowance is made for this additional cost, the cost works out to be the equivalent of Indian workers having to be paid $1.50 per hour. Thus the cost is ten percent of what it was.

Now when there are cost reductions, competition operates sooner or later to bring about corresponding price reductions, just as when there are cost increases there will sooner or later be corresponding price increases. To the extent that the cost of producing something is reduced by ninety percent, the corresponding part of its price will also tend to be reduced by ninety percent.

At this point, we must ask why the American workers who had been earning $15 per hour do not meet the competition of the Indian workers and retain their jobs by agreeing to work for just under $1.50 per hour. To ask the question is to answer it. There is no thought of meeting the competition of the Indian workers in this way because the alternatives available to the American workers while perhaps significantly less than $15 per hour are still far, far in excess of $1.50 per hour—say, $10 or $12 per hour.

Thus here we have a case in which the cost of production, and ultimately the price of something that Americans will pay, falls by ninety percent, while the wages of the affected workers fall by much less: twenty percent or thirty-three and a third percent.

And here we see the error. Cost inputs in India do not determine the real price of a good in the US. This is a surprising oversight by Riesman, because it’s is an application of the erroneous surplus labor theory of value.

It is not true that a ninety percent lower supplier input-price implies a ninety percent lower consumer price! Just because someone can buy something for less doesn’t mean they will sell it for less. Riesman must surely know it. To make his claim is to ignore the most basic facts of the free-market supply and demand model. It doesn’t get more basic than that.

This is the kind of muddled thinking one encounters among faith-based economists. Everything is consistent, the arguments are relevant and interesting – until we reach the question of outsourcing. Then, it’s all fallacy and obfuscation.

That’s the logical counter-argument, but there’s an empirical one too. Fact: real wages fall and stagnate. Fact: real prices don’t fall in response to imports. This chart shows that real wages and real prices track one another over time.

Real wages have declined. Real prices track wages.

How can this be? It’s obvious, once you see it. Currency values act as a third equilibria with the supply and demand of goods. It creates the opportunity for arbitrage instead of trade.

Our hypothetical call center capitalist, call him Joe Shmoe, outsources to India as an act of arbitrage not an act of trade. Joe hopes to increase the bid-ask spread for his services and thereby increase his profits. He buys labor where it is cheap relative to the US dollar. Each dollar will buy more in the Indian economy than the rupee will buy in the US economy. This fact is neither a result nor a cause of imbalances in supply or demand. Hence, it is not entrepreneurial activity strictly defined. Labor arbitrage is a result of fiat currency values.

Governments set the values of their currency to manage the rate and degree of both trade and arbitrage. This is the economic theory of Monetarism. It is a liberal trade philosophy, but it is not a free trade philosophy.

Who benefits from currency-based labor arbitrage? Owners of capital benefit; they get the larger bid-ask spread. The Indian call center workers benefit; they get jobs at US$1.50. Do US workers benefit? Reisman says they get lower prices. I have shown that claim is false. Prices have not fallen relative to wages, even with massive import and outsourcing levels.

Gomory and Baumol explain further,

Right. Suppose you make a good in the U.S. Why would you lose it to overseas? Because somebody outside can make it more cheaply. True, consumers are coming out ahead in that one industry. But they’re paying a price somewhere else. The goods they always imported get more expensive.

Outsourcing is labor arbitrage not trade. It should be analyzed as absolute advantage not comparative advantage. Outsourcing involves multiple equilibria and requires a more thoroughgoing logical analysis. Outsourcing, unlike trade, does not necessarily benefit everyone. It can profit owners of capital and workers in foreign countries, at the expense of US workers.

That’s why we have insanely high long-term unemployment. That’s why we must end crony capitalism. That’s why we must create real free markets.