Expansion Abroad by U.S. Multinational Firms: the Death Knell of the U.S. Economy? Matthew J. Slaughter Tuck School of Business at Dartmouth and NBER ITPF-Congressional Luncheon Washington, D.C. February 22, 2005

2 Outline of Presentation The conventional wisdom. A framework for thinking about outsourcing. Some facts about U.S. multinationals. What about insourcing? Some sobering politics and demographics. Conclusions.

3 The Conventional Wisdom

4 Outsourcing by U.S. multinational firms is different from other faces of globalization. “We are concerned that the United States may be entering a new economic era … the case for free trade is undermined by changes in the global economy” --New York Times Op-Ed 1/6/04 The magnitudes and consequences of this rising process are both obvious and dire. 3 MILLION IT-related jobs will be “exported” by The outsourcing of IT and similar “golden goose” sectors can only harm the overall U.S. economy. The political response to this process is well underway: think of The American Jobs Creation Act of 2004, H1-B Visa caps.

5 A Framework for Outsourcing Consider a U.S. multinational firm in software. –Suppose that in response to low labor costs abroad, it decides to relocate some of its programming activities to India. –What happens to labor demand in the firm’s U.S. operations? Substitution effects: If U.S. labor and Indian labor are substitutes in the firm’s cost function, then a fall in Indian labor costs leads to a decrease in U.S. labor demand. But what if Indian and U.S. labor are complements, not substitutes? Scale effects: If falling labor costs in India lead to an expansion in firm scale, then demand for U.S. labor may rise (even if U.S. labor and Indian labor are substitutes). Scope effects: If falling labor costs in India lead to an expansion in firm scope (holding scale constant), then U.S. labor demand may fall or rise depending on the labor intensity of the new lines of activity.

6 The World Wage Pool

7 What About the Jobs Count? Take at face value widely heard predictions: e.g., each year 300,000 US IT jobs are being “destroyed” by multinationals’ outsourcing. During this time the U.S. economy will “destroy” how many jobs annually? Nearly 50 million! During this time the U.S. economy will “create” how many jobs annually? Nearly 50 million! Careful to distinguish gross changes from net.

8 Are Multinationals Exporting Jobs? We can count net jobs that U.S. multinationals create abroad in all their foreign affiliates and in their U.S. parents. What do we see? Year Affiliate Jobs 6,878,200 9,775,600 +2,897,400 Parent Jobs 17,958,900 23,450,200 +5,491,300

9 Are Multinationals Exporting Jobs? But what if we compare employment growth in U.S. parents with that in the U.S. economy? Which has grown faster? Year U.S. Payroll Jobs 108,374, ,826, ,452,000 Parent Share 16.6% 17.8% +1.2%

10 Not Just Number of Jobs, But Kind Parents of U.S. multinationals also perform a very large share of many activities central for economic growth and rising U.S. living standards. Here are the 2002 numbers (shares of private sector). ActivityParent Share Parent Value Employ. 20.0% 22.4 million GDP 23.3% $1.857 trillion I 31.7% $341.2 billion IM 33.9% $393.2 billion EX 53.9% $373.2 billion R&D 72.3% $138.0 billion

11 The Bottom Line of Higher Wages One additional important fact: jobs in U.S. parents tend to pay more than do comparable jobs in their domestic counterparts. –2002 average compensation: $51,342. This was 22.5% above the average in the rest of private sector. This differential is partly--but not entirely--accounted for by firm characteristics beyond just being a multinational (e.g., industry of operation). It suggests Americans should prefer working at these globally engaged firms. Do they?

12 What About the Overall Economy? It is widely asserted that the globalization of IT and similar “golden goose” sectors can only harm the overall U.S. economy. Key premise: foreign expansion necessarily substitutes for U.S. operations. Amidst these assertions, does history offer us any guide?

13 What U.S. Industry Is This?

14 What U.S. Industry Is This?

15 What U.S. Industry Is This? Computers and Office Products (SIC 357). What was the world’s only industry in the 90s to eliminate all tariffs? Who gained from this evolution? Who lost? Where is your favorite firm on this timeline?

16 What About the Overall Economy? Since 1995 growth in labor productivity—and thus real income and U.S. living standards—in the United States has accelerated markedly annual average rate: 1.35% annual average rate: 3.11%. IT firms have been at the core of the productivity boom: both via better production of IT firms and via greater use of IT elsewhere. These highly successful IT-producing firms are among the most globally engaged firms in the U.S. economy.

17 Don’t Forget Insourcing U.S. affiliates of foreign multinationals also perform a very large share of many activities central for economic growth and rising U.S. living standards. Here are the 2002 numbers (shares of private sector). ActivityAffiliate ShareAffiliate Value Employ. 4.8% 5.4 million GDP 5.7% $453.6 billion I 10.4% $111.9 billion IM 27.9% $324.6 billion EX 19.8% $137.0 billion R&D 14.4% $27.5 billion

18 Don’t Forget Insourcing Like U.S. parents, these insourcing companies pay a substantial compensation premium— 31.4% relative to U.S. private sector in 2002, with average compensation of $56,667. They also purchase most of their inputs from domestic suppliers, not foreign: nearly 80 cents on the dollar in 2002, or $1.26 trillion. –U.S. Parents even more reliant on domestic suppliers: over 90% since 1977 to today.

19 The Politics of Globalization Question: “Now, I am going to read you two statements about foreign trade, and I would like you to tell me which statement best reflects your views on the issue. Statement A: Foreign trade has been good for the U.S. economy, because demand for U.S. products abroad has resulted in economic growth and jobs for Americans here at home. Or, Statement B: Foreign trade has been bad for the U.S. economy, because cheap imports from abroad have hurt wages and cost jobs here at home.” Answers:Good for U.S.: ___% Bad for U.S.: ___%

20 The Politics of Globalization Question: “Now, I am going to read you two statements about foreign trade, and I would like you to tell me which statement best reflects your views on the issue. Statement A: Foreign trade has been good for the U.S. economy, because demand for U.S. products abroad has resulted in economic growth and jobs for Americans here at home. Or, Statement B: Foreign trade has been bad for the U.S. economy, because cheap imports from abroad have hurt wages and cost jobs here at home.” Answers:Good for U.S.: 34 % Bad for U.S.: 58 %

21 The Politics of Globalization Question: “Do you think it is important that America remain on the cutting edge of technological leadership even if that means losing some jobs in traditional industries, or should we concentrate on protecting traditional jobs even if that means sacrificing American leadership in technology?” Answers:Remain on cutting edge: ___% Jobs more important: ___%

22 The Politics of Globalization Question: “Do you think it is important that America remain on the cutting edge of technological leadership even if that means losing some jobs in traditional industries, or should we concentrate on protecting traditional jobs even if that means sacrificing American leadership in technology?” Answers:Remain on cutting edge: 57 % Jobs more important: 35 %

23 The Politics of Globalization A plurality to majority of Americans oppose freer trade, immigration, and FDI. They acknowledge the various gains, but worry more about perceived labor-market costs. The single most-important cleavage beneath these preferences: labor-market skills. Not industry of employment. The same holds true in most other countries.

24 Rising U.S. Inequality Across Skills

25 The Politics of Globalization The skills cleavage in American preferences matches the poor earnings performance of less-skilled Americans since the 1970s—both real and relative to more-skilled Americans. Remember: the fact that a country overall gains from globalization does not mean that every worker, firm, and community gains directly. Should policy address this?

26 The U.S. Labor Force of the Past

27 The U.S. Labor Force of the Future

28 Foreign-Born Share of U.S. Population

29 The U.S. Labor Force of the Future

30 Conclusions The forces of globalization increasingly shape national labor-market outcomes. This will change only if governments intervene (not impossible). Impact on globally engaged firms and their workers? For firms, especially multinationals, the widening ability to produce and sell in many markets is a competitive opportunity. For workers, the direct impact is less certain. It will depend largely on whether the global evolution of their employers make them more or less productive—and thus valuable. In the longer term, the answer to this question increasingly depends on what skills U.S. workers offer relative to workers worldwide. How do these facts inform U.S. economic policy?