Feature Stories | May 29 2006
By Greg Peel
GaveKal Research is an independent economic research house and consultancy created in 1999 in the US by Charles Gave and partners. GaveKal has a reputation for "original thinking". The following feature series is drawn from a GaveKal publication of 2005 entitled: Our Brave New World. This is Part V.
Under the platform company model, the labour and capital intensive and low-margin step in the economic process – production – has been outsourced to emerging economies in order to exploit low cost opportunities. This has allowed companies in the Western world to reap most of the profits while reducing a lot of the risk.
But the practise of outsourcing has not ended with factory workers in China. It has also seen the emergence of the Indian call centre. Thousands of low-paid Indians now sit in call centres in Mumbai or Bangalore either receiving call for the likes of phone directories to insurance claims to help desks, or ringing out with sales pitches of every kind. The outsourcing process has taken a further step – from blue collar worker to service sector worker. Where will it end?
The Australian government has recently shocked its electorate by on the one hand providing airline route protection to Qantas, which blocks competition and allows ticket prices to remain high, while at the same time making no moves to prevent Qantas’ plans to move maintenance of aircraft offshore.
While the former is frustrating, the latter cuts to the heart of the Australian people. Qantas has the best safety record of any airline, and yet both Qantas and the government are prepared to compromise that record for the sake of lower costs. The safety record was established by good, honest, hard-working Aussies who had pride in their job and their reputation. Now those people will be forced to look for work.
Taken to the nth degree, one presumes eventually all jobs that can be filled for less wages outside a mature economy will eventually go, leaving less and less traditional jobs available for the average worker. Can this be sustained, or will there ultimately be a revolution as unemployment reaches desperate levels?
While traditional economists see this evolution as unsustainable, platform model economists do not. If government’s move to stifle the natural redistribution of labour, they will only end up shooting themselves in the foot.
Adam Smith proved that the capitalist system is one that works because it is based on inherent human nature that every participant in the market place aims to maximise profit. Marx argued that rising profits is representative of the exploitation of the humble worker.
Some 60% of Americans now own shares, either directly or through pension plans, and US corporate profits keep rising steadily under the platform model. In Australia, a country with compulsory superannuation, that figure would be higher still. This means that the majority of wage or salary earners are also shareholders, and thus they also benefit from increased profits.
The number of blue-collar workers in the US has fallen from around 40% to around 25% in the last 30 years. While this upsets many hard-working traditionalists from factories around the country, there has been an offsetting gain in service workers, administrative support, sales jobs, technical, professional and management roles. Tradition aside, does it really matter what form of employment is on offer, particularly at the low end of the market? Is a sales job less respected than a factory job?
The Industrial Revolution ushered in the Second Wave of the economic model that provided the great factories of the mature economic world. While emerging economies are catching up to the Second Wave phase, mature economies have moved on to the Third Wave. As Alvin Toffler predicted, in the third wave the source of all wealth is knowledge – this is the information age.
In the period 1973-2001 the average real wage (inflation adjusted) of male college graduates in the US grew by US$5/hour. The real wage of high school graduates remained stable, and the real wage of non-high school graduates fell by US$3/hour. It then may be surprising to note that the number of male college graduates (and this is before one even considers the entrance of women into the equation) grew much faster than either the high school graduates or non-graduates.
This implies that the Third Wave is creating an economy where the vast majority of Americans are better off. Only the high school "drop-outs" have suffered, but such is their lot. In Australia, too, university and high school graduation has grown tremendously as fewer young people aspire simply to be a factory worker like Dad, leaving school at fifteen, but to embrace the new age of information technology and service by spending the time to educate themselves and provide a life better than Dad’s was.
But coming back to offshore outsourcing, Indians can graduate university too, so isn’t there still a risk that there will be fewer jobs available for US or Australian graduates?
To answer this it is necessary to understand that outsourcing is not a zero-sum game. In other words, it does not represent a loss of wages available to locals but is mutually beneficial to the people of both countries. The Milken Institute conducted a study in 2004.
The Institute found that for every US dollar of corporate spending, the receiving economy (ie India in this case) receives 33 cents in the form of wages, profits and taxes. The US company on the other hand, saves 58 cents. With this saving the company can invest in more product development, pay higher dividends to shareholders, or both. The US consumer also wins because lower costs mean lower prices.
The call centre in Bangalore will also need to be fitted out with computer hardware, software, phone systems and so forth. Hence companies like HP, Microsoft and Lucent will benefit, as will service providers such as PriceWaterhouse who will audit the books. At the same time, young Indian workers are receiving wages that allow them, for the first time, to buy mobile phones, computers, iPods, whatever, again providing a beneficial flow back to corporations.
Thus the US corporation experiences savings, increased exports and repatriated profits. All in all a benefit of 67 cents, calculates the Institute, which is twice that of India’s gain. Where will that money go? Apart from dividends it will be invested in new businesses which will boost productivity and, more importantly, create new jobs.
On average, the job added as a result of outsourcing will provide more value than the job lost.
US manufacturing employment has shrunk by two million in twenty years, but net employment grew by 43 million, representing jobs in the fields of education and health services, professional and business services, trade and transport, government, leisure and hospitality and financial services. As more jobs are shipped offshore, greater value jobs emerge locally. Hence it is wrong to assume a job lost is a net reduction in the amount of jobs available.
And despite the whinging, the reality is that jobs outsourced tend to be low-satisfaction jobs that Westerns scorn (and a high turnover occurs) but emerging market workers lap up. One British bank’s call centre agents in Bangalore process 20% more transactions than their UK counterparts with a 3% higher accuracy level.
The platform company model represents an efficient reorganisation of talents. That is one of its fundamental bases. Another is new inventions.
While new inventions are creative, they can also be destructive, albeit for the ultimate benefit. For example, the fax machine replaced the telex machine, and now faxes have all but been overtaken by email. While the manufacturers of telex machines moved onto new technology, there would have been some in the wash that were forced out due to new technology. Email, for example, requires less use of paper, and global paper manufacturers are struggling.
This brings us to a very important requirement for a successful platform company economy, as was first introduced in Part I of this series, and that is the right, and the ability, to fail. Without failure, an economy cannot evolve efficiently. Propping up antiquated industries or protecting companies from their own inefficiencies in order to save jobs is to dig a deeper and deeper hole.
Japan has done it, Europe has done it, and even the UK has had its moments as it has tried to save, for example, iconic car manufacturers. In the US and Australia, as elsewhere, organised interest groups such as unions have leant on governments to protect jobs in, for example, the steel industry, which is now the domain of rampant Chinese participation. But to a great extent, these governments have let the efficiencies dictate, whether they be right or left wing leaning. The capacity of companies to fail (auto is a good example) or to outsource (call centres) has provided for both countries to experience solid economic growth.
In the meantime, the economies of Japan and Europe have taken a long time to become reinvigorated.
Nationalisation is anathema to a strong capitalist government, which is why countries such as Australia have privatised constantly, from banking to telecommunications, from education to healthcare. In Britain’s heyday it boasted thriving nationalised industries in the likes of steel, coal and rail. These industries slowly ran themselves into the ground (remember British Rail jokes) before Thatcher unleashed her unpopular shut-it-down or sell-it-off policies. The UK economy is currently a strong one.
Whether or not Thatcher went about it the right way is a different matter, and any good government will still pay heed to social aspects of economic change, but under the platform model efficiencies dictate that capital should be placed in the strongest hands. We now have debate about whether services such as health, education and childcare should be allowed to be corporatised, and again these are areas that cut into the heart of the people.
In Europe, the trend is to make such areas untouchable. While this is popular in winning votes the reality is these services need to be paid for either through taxes or deficits. To protect any industry is to stifle the creative side of corporatisation, and ultimately use capital inefficiently. This is also true for service industries as well as manufacturing.
The platform model is not one which dwells on social responsibility from a benevolent perspective. From this will flow hardships, until such time as the people speak not through votes, but through their consumption. When the Commonwealth Bank of Australia was privatised, and the banking industry deregulated, there was a slow and steady decline in customer service. Only now have banks woken up to the fact that customers are actually something a company needs, so they have begun to reverse some of their more cost efficient, but less equitable policies. This has resulted in a reversal of market share loss for some, which tends to suggest the search for the greatest efficiency is a bumpy trail, not a smooth transition. But the end result will need to be that which keeps the majority of people happy, not the minority.
Nevertheless, under an economic model in which the prime motivator is the individual pursuit of profit, there must be losers. One of the biggest perceived problems of the Third Wave world is the growth of income disparity.
As addressed in Part IV of this series, Americans and Australian have become big spenders and poor savers largely as a result of the fall in volatility of job security and corporate profits under the platform model. China, on the other hand, faces volatile corporate profits and low job security as the industrial explosion has meant rushing headlong into the next opportunity while it exists, only to find that everyone is doing the same. Profits are low but saving is high in case there is no job tomorrow.
The end effect of the emergence of the likes of China and India has been, however, a more affluent society for many. Chinese are now buying their first mobile phones in their millions, and are eying off a first car. Those in the more mature economies of the US and Australia have found themselves wealthier as well, through increased property values, corporate profits and stock prices.
But tell that to the laid-off auto worker in South Australia, or the unskilled subsistence farmer in China. It is these people who have effectively become poorer while everyone else has become richer.
However, under the platform model it is necessary to accept such disparities, rather than redistribute through intervention. If capital is taken away from where it can be most efficient, and can generate the highest returns, then this leads to an impoverishment of the entire society, in which those at the bottom will only be even more worse off. That is why socialist societies have failed to survive.
It must also be understood that income disparity is a strong motivational force. Human nature dictates a desire to get on in life, and to succeed at whatever one puts one’s mind to. For the average person this means the desire for conspicuous wealth. If there was nothing to strive for, then why go to the effort? There would be little in the way of creativity or economic growth under such a model.
More in Part VI.
The ideas and examples put forward in this series are the work of Gave, Kaletsky & Gave: Our Brave New World, self-published, 2005. The writer has added observations as well.