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The Division of Labor is World-Wide

Mises Daily: Tuesday, March 23, 2004 by

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The history of mankind is the record of the progressive intensification of the division of labor […] The operation of [this] principle … and its corollary, cooperation, tends ultimately toward a world-embracing system of production. (Ludwig von Mises, Theory and History, 1958, pp. 234, 235)

The more [we] want to improve [our] material well-being, the more [we] must expand the…division of labor. (Ludwig von Mises, Human Action, p. 831)

Within a world organised on the basis of the division of labor, every change must … affect the short-run interests of many groups. (Ludwig von Mises, Human Action, p. 82)

Those goods and services that people trade across political boundaries are rendered highly visible by that very fact. Thus political advisors, politicians, and journalists can easily divide these outputs into sheep and goats, according to the direction in which they cross these administrative limits. Outputs that go from the 'domestic' to the 'foreign' side are good—they are 'exports'. Outputs that go in the opposite direction, however, are bad—they are 'imports'.

Reactions to Two Recent Changes in US Imports

Very recently, political advisors and politicians have focussed on two extremely recent developments in American imports. Some American multinational corporations have closed their 'domestic' operations and opened plants in China, from where they sell cheap, relatively simple consumer goods—e.g., clothing, toys—across the US ('offshore production'. ) Other corporations have dismissed Americans and hired Indian professionals in India, to provide various computing, data processing, radiographic and similar services in the US, through the internet ('outsourcing'). Parallel developments have appeared in Western Europe.

We may outline the views of these advisors and politicians on these issues (or the reader can skip ahead to the answer):

Both these happenings (we are told) are ominous. They are not really imports but the substitution of cheap foreign labor for expensive US labor. Such apparently cheap imports actually come at a very high price—the loss of high-paid US jobs. To move output for home markets abroad is to shift domestic output to foreign countries: what used to be home production becomes imports. The trade deficit will never be reduced.

Capital is mobile and technology can be acquired. And so modern production functions for manufactured goods, their relative cost ratios, are uniform everywhere. So comparative advantage cannot operate any more (it seems.) What remains is absolute advantage—the level of labor costs. Inevitably all the gains will go to countries with huge labor surpluses—the greatest absolute advantage. US capital and technology and therefore jobs—will all drain to these countries. The US will lose lines of employment, productive capacity, output, industries. US wages will have to fall—American workers will be reduced to assembling, at low wages, inputs made abroad. They will have lost the very prerequisites for development.

Thus (it would appear), outsourcing and offshore production benefit certain companies and consumers, but overall are a severe detriment to the nation. Just so, modern trade theory (it is pointed out) demonstrates that trade amongst countries is inherently antagonistic. When all countries are taken together, free trade permits only some countries to obtain their maximum benefit; others do not. In some instances, both countries lose; in others, one gains at the other's expense. Only in some cases do both countries benefit. Free trade means the loss of most modern—increasing returns—industries. Countries that subsidise such industries can monopolize them indefinitely. In sum, that country which produces most of the world's tradeable output, reaps enormous advantages: high wages and high consumption.

Thus (say these policy advisors) the most up-to-date theory supports this conclusion: Japanese industrial policy, outsourcing and offshore production—all result in the loss of American jobs. Free trade cannot be relied on to create replacement jobs, in new industries producing high value-added outputs. And the enormous US trade deficit continues—but foreigners, with all that money in their hands, are still not persuaded to buy more American exports. So this avenue of job creation is also closed.

Is The Sky Falling?

Dear Reader, I think you are sufficiently alarmed and despondent by now. Time for some perspective. We begin with some relevant figures. As the table below shows (inter alia): investment outside China equalled more than 99 percent of all American direct investment abroad in 2000. Imports from countries other than China came to more than 92 percent of all American imports of both goods and services in 2001. Imports of computer and similar services from all countries came to less than ½ of one percent of all imports. (For what it's worth: exports of such services equalled 0.6 percent of all exports of goods and services in 2000.)

Clearly these imports (and investments) are only a tiny part of the whole. To learn about the trading and investment interconnexions amongst Americans and others, we will have to look systematically at the overall picture. (And just to round off: within the US, employment outside computer and allied services equalled more than 99.5 percent of the total. Clearly there remains extensive room for employment in other lines.)

Table 1. The Thin End of the Wedge?

China 2000

a. US FDI = 0.77 % of total US FDI
b. " " = 0.54 % of private US GFCF

China 2001

Imports into US = 7.56 % of total US imports of goods and services

China 2000

Imports into US = 1.00 % of US GDP

All countries 2000

Imports into US of telecommunications, computer, DP services = 0.43 % of total imports of goods and services

US 2001

Employment in computer and DP industry = 1.77 % of total employment

Capital and Output Are Not Fixed

There is a further major drawback with using the lenses provided by theoretical and policy views. The pivotal assumption in both is that capital, and therefore output, is a fixed 'stock.' Ineluctably, therefore, when some have more, others must have less: when American capital is invested abroad and output there increases, capital and output at home must go down. So too in modern theory: the larger the share of the world's tradeable output produced in a country, the higher are its living standards. Again, capital and therefore output must be fixed. But then 'trade' can only be a zero-sum game. And the capital itself cannot be produced—it must simply drop from heaven, one fine day ('factor endowment').

But in fact, the range, quantities, and quality of mass-consumption goods and services all improve and diversify continuously (in the present historical context). For instance (in the US): compare the current Sears catalogue with that produced ten or even five years ago, let alone earlier. And again, look at the variety and spread of trade catalogues and their contents—currently, and in earlier years.

In sum: people, in their actions, are continuing to extend the capital structure [see Table 3, p. 4]; these are simply some very small pointers to the substantial changes involved. And the same is true of the US's trading partners—still mainly the other developed countries but also now the various territories of East and Southeast Asia and other parts of the world. Mass-consumption outputs in all these regions are continuing to rise, improve, and diversify as people continue to extend the capital structure.

Americans and The World Are Interlinked Economically

Since 1970 or so, American economic activities have become ever more integrated into this world economic structure. The entire gamut of goods is involved—all types are both 'imported' and 'exported', as are a small but growing range of services. These deepening interconnexions are reflected in a crude and hazy way, in the ratio of 'foreign trade'—'exports' and 'imports' combined—to 'aggregate' output. This figure went from 11 percent in 1970, to 26 percent in 2000. (For comparison: In that year for the developed countries (except Japan), the proportion ranged from 47 to 67 percent. The US has still some way to go.)

As production expanded and diversified in more and more areas, the American (and world) network of trade relations also became wider. US trade grew with East and Southeast Asia and the rest of the world (relative to its trade with the developed countries):

Table 2: US, Direction of Trade, Goods (Percent to Total)

1990,
Exports

2000,
Exports

1990,
Imports

2000,
Imports

Japan

12.3 %

8.3 %

18.1 %

12.1 %

Other DCs

55.3

47.7

43.9

38.2

China

1.2

2.1

3.1

9.0

Other E and SE Asia

13.1

14.5

15.9

13.9

Rest of World

18.3 %

27.3 %

19.0 %

26.9 %

Since China has been singled out for attention, let us take a closer look.

Since the mid-1980s or so, investors from Hong Kong, Taiwan and the overseas Chinese, have established, expanded and diversified a range of productive activities in southern China. These investors are drawn (inter alia) by the abundance of cheap labor. This region now supplies a vast array of relatively simple goods to the rest of the world—including clothing, textiles, footwear, small calculators, screwdrivers, spanners, and the like.

Americans have only recently joined in. By attaching their investments to this burgeoning production structure, American companies now add a wider assortment and larger quantities of these items than before, to the range of final outputs available to American workers and their families.

The Global Production Structure

The table below can provide an outline sketch only, of the successive stages of production leading to the supply of one item: Chinese-made clothing in US retail outlets.

As this sketch is followed through, it demonstrates:

  1. this production structure is geared to turning out a vast array and huge variety of final outputs; clothing is but one of these outputs

  2. the capital interrelationships actually listed are only the tip of the iceberg; a few selected interconnexions from a vast, extremely intricate and complex web

  3. the global coverage of the production process. This production structure, linked onto the older ones, built up much earlier and over much longer periods in the developed countries. That is why it could expand so rapidly.

  4. this investment structure simply ignores political boundaries—it has to. 'Economic' influences are overriding—as they must be, for the structure to be built up and expand further. Political boundaries are in the nature of haphazard lines, crossing various portions of the capital structure, completely at random.

Production Structure for Clothing from China in US Shops

Goods/investments of the:

1st order
Clothing in the cupboard at home. US
2nd order.
Retail shops with stocks. Buildings, offices, fittings, power, labor. US
3rd order.
Wholesalers. Warehouses, equipment, offices, power, labor. Transport - vehicles, fuel, labor. US
4th order.
Transport from docks. Vehicles, fuel, labor. US
5th order.
Docks. Cranes, equipment, depots, offices, power, labor. US
6th order.
Shipping. Container ships, containers, fuel, labor (from LDCs) Liberia, Panama, Greece, Norway
7th order.
Transport (for clothing) to docks. Vehicles, fuel, labor. China
Shipyards, dry docks, cranes, equipment, shipbuilding steel, tools, power, labor. Korea, Japan)
8th order.
Clothing factories. Workshops, offices. Cloth. Cutting tables, shears, measuring tape. Industrial sewing machines. Sewing thread, accessories ( buttons, zippers, ribbon, etc.) Power. Labor. China. (US investment)
Steel mills (for shipbuilding steel). Buildings, furnaces, coal, iron ore, other inputs. Offices. Power. labor. Korea, Japan. Transport to shipyards.
9th order.
Dyeing and finishing works. Buildings, vats, equipment, dyestuffs, unfinished cloth. Power. labor. Button factories. Workshops, plastics, machines. Offices. Power. Labor. China (NB. Investment throughout from Hong Kong, Taiwan, overseas Chinese.)
Zipper factories. Buildings, offices. Plastics, machines, fabric, sewing machines, thread. Power. Labor. Japan. Shipping to China.
Factories producing industrial sewing machines. Buildings, office. Machinery, equipment, steel, other inputs. Power. Labor. US. Transport and shipping to China.
Shipping. Cargo ships (for coal, iron ore, etc.), fuel, labor. Japan.
10th order.
Weaving mills. Buildings, office. Machinery. Yarn. Power. Labor. China.
Mines (coal, iron ore). Mining machinery, equipment. Power. Labor. Australia.
11th order.
Spinning mills. Buildings, office. Machinery. Raw cotton. Power. Labor. China.
Factories making weaving machinery. Buildings, offices. Machinery, equipment, steel, other inputs. Power. Labor. England. Transport and shipping to China
Factories making mining machinery. Buildings, office. Machinery, equipment, steel, other inputs. Power. Labor. US, Canada, Germany. Transport and shipping to Australia
12th order.
Factories making spinning machinery. Buildings offices. Machinery, equipment, steel, other inputs. Power. labor England Shipping to China.
Cotton dealers. Warehouses, stocks. Power. Labor. China
13th order.
Farms producing raw cotton. Fields, cotton seeds, fertilizer, pesticides, irrigation facilities, agricultural equipment/tools, plough animals, transport animals, carts. Farm buildings, power, fuel, labor. Cotton gins. Uzbekistan, China, Egypt, US
14th order.
Chemical factories producing fertilizers. Buildings, offices. Machinery, equipment, chemicals. Power. Labor. Germany. Shipping to Egypt, China.
And so on … (NB: Legal services and insurance are inputs in all stages.)

Two points may be underlined.

One is now perhaps abundantly clear: customs, duties and the like, levied at political borders, are taxes imposed completely at random on the flow of goods and services through the capital structure to the final consumption stage. It follows that free trade policies are in effect simply a recognition of this established reality: the production structure which yields final outputs is a global formation. The peoples of the world are already united. It remains for them to lose their government chains.

Secondly, the capital structure demonstrates a continued and growing cooperation and interdependence in peoples' actions—the continuing development and expansion of the 'social division of labor', in one of Mises' favorite phrases. Thus to claim that when people take outputs across political boundaries, it involves an 'inherent antagonism'—is to walk away from reality.

Change and Former Suppliers

Increased and more diverse supplies of clothing from China are part of a wider growth in final outputs. On finding larger supplies of clothing at lower prices, many households simply buy more. Others take advantage of the opportunity to buy more of other goods and services as well. Some families also add to their savings (however modestly); others are happy to find they can leave their savings alone. Thus the supply of more and cheaper clothing is conjoined with somewhat larger supplies of other outputs. Before this happened, all that was available was smaller quantities of clothing, with a narrower range, at higher prices.

Exactly the same type of situation is found in the supply of professional services from India. Users now pay a fraction of what they paid before. Naturally they buy more; or else they purchase other inputs and increase or diversify their outputs. Many lower their own prices. And the ripples are still spreading. And once again, in the status quo ante, all that could be found were smaller quantities of services, at far higher prices.

Because of these particular changes, some American companies, formerly profitable, now make losses. Some workers and professionals are looking for new jobs or now have lower incomes. All of them naturally wish to restore the status quo ante. But there is a policy problem: it is American companies who supply these outputs—and US companies cannot be accused of 'dumping.' Some other basis has to be found for excluding goods made abroad with US capital and professional services brought in by American firms.

In addition, only the displaced suppliers have any reason for preferring higher prices and smaller quantities of these particular outputs. The various arguments that policy advisors have developed fit in neatly here. Their aim is to reverse the outflow of US capital to China and India, stop the inflow of these particular goods and services and thus return these unsuccessful producers to their former profitable/high income position. But that can't be done. The circumstances under which these companies and people were once prosperous are gone forever. They must now succeed in the new circumstances now prevailing which in turn will change …

'Job creation' is also used to argue for the exclusion of goods and services provided from abroad with US capital. But limiting or halting such inflows will 'help' only those companies and workers displaced by these new developments. There are some eight million people registered as unemployed in the US at present. Helping them means providing more jobs across the board. This involves another set of policy obstacles. It creates a fishy stench to drag in 'free trade' here.

The Famous (Or Infamous) American Trade Deficit

One last related issue: the US trade deficit and US capital imports. We are told:

"Because of outsourcing, offshore production, and the fall in manufacturing employment, Americans now import consumption goods and run a trade deficit. Thus foreigners' incomes rise. To cover the deficit, Americans sell off productive assets—trillions of dollars worth. So current and future income all leave the country. The bulk of the capital inflow now consists of portfolio investment—i.e., purchase of existing assets—shares, bonds, real estate. Direct investment—which creates jobs—is only a small part of the total. Thus the capital inflow really represents American capital consumption."

Some observations:

  1. US imports consist of the entire range of industrial products; identifiable consumption goods are only about a quarter of the total (industrial products are quite clear in the statistics; consumer outputs, not always.) Some three-fourths of all imports are for production purposes. Thus the trade deficit is not analogous to the individual who lives beyond his/her income and sells assets to make up the difference. The analogy is rather with the individual who obtains production goods on credit.

  2. Portfolio investment: Companies have been known to float shares on the stock exchange. When foreign investors buy these shares, they make capital funds directly available to the company. When foreigners buy 'old' shares, some of the funds at least, will go into new issues, at one or more points along the chain of sellers. So foreign portfolio investment adds, directly and indirectly, to the capital funds of US firms. (American investors, too, make portfolio investments abroad, of course.)

  3. Up to around 1980 or so, the US ran a current account surplus with, and so exported capital to, the rest of the world. Necessarily, therefore, the rest of the world had a current account deficit and a capital account surplus, vis-à-vis the US. Since then the situation has been reversed. The US savings ratio has certainly fallen but capital accumulation has grown dramatically in Western Europe. Part of these savings are being invested in production opportunities in the US. Therefore the US now has a current account deficit with and imports capital from, the rest of the world. Nothing stands still.

And this situation is not necessarily the end of civilization as we know it. Australia has run a current account deficit and continuously imported capital since the 1860s. We flourish.

Statistical Sources:

2002, 1982. International Financial Statistics Yearbook.

2002, 1995. Statistical Abstract of the United States.