I see so many jobs being sent overseas. How can we bring them back?
First, let's talk a bit about personal observation. I hear a lot of people talk about how they see so many jobs being shipped overseas and none being shipped back. Well, personal observation in this case, as in many economic topics, is absolutely worthless. When we use personal observation, we "can't see the forest from the trees". When it comes to outsourcing, there's a good reason for this.
We send a lot of jobs overseas, that's true, but a lot of jobs are sent back. The vast majority of people who witness jobs being sent overseas live in highly populated manufacturing centers like Detroit and Chicago. Well, these highly populated areas are also pockets of inflation - the cost of living in New York City and Los Angeles is much higher than in Kearney, Nebraska. So, when companies from overseas are opening manufacturing plants in the US, they're not going to spend all that extra money to open it in the same places where othe companies are sending jobs out. What kind of sense would that make? Instead, they're going to create jobs where they're cheapest, like anyone else. That why Toyota opened a plant near Princeton Indiana, rather than Detroit Michigan. Princeton Indiana, before the plant, had a population of just a few hundred people. Now it's a quickly growing industrial and commercial area.
This is the same process that drives capital flight and brain drain out of cities. Operating expenses in the cities increases too much, and it becomes worth it for companies (and individuals) to relocate to lower-priced areas in suburban or rural areas. This drives something called urban sprawl. If cities can't effectively stem the outward flow of capital and skilled labor, then their tax-base is eliminated and they can no longer afford the upkeep on the infrastructure. This is a state called urban decay - recognizable by delapidation of buildings, roads, and more. Once this decay starts to make entire districts unusable, you now have a state called blight.
This is actually occurring in Omaha, right now, thanks to incompetent city planning. A comprehensive study recently showed that Omaha's westward growth is increasing costs faster than our economy is growing. The reason for this is that this westward growth is very much driven by a desire to live in low-population density areas. Well, when you have low population density, you have fewer people paying for the upkeep of an equivalent cost per mile of infrastructure. That's why successful cities grow up, instead of out. This is a very large part of why Detroit failed. Right now the recommendation being asserted by the mayor of Detroit, and the state's emergency financial manager, is to relocate the remaining population (Detroit isn't technically a city anymore, with fewer than 1 million people) toward the downtown area, then completely raze the outer districts of the city to create farmland. Right now the proposal made for Omaha is to set property taxes as an inverse proportion of population density - if you live in a lower-density area, you pay higher taxes.
The point is this: Don't rely on what you see. Personal observation is flawed. If you live in a city, as the majority of people on the planet do, then you're going to see outward movement, but that's it - you won't notice the low-population areas growing, because you don't live there. That's why in economics we rely on proper research and data analysis. Treat this class as a research class - not a personal observation class. I honestly don't care what you think - tell me what you know. Go look up the data from the Bureau of Economic Analysis, from the Department of Labor, from the US Treasury, from the Federal Reserve, or other sources of original data. Don't rely on the word of politicians, journalists, or other secondary information sources that have been filtered - they'll lie to you, and their observation is no better than anyone else's.
That being said, outsourcing isn't a bad thing. It's all in the nature of competitive and comparative advantage. There is a lot of misconception regarding the role of outsourcing. Let's take a look at where trade comes from. Look at the tables below.
w/out Trade Beer Pizza
US 5 10
CHINA 15 10
Totals 20 20
w/ Trade Beer Pizza
US 0 20
CHINA 30 0
Totals 30 20
Each nation allocates its factors of production (land, labor, capital, and entrepreneurship) in such a way that they can produce goods. Each nation cannot produce as much of everything as they want, they are limited by scarcity. So, they must choose which goods to produce. Say, for example, each nation must choose between producing beer and pizza. They can allocate all their resources to producing beer, they can allocate all of them to producing pizza, or they can choose some combination of the two. The range of possible combinations of production given a set amount volume of resources is called the production possibilities curve.
Each nation can produce less than their maximum potential, which would fall inside the curve, but they cannot produce beyond the bounds of the curve by themselves. When a nation is producing the maximum volume of any combination of beer and pizza, the dot falls on the curve, called the efficient frontier. At that point, a nation must give up production of one thing in order to allocate any more resources at all to the production of the other. In other words, if a nation wants to produce even 1 more pizza, they must give up production of beer in order to free-up the resources. The state in which an organization is utilizing their resources so efficiently that they must give up some of one thing to produce another is a state called Pareto Efficiency.
Ok, back to the point. Notice in the tables from earlier that China is simply able to produce more of everything. That's called having an absolute advantage, and this is a temporary state that cannot be sustained indefinitely. China's absolute advantage comes from its massive population, driving wages down but maintaining massive production potential. The problem with this is that its inefficient. We'll look at why in a moment.
Comparative advantage is a state wherein two nations are trading based on their ability to produce something more efficiently than the other nation. Notice in the tables that the US has a comparative advantage in pizza, because they only have to give up beer at a 1/2 ratio (allocating the resources away from 1 beer produces 2 pizzas). On the other hand, China's comparative advantage lies in beer, having a 2/3 ratio opportunity cost in pizza.
So, when one nation attempts to produce everything on their own, they must allocate resources away from those things they produce most efficiently in order to produce those things it needs but are not quite as good at making. This causes an increase in the factors of production being consumed to meet demand, thereby raising prices and driving down competitive advantage in the international trade markets.
From the US's perspective, trade with China is like a big discount coupon for whatever we want. We buy up stuff more cheaply than we could otherwise produce it ourselves, then use those goods to improve our own production potential. Think of it like an investment - if you wanted to purchase a machine that could produce 10,000 units, you could generate greater returns on investment by purchasing it for $100 than you could purchasing it for $1,000. From China's perspective this is also an investment. They send us stuff that's useful, and in return we give them currency. China wouldn't give us anything for our money unless they thought they could use it later on. In the meantime, China's prices and wages are increasing dramatically during the same period that the US's are stagnant. They are also looking at the world's largest influx of people entering retirement age, which will further increase prices. They know it, and they've been trying to modernize as quickly as possible. In 2008 a lot of Americans lost their jobs, but even more Chinese lost their jobs. Not due to a down economy, but due to labor being replaced with capital - technology. They're losing this race, but they have something else now: the second largest reserve of US currency in the world (second only to the US itself).
So, trading on absolute advantage is inefficient and it's not sustainable. The top table shows production potential without trade, which illustrates the inefficiencies of absolute advantage.
Comparative advantage, on the other hand, means that each nation allocates resources only to the things they are good at producing, and then trade with each other. As China's prices increase, and our remain stagnant, the two nations will start to trade on comparative advantages rather than absolute. In the meantime, our production potential has increased as the result of acquiring so much cheap capital, while they have invested in a huge amount of currency that they can then use to purchase the things we make. We're already starting to see it; China posted its first trade deficit in years this year, and US exports have been steadily increasing. Chinese automotive plants are starting to open factories in the US too; there's a bus plant being opened in California soon.
As two nations trade on comparative advantage, that each nation is producing something different utilizing the most efficient allocation of resources to both, average prices will equalize. This process is call factor price equalization, because the factors of production utilized to produce beer in one nation is the same as the other nation, since only one nation is producing beer. The other is producing pizza, and they trade together.
In the process of outsourcing and trading (the two are one and the same, really), some peopel lose their jobs. That's true, and it can suck. These are growing pains, though. They are necessary for growth. Just as the invention of the digital camera put film developers out of a job, so too can trade. To try and protect every job, though, would decimate our economy. It's been attempted before - North Korea, USSR, Cuba, Iran, Australia, and even the US. It's always ended disasterously. Protectionism drives inefficiencies which, in the long-run, will slow growth, slow technological development, cause price increases, wage decreases, and eventually massive shortages. On top of that, and let's be honest here, everyone thinks their own job is most important. When everyone's job is most important, no one's is, and to think otherwise is simply ego.
So where does comparative advantage come from? It comes from the collective competitive advantages of individual companies. Competitive advantage and comparative advantage are the same thing from different perspectives - micro and macro, respectively. When an individual company can produce the most value using the fewest factors of production, they will remain highly competitive. Rather than attempting to produce everything yourself, you go to the store and simply buy those things when you can get the most value from them. Rather than producing your own food and clothes and housing and tools and everything else, you buy most of this now and focus on doing just what you're good at. This is called specialization of labor, where you do only 1 job and you produce more of it than you need, then trade for the other stuff you need. Starting to sound familiar?
Specialization of labor allows us to generate gains from trade. We can produce more by working together and becoming specialized in our own jobs than we can trying to produce everything we need on our own. Across a single nation we begin to see trends in what people are good at, and what companies are good at, and that generates a national comparative advantage. As a result, "Buy American" is fundamentally no different than "Buy Nebraska", or "Buy Omaha", or "Buy Dodge rd.". It's all artificial constructs that put restrictions on trade resulting in inefficiencies and economic harm.
When you think about trade, remember that trade is not some abstract concept. It happens all the time right here in Omaha, as people in Omaha trade with each other. People in Nebraska trade with each other. Buying something from China is no different than buying something from Georgia. If you want to stay competitive, you'll go where you can find factors of production most cheaply, and you'll produce as much value as you can to generate returns on investment.
As our economy improves and China starts using their huge reserve of US dollars to fund purchases of American Made goods, remember that this was only possible because of the growing pains we experienced to get to that point.