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Tuesday, September 09, 2003

Spectral Imaging

A spectre, it was once said, is haunting Europe. Fastforwarding a little, perhaps it would be more appropriate to say that at the present time there is a spectre haunting the entire OECD. But this spectre - surprise, surprise - is not, at least this time round , a demographic one. It is for all that a no less revolutionary one. The spectre I have in mind has little in common with the obsessions and broodings of the expression's Teutonic creator: except, that is, insofar as the reflections of the former on the demise and plight of the Indian handloom weaver might now justly be deflected towards those who every day seem more likely to become their modern-day equivalent, the run-of-the-mill IT sofware professionals who work in America's great 'valley of opportunity'.

The 'efficient cause' of this current reflection: well Friday's latest round of US employment statistics, with the glaring presence of a total of 67,000 service jobs lost in August, begin to give us the clue, and perhaps Ben Bernanke has given us the name - the job-loss recovery. Now that the US economy is losing jobs in the agricultural and industrial areas would neither be new nor shocking. These sectors - at least in the information age - are assumed to be in decline across the OECD world. That the world's most advanced economy is a net loser of jobs in manufacturing industry is entirely comprehensible - anti-China xenophobia notwithstanding. But, at least according to normal economic theory, what should accompany the historic decline of the industrial and agricultural sectors should be a growth in activity in the relatively higher-value services sector. And it is precisely here that the problem is to be found. As the late Walt Whitman Rostow said: it's all about sectors.

Interestingly enough, recent research by the New York Fed has highlighted the way the characteristics of the job creation process in the recovery phase may be changing, and this may well indicate a long term structural trend, which deserves more analysis in its own right. This may be important since we may well find with the benefit of hindsight that the US has been on this path for longer than we imagine. But today I am going to limit myself to 'efficient' not 'final' causes.

As you will all have probably noted by now, the US press is full of almost daily articles on the 'employment drift' off-shore. And when it isn't wasting it's amunition firing off at the distinctly non-impressionable Chinese, it lets off a salvo in the direction of India. The two cases are in fact quite distinct, since the majority of activity being sourced in China is manufacturing (although this may, as I am noting in the blog, lead to longer term technological issues) while the case in point with India is the displacement of services. (BTW don't miss the irony in all the fuss over the rinban valuation, the Indian rupee is actually floating and going up, from 49 to 45 to the dollar in recent months: see how 'they've all gone quiet over there'). Recognition for identifying this 'services' issue really deserves to be given to Morgan Stanley's Stephen Roach, who has long been flagging the question in connection with the deflation debate and the lack of resilience in US service prices. There is no immunity platform underneath services, as we are now finding out. (Incidentally India is by no means the only provider in the game - a recent Forrester report mentions the Philipinnes, Russia, the Baltic countries, Mexico and Costa Rica - and I personally can add Bulgaria to this list on the basis of my own research). The critical 'intitial condition' which precipitated what may well now be the present point of no-return may well have been the internet boom and the Y2K problem, both of which placed an overload on US (and other OECD) IT capacity and lead to the need to find alternative supply sources. As Forrester's Stephanie Moore says: " for them, Y2K and the Internet was their Trojan horse..........They got into the companies and did a good job." Now the dynamics work the other way round, and the same offshore providers who benefited from the supply shortage of the mid-1990s are providing the cost savings and efficiency that U.S. companies need and can't find at home in the 'slow recovery' of the early 2000's. And the leak hasn't just sprung in IT. According to press reports, companies like San Diego-based Chembridge and New Jersey-based Pharmacopeia show the trend may have started seeping into biotechnology. Chembridge, which does chemistry work for drug companies, employs more than 300 chemists in Russia, another locale where doctoral degree-level professionals are paid a fraction of what they would receive in the United States. Pharmacopeia, the parent company of San Diego-based Accelrys, has information technology operations in Bangalore, India.

(Can I sneak a personal detail here, I am, as I keep mentioning, working a project on Bulgarian immigration in collaboration with anthropologists from the university of Sofia. Staff there earn around 150 euros a month, here in Barcelona university researchers get at least 10 times that amount. Last week I was in Valencia with a young Bulgarian research student - who at this point is even working on a voluntary basis, amor del arte, as they say. But the interesting point is that as an ethnographer he works much better than I do. The quality of information he was able to extract was much better than I could have gotten alone. The trouble is all the material is in Bulgarian. No problem, he said, we can send it back home and they will do the translations, real cheap. Not only this, anyone who has ever done qualitative reasearch knows that the real drag is typing-up the transcripts, well he said, we could also have that done there. The only important difference in attitude that I noticed was that the high cost of buying books makes it difficult to be on the sharp-end of knowledge. However an afternoon of in-service-training over at my place means that he is now reading Strogatz-Watts-Cavalli Sforza and has learnt to move much better in the internet (where most of this is free). You see, I said, the important principal here is play. Ah, 'homo ludens' he replied. You know Huizinga, I said surprised. Yassen is 23, the same age as my own son, who sure as hell doesn't know Huizinga, yet. I doubt many of my colleagues at work do either. Bottom line: the intellectual distance between the relatively poor and the relatively rich economies is not as great as it seems, and the distance is much more easily closed in the information age than it was in the industrial one. Forgive my self-indulgence).

This services outsourcing trend is not only evident in the private sector. The US government-funded San Diego Workforce Partnership, which ironically provides training to local residents and helps them find work, reputedly hired computer engineers in India to finish a data management project. In fact they paid more than $200,000 to Karna Global Technologies for engineers in India to re-write one of the organization's computer programs. Larry Fitch, chief executive of the Workforce Partnership, was quoted as saying that the organization generally hires domestic companies, but Karna was hired when the original contractor from Orange County suddenly folded.

What started off in many cases as a low-end routine-based operation, may in fact now be moving upwards. Intel for example which has invested $2.3 billion in its Malaysian operations, and which has always included some R&D in this work, now plans to build a new $80 million R&D facility there. Or try Yahoo, who have denied reports of a new R&D facility in Bangalore by insisting that the 150-person R&D facility has been around since 1996 and that the recent "news" merely refers to a reinauguration of the existing facility. A view which is not shared by India's Rediff.co which in reporting the same story quotes Yahoo's chief executive in India Venkat Panchapakesan as saying that the R&D facility will indeed hire more people soon. "We will have about 150 professionals at the center by the end of 2004. These will be new jobs created to outsource our global requirements". In fact the relative importance of the phenomenon in India can be appreciated by the fact that Rediff have a special page dedicated to the question of business services outsourcing.

How to make sense of all this, that is the question. The first point that comes to mind is that history, apparently, is not kind to its beneficiaries: it is, one might rather say, bitter sweet. The root of the 'evil' here is not money, but globalisation. Now don't get me wrong, this is not just another one of those standard anti-globalisation tirades. I am a globaliser at heart. But then I am also interested in the economic welfare of all the population of this fine planet. What seems clear to me is that, while there are many pros and cons on either side, the developed world did have something of a natural advantage when it came to the globalisation of industrial products. The third world also needed industrial globalisation, since it needed both capital and technology. But, at the same time, this was an area in which, by moving up the value chain, the 'incumbents' could always keep ahead of the pack. In the knowledge economy, as we can now see, things may not be so simple.

One of the reasons why this may be the case is the question of set-up costs. The cathedral of the industrial age was the factory, and the factory implied a high fixed-costs entrance fee. Today the situation is very different. According to economic historian Joel Mokyr:

"the 'factory' as a system is in retreat not only as a physical central location of activity, but also as a time-organising institution in which work begins and ends at given times and the lines bewteen labour and leisure are firmly drawn. Instead, work is dispersed over space as well as time, allowing workers to calibrate their trade-offs to reflect their preferences.............For services, a similar phenomenon is increasingly visible on the horizon. The twentieth century witnessed the virtual demise of the household-sized mom-and-pop corner stores, replaced by large scale department and speciality stores. The trend towards e-tailing may well encounter some teething problems, but if it continues, little in the industry besides warehouses and shipping cannot be outsourced to independent agents or assigned to employees working from their homes. The same holds true for banks, law firms, insurance companies, and higher education."
(The Gifts of Athena, pages 153/157: the whole of chapter 4 Technology and the Factory system is thoroughly recommended).

Two problems then, kept the developing countries at a distance during the industrial age, the cost of entry (and the lack of capital), and the absence of the adequately trained work-teams. In the knowledge economy things are a little different. Look, for example at Google and the low tech use of PC's in parrallel, or the rise of blogging, or home-made video clips, or the uses of grid-computing. Entry costs are not what they used to be, and a little strategic capital goes a long way. Also the labour force difference is nowhere near what it was. Maybe there is still a difference between the Indian IT or accountancy graduate and the US one, but it is nothing like the difference you can find in the comparative wages. The difference is also more transparent, and hence more easily closed, than it was in the days of machine manufacture. There is tacit knowledge, but it may well be less, and it may be more easily learnt. It seems a three to five year stay in Silicon valley on a temporary contract may work wonders in this context.

Which brings me to my principal point. On 10 Sptember in Cancun the next session of the Doha round will begin. High on the agenda will be what is known as the General Agreement on Trade in Services (GATS), and central to this negotiation will be the question of of what is known as mode 4 sevices delivery: the temporary movement of natural persons (mode 1 is the delivery of the service from one country to another, cross-border supply, mode 2 is the use by a company in one country of a service in another, consumption abroad, mode 3 is the setting up of a branch or subsidiary to deliver the service, commercial presence). Already (3 September) modalities have been established to prioritise the special treatment of LDC's in these negotiations. These modalities were welcomed by Dr Toufiq Ali, Ambassador of Bangladesh, speaking on behalf of the 30 LDC Members of the WTO, at the Special Session of the Council for Trade in Services.
There are numerous estimates that indicate that the potential benefit of free trade in services may be several times that of free trade in goods..........the most important means of supplying services is through the export of services supplied by less skilled persons...........a temporary visa scheme that amounts to no more than 3 per cent of the OECD labour force would yield economic benefits for both developed and developing countries equivalent to almost US$150-200 billion.

Now the numbers referred to here were developed by Alan Winters of the University of Sussex (see 3 and 4 below), and they constitute in themselves a fairly dramatic example of how one tiny little meme can go a very very long way. In fact the call for liberalising the movement of natural persons has been taken up this week by the World Bank in its Global Economic Outlook and is also under active consideration at the OECD (see 5 below). So in some ways the 'more developed countries' (ie the OECD) are actually hoist on their own petard here. Unwilling for cultural reasons to accept third world immigrants on a legal basis to address the growing demographic shortfall, they have collectively indicated a willingness to accept temporary migrant labour. From the third world point of view this may well be a preferable alternative. Here it is necessary, I feel, to distinguish two classes of migrant worker, the skilled and the unskilled. In the case of the unskilled, the situation is not very different than that - in muanufacturing - of the direct cross-border import of the finished product. The service is simply provided in-situ by the citizen of a foreign state.

As Alan Winters puts it:

Unlike with the mass migration of less skilled workers, fears for cultural identity, problems of assimilation and the drain on the public purse are hardly relevant to TMNP. The biggest concern it raises is its competitive challenge to local less skilled workers. This is neither more nor less than the challenge posed to such workers by imports of labour intensive goods from developing countries, which has been overcome by the weight of economic gain that trade could deliver and by policies to ease adjustment among local less skilled workers in developed countries. Applied with the same sensitivity and the same sorts of policies as trade policy reform in goods has received in the past, the temporary movement of less skilled workers between countries would offer the chance to reap some very large gains from trade.

The arrival of these workers inevitably exerts downward pressure on wages in the unskilled sector (a point that is normally made forcefully by US economist George Borjas before the US Congress whenever a hearing on immigration provides him with the opportunity so to do). But these same cost reductions make things cheaper for the majority of middle-income consumers by facilitating the provision of any number of otherwise unthinkable services (like the proverbial taking the dog for a walk). They also, in a growing economy facilitate the possibility of low inflation rapid growth. From the third world point of view, they reduce pressure in the local labour market and they help the balance of payments due to the remmitances home of the migrant workers (which again are a reality, as I know only too well from my own research: it is estimated that during the first years around one third of wages earned are sent home). BTW, again both the inflow of low-skilled worker, and the outflow of mode 1 outsourcing will contibute to the generally deflationary environment inside the US as the 'sevices immunity' gradually factor falls apart.

At the other end of the scale are the skilled temporary workers, and it is here I think, more than anywhere, that our difficulties in accepting the arrival of those from other countries have lead us - in the west - to shoot ourselves in the foot (Again a disclaimer. I am not especially upset by this, the world is an unjust and unequal place, and anything which helps to 'even the odds' is fine by me. What I am pointing to is the fact that this is the unintended consequence of a selfish act). For temporary high-skill contracts are the perfect, learning-by-doing, training scenario. If this were the old Russia you would probably have to pay a great deal of money to bribe your way out having learnt what you had learnt, and we 'send them back' (xenophobism has always seemed a perverse phenomenon to me). So really here we are in the middle of one of those typical non-linear, up-side/down-side swings produced by what many consider to be the most 'effective monetary policy in history'. And meanwhile - with our central bankers carefully targeting short-term inflation rates as the 'clavis universalis' for economic policy - we have been through an enormous assest boom-bust cycle, a cycle which seems to have carried as one of its side effects the 'freeing' of parts of the third world from their one-sided dependence on us. For as we went up in the cycle we sucked them in, during the ride we trained them up, and now on the way down we have told them to pack their bags and leave for home. Advice which they have meticulously followed to the letter whilst taking part of the business back with them!

That this lesson has not entirely gone unlearnt is shown by the conclusions drawn by Armind Virmani of the Indian Council for Research on International Economic Relations in yasterday's Indian Financial Express

The USA activated the GATS when it perceived that its comparative advantage was shifting from manufacturing to services. At that time the USA and other OECD countries opened up their service sector to cross-border imports (Mode 1), while we had some justification for taking a cautious approach to an area in which the rich countries appeared to have an increasing comparative advantage. More by accident than by design our position has been completely transformed since then. At the beginning of the 21st century, India is poised to become the largest developing country exporter of Service in the World by the end of the decade. What is needed is a change in our mind set, by transiting from a defensive to an activist posture. We must lock-in 'free trade in services' under mode 1, against the emerging threat from the new protectionists in the rich countries, the 'unions of white collar workers'.

This also requires that we be more forthcoming with respect to opening sectors in mode 1 where we have been excessively defensive. We must trade in greater access for FDI from the rich countries under mode 3 against clear and transparent rules for 'temporary migration' of skilled and semi-skilled personnel from India to these countries under mode 4. The focus of the latter (mode 4) must be on facilitation of cross-border export of services under mode 4, not on the export of labour per say.

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