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Volume 24, Number 6
June 2004

Government Fuels the Drive to Outsource
By Ivan Pongracic, Sr.

Outsourcing, offshoring, what- ever the name, has become a hot issue in this election year. (As I write these lines, the government has announced that 2,400,000 manufacturing jobs have disappeared in the last three years, currently leaving more than 9,000,000 Americans without jobs.)

Blaming free trade for the present predicament of so many workers is misplaced. But who should be blamed? The American politicians have themselves to blame for most of the job losses we have seen over the last several years. The simple fact is, our politicians continue to engage in something Ludwig von Mises used to call "interventionism." He defined interventionism as the government’s attempts to correct some perceived market failing through its own power of coercion. Good intentions may be behind interventionism, but, as the saying goes, "the road to hell is paved with good intentions." 

As Mises never tired of emphasizing, inevitably, government coercion leads to unexpected and unintended consequences that often create a situation worse than the one the government was trying to fix. This "surprising result" usually prompts further interventions intended to fix the new problems, which of course lead to some other unexpected and unintended consequences, once again creating a worse outcome. One round of interventions follows another until the original situation is long forgotten, and the current undesirable state of affairs is blamed on market forces, though it was not created by the "market" but exclusively by the intervening politicians.

This interventionist dynamic can these days be seen in the labor markets, especially in relation to two issues: high nominal wages and regulations. Both forms of interventions have led to job losses, a fact not recognized by often economically ignorant politicians.

It is politicians that are destroying any comparative advantage that American workers used to have.

Let us first take a look at myriad laws directly or indirectly affecting wages and salaries in the US. The government can impact wages directly through minimum wage laws, or indirectly through mandated benefits like paid vacation, health care, unemployment insurance, and many other programs. These interventions are sometimes justified by "class warfare" claims that higher wages would come from the excessive profits of the capitalists, and at other times by the Keynesian macroeconomic policies of providing market "stimulus."

One way or another, politicians expect that the ultimate consequence of these interventions would be an increased standard of living for the American people. What they fail to understand is that they can only raise nominal wages and salaries, i.e., the amount of money that a person receives for the work done. The real pay, consisting of the actual purchasing power, is mostly beyond their control.

To better understand the relationship between nominal and real wages consider 1920s Germany and early 1990s Yugoslavia, where rampant hyperinflation (defined as extremely high rates of inflation or general rise in prices) resulted in some people being paid in billions, but able to purchase very little for their money. Hyperinflation, always and everywhere the result of the governmental monetary policies, in both cases created poor—very poor—billionaires. The reason for this is simple: every time prices rise faster than wages, people get poorer.

For example, imagine a country in which all nominal wages are rising by 5 percent annually, while prices are rising by 6 percent, and compare it to a country in which all nominal wages remain exactly the same, while the prices are decreasing by 1 percent. It is obvious that the workers are better off in the latter case, where nominal wages are not changing, but real wages are increasing.

What most people fail to understand is the fact that more money, and higher nominal wages and salaries alone, does not necessarily mean a higher standard of living. Higher nominal pay may temporarily increase the standard of living, for as long as the prices are dormant. But, and this is the key point, if they are soon followed by higher prices, the standard of living goes down, with one bad consequence left: making American workers less capable to compete with other countries where the wages had not been raised. The conclusion: these temporary, higher wages can in fact be the very source of future job destruction.

This is the point we want to emphasize without trying to be too technical. There is a world of difference between nominal and real wages. Nominal wages ultimately don’t matter much to one’s well-being. What matters is the real power to buy goods and services, and that power depends on many micro and macro events in the market, most notably government’s monetary and fiscal policies.

The purchasing power of the nominal wage depends on the level of prices and the level of prices depends on the amount of money circulating in the economy, as Mises and many others explained many years ago. Further, the level of prices also depends on the entrepreneurial spirit of employers, the productivity of the workers, the level of capital goods the workers are using (and their skills in using those capital goods), the prices of natural resources, as well as government economic policies, especially regulations. (More about regulations shortly.)

How can higher nominal wages lead to job destruction? Well, workers who are paid, let’s say, $3,000 a month (in some cases even much more), must all of a sudden compete with those who are paid $600 a month. Many a company finds this too tempting and moves a lot of jobs to a lower-cost country, destroying in the process "well-paid jobs," and people who depended on those jobs.

If the labor markets were left alone, the natural tendency would be for the greater innovation and increased labor productivity resulting from free competition to bring about generally lower prices. Increased production, by increasing the number and quality of substitutes, sooner or later creates a more elastic demand for goods, which forces producers to offer lower prices to continue to attract customers. Though obviously welcomed by consumers, the general lowering of prices is greatly feared by all governments. According to the "gospel" of John Maynard Keynes, lower general prices, or deflation, lead to all kinds of economic problems, most significantly a recession, or even a depression.

It is obvious that in unhampered labor markets, wages (at least for some occupations) would be lowered as a result of free competition. Changing demand conditions and technical advances make some occupations obsolete. The workers in those sectors either have to re-educate themselves to be able to perform different tasks, or become unemployable at a certain wage level. Market dynamics force nearly everyone to readjust from time to time—few are spared these painful changes.

But refusing to carry out this readjustment by using government coercion only creates opportunities for the foreign workers willing to work for much less then their American counterparts. When American companies calculate their costs, they are concerned only with nominal wages. They don’t care about the purchasing power of a dollar in China. They simply calculate the output per dollar in China compared to the output per dollar in the United States. And in this calculation, Chinese workers have been increasingly beating American workers.

If the American government had not artificially raised nominal wages, American workers could have still been competitive in many areas in which they no longer are. But with the nominal wages being 10 or 20 times higher than in China, India, South Korea, South Africa, or dozens of other countries all over the world, American labor’s prospects are bleak. On one hand, those who keep their jobs often cannot support their families with the pay they receive. On the other hand, they are constantly in danger of losing even such low-paying jobs. With wages growing, even without outsourcing, the companies find it profitable to invest in labor-saving technology, hire temporary workers, or find some other way to "cut costs," a nice euphemism for laying off workers.

The other major reason for the recent job loss in America is regulations. Today the cost of regulation is approaching $1 trillion, and still most of us continue to go on with our daily jobs unperturbed. Very few Americans understand how much $1 trillion is. Here is a good way to think about it: counting $1 a second, it would take more than 32,000 years to count $1 trillion.

To understand this gigantic cost of regulations, we need only to take a look at the Federal Registry, a book which lists all the federal laws and regulations. In 1950, it consisted of 9,500 pages; in 1970 it grew to 20,000 pages; in 1990 it went up to 50,000; and finally, in 2003 it contained a stunning 75,000 pages.

Regulations incur several different types of costs:  the cost of creating the regulations (a political process in the case of laws, and an administrative process in the case of regulations), the cost of publishing the books that contain them (hundreds of thousands of copies so that we all may be able to access it, since ignoratio iuris non nocet [in English, "the ignorance of the law is no excuse"]), and finally, in enforcing the laws and regulations (thousands of government agencies employ hundreds of thousands of people whose jobs consist of seeing to it that we live by those regulations).

And let’s not forget the costs incurred by firms in complying with regulations: hiring lawyers that can read and make sense of the regulations and explaining them to those in charge, the labor costs of filling out thousands of forms and ensuring that forms are filed in proper ways with appropriate agencies, etc. And, of course, in addition to the federal regulations, businesses are also subject to state and municipal regulations, which add significantly to the total cost of regulations.

Many of these regulations may have been created with the best of intentions, but Mises’s theory of the dynamics of interventionism dictates that they will inevitably create undesirable, unintended consequences. In this case, those consequences are the destruction of American jobs. Regulations sometimes actually forbid potentially productive economic activities, and the jobs that would have existed in the absence of regulations never materialize. Other times, regulations will simply raise the costs of production. Companies must follow procedures and fill out forms, for which they may have to hire some people.

At first glance, it would appear that the regulations decrease unemployment, by creating demand for workers who can perform these tasks. But, by being forced to hire these people, companies will have to bear a higher cost while producing the same output as before. These workers are ultimately unproductive and wasteful, not adding anything to the total production but still increasing the cost. If businesses are facing relatively inelastic demand for their goods, they will raise the prices, forcing the consumers to bear the burden of higher costs. As explained above, these higher prices will lower the real wages of the workers, making them worse off.

This is a classic example of, in Frédéric Bastiat’s famous words, the difference between what is seen and what is not seen. People easily see the few jobs that are added as a result of the regulations, but they do not easily see all the jobs that are lost because workers will make lower real wages. These lower real wages will bring about lower incomes, resulting in less demand for the goods and services, and ultimately less employment by the businesses producing those goods and services.

The important thing to understand here is that regulations reduce labor productivity. They always create waste, both of labor and capital. (During this year’s meeting at Davos, Switzerland, about 1,400 business leaders from around the world put the government regulators as the biggest threat to their companies. Global terrorism, by the way, took the sixth place in assessing the usual threats to their businesses.)

The politicians anxious to do something should be aware of the law of unintended consequences. Add to the above examples complicated tax laws, increasing health care costs, a failed educational system producing diplomas instead of skills, and the picture is complete. American companies will opt for the greener pasture of less regulated, cheaper markets in Asia, Eastern Europe, and any other country in which governments decide to stay away from intervening in the markets.

In order to survive in the global economy many companies must move to a more hospitable environment. Companies that want to make profits must offer lower prices, and lower prices can only come from lower costs. Although lower costs may come from innovations and higher productivity, often they must come from cheaper labor or fewer regulations. The countries that offer one of those, or even both, advantages win in the global economy.

Intent on cutting costs, businesses outsource a lot of functions—employee compensation and benefits, accounting, customer complaints—to those countries in which they can achieve the same results with much lower cost. Those are the facts, and they have nothing to do with greed, and everything to do with discovering how to serve the customer cheaper and better.

American workers must realize that government interventions cannot help. In a globalized economy, the government’s "help" will only produce a ticking time-bomb. The American politicians and workers can continue to blame "free trade" and "greed" and whatever else they wish for their predicament, but the real culprit for the loss of jobs in America is still the government, its short-term-oriented economic policies, and its complete lack of economic understanding.

Ivan Pongracic ic, Sr. teaches at Indiana Wesleyan University (Ivan.Pongracic@ indwes.edu).

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