Atanu Dey On India's Development

Outsourcing and Comparative Advantage

Are you as tired of reading the next article on the out-sourcing of white-collar jobs from the US to India as I am? If not, here is one by Katharine Mieszkowski in called “Gone in the blink of an eye”.

A couple of UC Berkeley economists, Ashok Bardhan and Cynthia Kroll, estimate that 14 million white-collar jobs are at risk of being outsourced, or about 11 percent of the total, by 2015.

I find nothing surprising about that. Consider the structural transformation of any economy. First, you have 100% of the labor in agriculture and you have a subsistence economy. Somehow agricultural productivity increases. Labor gets released from agriculture and moves to manufacturing. With time, the share of labor in agriculture declines, and share of labor in manufacturing increases. With manufacturing producitivity increase, that sector also releases labor so that the services sector grows in the labor share. Finally, agriculture and manufacturing share of labor reach very low numbers and the rest of the labor force is in the services sector.

The US had 40% of its labor in agriculture in 1900. A hundred years later, that number is only 2%. With time manufacturing will also shrink to about 5% of labor. Then the US economy will have 90% of its labor in services.

In a world where trade is possible, the old story of comparative advantage continues to hold. So tradeable services — such as BPO, programming, research, etc — will migrate to countries which have a comparative advantage in providing them.

The US does not have a comparative advantage in those services which are tradeable; India has. The good news is that India has a comparative advantage in those BPO and programming services; the bad news is that India does not have an absolute advantage in those services. We have a comparative advantage only because the average productivity of India is so abyssmally low. Low average productivity translates into low average wages. So programming wages and other wages are low in India. Therefore, if on average the productivity of Indian programmers is somewhat comparable to the productivity of US programmers, then India can potentially enjoy a comparative advantage in programming (and it does.)

Here is a related report form the NY Times of November 7th The Great Job Machine by Cox and Alm which talks about the structural change in the US economy.

A century ago, 40 of every 100 Americans worked on farms to feed a nation of 90 million. Today, after one of history’s most brutal down-sizings, it takes just two agricultural workers out of 100 workers to supply an abundance of food to a nation more than three times as large.

Likewise, the telecommunications industry employed 421,000 switchboard operators in 1970, when Americans made 9.8 billion long-distance calls. Thanks to advances in switching technology, telecommunications companies have reduced the number of operators to 78,000, but consumers ring up 98 billion calls.

…during the past decade total United States employment has risen to 130 million from 91 million since 1980, a net gain of nearly 40 million jobs. Productivity, measured by output per worker, increased a staggering 56.2 percent.

To the question of what is wrong with the US economy with regard to the ‘jobless recovery’, they answer, “Nothing.” I agree with them. There is a shift in the pattern of production. The services sector is not a monolithic entity. Different parts of it are tradeable and thus have the same dynamics as other tradeables such as cars and TV or steel. Just like the manufacture of cars shifted to Japan and then Korea, so also some services will shift to India and China and Russia.

It is as inevitable as the change of seasons. But as Robert Frost asked

When was is it to the heart of a man
Ever less than a treason
The change of a love or a season?

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