(07/03/05) Three Billion New Capitalists reviews in the New York Times
Consider the Outsource
New York Times (NY)
Copyright (c) 2005 The New York Times. All rights reserved.
July 3, 2005

Consider the Outsource
Henry Blodget

THREE BILLION NEW CAPITALISTS
The Great Shift of Wealth and Power to the East.
By Clyde Prestowitz.
321 pp. Basic Books. $26.95.

If you've managed to ignore the alarm bells on the outlook for American economic leadership -- and you enjoy dreaming -- don't read Clyde Prestowitz's "Three Billion New Capitalists: The Great Shift of Wealth and Power to the East." It argues that the United States faces such serious fiscal and competitive challenges that we may be headed not only for a declining standard of living but for a 1930's-style depression with a capital D.

Here's the story. In the golden age, 1950-73, we had it all -- low-cost manufacturing, rising wages, technological dominance, a highly educated and motivated work force, a trade surplus. Until 1971, our reserve currency was backed by gold, forcing us to be responsible. We had control over our economic destiny. Since then, bit by bit, we've lost much of our strength and are in danger of losing the rest.

Our first problem is the surge in competitiveness on the part of the rest of the world, especially China and India, a trend Thomas L. Friedman analyzes in detail in "The World Is Flat." Even if the playing field were level -- which it isn't -- we would not be able to compete with the combination of low-cost labor, talent and fire in the belly of these two behemoths. Our second problem is that we still think we're living in the golden age. In fact, we suffer from a misguided sense of superiority, profligate spending habits, a weak education system, mammoth debts, a ballooning trade deficit and a religious devotion to free-trade theories developed before the Industrial Revolution.

Each of these issues could consume a book, but Prestowitz, president of the Economic Strategy Institute and a trade negotiator in the Reagan administration, packs them into one. The heart of the question, as he sees it, is that we are not defending the jewel in our economic crown -- our technology and manufacturing capabilities -- but are instead waxing poetic about the virtues of free trade while more practical countries walk off with our loot. This, he contends, will lead to the gutting of our economy, with well-paid skilled jobs replaced by low-paid menial ones, and an America in hock to the world's next economic leaders.

Globalization, of course, is nothing new. The "hollowing out" debate hinges on whether the United States can replace the jobs it loses with equal or better ones. Capitalism is fueled by Schumpeter's creative destruction -- new forever displacing old -- and this country has thrived through transitions from agriculture to manufacturing to automation to outsourcing to services. Free-trade advocates argue that globalization is just the latest phase of a continuing evolution. Trade hawks like Prestowitz argue that now is different because of the sheer size of India and China and our inadequate response to the new situation.

Globalization has always been a touchy subject (after all, Americans lose jobs when companies move production and services overseas) -- so touchy that most popular discussion of it is inflammatory or inane or both. Last year, John Kerry branded corporations and executives who send jobs offshore "Benedict Arnold companies and C.E.O.'s," and a White House adviser, N. Gregory Mankiw, provoked many a storm by suggesting that offshoring was actually beneficial because, among other things, it lowers prices and makes labor available for new opportunities. Mankiw may have been impolitic, but Kerry was just pandering. If the choice is go offshore or go out of business, a chief executive doesn't have a choice.

Prestowitz acknowledges that many companies can't survive today without offshoring, but argues that we often abandon industries we could continue to dominate and so lose the ability to lead the next wave of innovation. He lays the blame on government, not the private sector. "Whether it recognizes the fact or not," he declares, "the United States has a de facto economic strategy, and right now it is to send the country's most important industries overseas." He observes, moreover, that the benefits of offshoring go beyond cost:

"You do save money," a senior manager at the semiconductor equipment maker KLA-Tencor says about sending work to India. "But pretty soon, you realize the work is getting done faster and better, and you start sending more and more of it. You also start sending more advanced work and then have to figure out what, if anything, you really don't want to send."

The work is getting done faster and better, Prestowitz argues, because Indians are not only hungrier than we are, but better educated. China, India, Japan and Europe all churn out more science and engineering degrees than we do. Worse -- and downright embarrassing -- is the state of American education. Globally, our 12th-graders rank only in the 10th percentile in math (that's 10th percentile, not 10th). Our students also rank first in their assessment of their own performance: we're not only poorly prepared, we have delusions of grandeur.

One common argument against the hollowing-out theory is that we can afford to lose jobs in low-tech manufacturing because we retain our high-tech design and manufacturing capabilities. Prestowitz counters that China's and India's incentives and resources are so compelling that the high-tech work is leaving, too.

Another argument is that a revaluation of the yuan will curb imports and stimulate exports, thus repairing the trade deficit. In fact, Prestowitz asserts, our manufacturing capacity has been so gutted that we can't export our way out, even if the dollar's value drops to zero. The only path is to cut spending.

But Prestowitz risks sounding like Chicken Little when he pronounces the globalization of today more than just another "gale of creative destruction" to which our economy will eventually adapt. Manufacturing has long been declining as a percentage of the United States economy, but the jobs lost have been more than offset by growth in services (in health care, financial services, law, retailing, and so on). Prestowitz points out that services are now being offshored, too, but not (yet) at a rate threatening our main growth industries. The McKinsey Global Institute, for example, reports that while 24 million Americans switch jobs each year, only 3 million jobs are estimated to go offshore by 2015.

The critical question, still to be satisfactorily answered, is whether offshoring produces net economic gain or loss. Prestowitz deconstructs an oft-cited McKinsey study concluding that each $1 of spending sent offshore results in an overall gain in the gross domestic product of $1.12 to $1.14. He points out the study relies on data suggesting that 69 percent of displaced workers found jobs at an average of 97 percent of their former pay. This leaves 31 percent who didn't find new jobs. Not only that, "if employers took McKinsey's advice to increase their offshoring," he says, the gain would quickly become a loss.

In America's boom time, government-business cooperation was considered anathema to free-market principles -- "Politicians shouldn't pick winners and losers!" In Prestowitz's view, the laissez-faire trade theories of the 19th century have no place in 2005; since he holds that many of our successes have resulted from public-private collaboration, most of his proposals for maintaining American competitiveness boil down to government taking a more active role. Pay teachers more. Help workers move between jobs by offering wage insurance and portable health coverage. Reduce oil consumption by providing incentives for efficient cars (and include S.U.V.'s in mileage regulations). Tax spending, not saving. Help strategic industries with federal loan guarantees and grants. Call "a new Bretton Woods Conference" to set steps for reducing the role of the dollar in the world economy and so defuse the trade-deficit bomb. Whatever you think about offshoring, most of these ideas are no-brainers.

Drawing (Drawing by Ray Bartkus)