Offshoring: What is at stake?

With the case of Bangladesh workers deaths (over a thousand), where clothes for well known brands were being made still in our minds, the issue of offshoring is once more put forward. I spoke about the history of offshoring in the clothes industry on a previous entry,  but here I want to generalise on the issue itself, what is at stake in offshoring, what is at stake, who is responsible.

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In the 19th Century, David Ricardo praised the virtues of free market through comparative advantage with the example of trade between England and Portugal, exchanging cloth and wine. The simple idea was to present that Portugal, being better at producing wine than England, had a comparative advantage in this sector, whilst England, being better at producing cloth than Portugal, had a comparative advantage in that industry. As a result, both nations would focus and trade in those two goods, and would forget of even investing in the other industry, and ultimately create full employment everywhere.

Critics to this theory appeared right away and remain today (transport costs not included, goods don’t have similar total values, etc..), but what Ricardo and his critics could did not foresee was that the future would make this theory completely irrelevant. In today’s economy it is the added-value of a product (the transformation of the product into the finished good) where the profit is made, rather than from the initial product. As a consequence, since anything can be made anywhere, profits and employment can be made anywhere too.

In laymen terms, what really matters is where it is cheaper to make everything, in terms of taxes, labour costs, transport costs (proximity to markets, distribution points and large trade routes) and other costs. But it is these three main costs that pin-down the decision, since they are not a one time expenditure (such as buying a machine or a factory), but  constant expenditures. And of these by far the highest cost, and therefore the most important factor in deciding a location, is labour. And the cheapest wages are the best. This derives into going to places not only with low salaries but also with practically no labour regulation, including worker safety.

Going back to Ricardo’s example, nowadays England wool and Portuguese grapes can be processed cheaper in other places than in their home countries.

So, how can we reverse this tendency and allow the production to be more evenly distributed amongst nations and their workforce? Well there are two mutually inclusive actions I can personally think of:

1) Reducing the added-value price margin by increasing the initial product price margin.

To go back to its origin, the fierce competition of primary products has meant that prices have systematically gone down to its minimum levels. Just like in agriculture, prices, for other raw materials, prices have gone systematically down, shutting uncompetitive businesses in countries where costs were to high. But if the price of, let’s say iron, was lifted and kept at a high level, then previously uncompetitive areas would reopen, Portugal would return to its vineyards and England to its sheep rearing. Not fully, but enough to reinstate Ricardo’s theory up to a certain level and generate industry and jobs everywhere.

Everybody would say that an increase in the price of raw materials automatically leads to an increase in retail price. But does it? Let’s look at the second action to challenge this.

2) Carefully analysing the way in which prices of products are set, and cutting where we should.

What is the companies justification for offshoring industries? Well the first and foremost is fierce competition from emerging economies and these cheap products invading home nations. Well, that is true, but how is the price of commodities in rich nations determined? Is it the simple addition of costs and a slight margin for profits, or is it a policy of the maximum price consumers are ready to pay and oligarchic behaviour in prices (price rigging)? Well we see two things: Firstly these companies now produce in the same places with the same salaries, but still they complain of unfair fierce competition. So where it the extra cost coming from? Secondly, all the global products have different retail prices in different countries: a Coca-Cola will never cost the same, nor does a Big Mac, nor does a Ford Focus. Why is that? Is it because of the cost of labour, or is it because companies look at people’s pocket size per country?

I often imagine a fat intermediary pushing two walls. To his left, the wall is pushing the raw material producer as much as he can, setting prices low, and to his right, the wall is pushing the consumer as much as he can, setting prices high. Thus maximizing benefits. You only need to look at CEO salaries, and imagine how these massive compensations trickle down to other directive positions. What bonuses do the directors of these fierce competitors from emerging nations get? Well, the latter figures either don’t get reflected in the international statistics, or they are too far down to even be mentioned in the lists. Food for thought.

 

These two measures accompanied by other minor ones, would not only redistribute wealth amongst countries, but would also bring production closer to home (wherever home is), distribute wealth more evenly through jobs and through smaller businesses, and ultimately bring to an end the harsh move to offshore production.

But why doesn’t this happen? Well mainly because governments, national and local, have been drawn into this spiral of overall competitiveness, reduced taxes and increased incentives for companies to produce in their country, region or town, and they have also lost all perspective on what really is going on. And as always those on top are richer everyday whilst those at the bottom are poorer everyday.

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