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Eroding Western living standards

January 07, 2008

Eroding Western Standards of Living

Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005) -- details can be found on the Web site

Germany looks like a counterexample

Tata Motors’ emergence as front-runner to buy Jaguar and Land Rover from the ailing Ford brings one question uppermost to a commentator sitting at a wealthy Western desk: Precisely which economic sectors can be relied upon in the future to provide jobs for Westerners at wages higher than are obtainable in the Third World?  Will there continue to be opportunities to improve Western living standards, or are those living standards destined to descend to some kind of population-weighted average between Boston and Benin?

Tata is a typical and highly capable example of that new breed: the third world multinational company. Part of the multi-industry Tata Group, over a century old, from which it had access to both capital in its formative years and steel currently, it has established itself as the premier manufacturer of light trucks in India and as one of the top three automobile manufacturers. At the bottom of the market, it has announced plans to being out a 100,000 rupee (about $2,500 currently) automobile, which if successful will undercut its major competition by more than 30% and greatly expand the market for automobiles among the still impoverished Indian people.

Conventional Western business analysts have no problem with Tata manufacturing mini-cars for the Indian market, or indeed for developing country markets in Africa and elsewhere. They imagine that Tata is able to use its comparative advantage of cheaper labor to squeeze costs out of the manufacturing process, thus achieving what in the West would be an impossibly low price. They point knowingly to the expensive environmental features that the new automobile will lack, and imagine smugly that the it will be both tiny and of low quality, adequate for the noble impoverished of the Third World, but not seriously to be imagined as competition on the roads of London, New York or Stuttgart.

The announcement that Tata is to buy Land Rover and Jaguar has thus caused a considerable amount of cognitive dissonance. Land Rover and Jaguar are both icons of British automobile manufacture, hand crafted by generations of British skilled labor. Admittedly in the 1970s Jaguar’s quality control became so poor that Jaguars rivaled the Moskvich or the Yugo for frequency of repairs, but since 1979 or so quality has improved and the marque has established a cherished if not particularly profitable niche among the luxury automobiles of the world.  Moreover, would Western buyers shell out the substantial cost of a Jaguar if they knew it had been manufactured in India; after all, how could the quality be relied upon?

Such thinking betrays a limited understanding of modern automobile manufacturing. Fifty or eighty years ago, you could reasonably contrast mass produced automobiles such as the Ford Model T or the Morris Oxford with luxury automobiles such as Mercedes and Rolls Royce. The former were manufactured on assembly lines to relatively low tolerances, whereas the latter were hand built one by one, with parts being filed down to precision so that everything fit precisely. Mass produced automobiles rattled, luxury automobiles didn’t; it was as simple as that.

With the advent of automated manufacturing, this distinction has disappeared. The only differences between a cheap automobile and a luxury automobile today are materials and gadgetry; the manufacturing process is the same. Both Mercedes and Ford are made by robots. The only exceptions are a few models such as Aston Martin and Maserati, where production volumes are so small that it’s not worth buying a full set of robots, so highly skilled craftsmen remain cheaper.

In such a world, Tata is just as capable of manufacturing Jaguars as Ford; it can use the same computerized manufacturing techniques, merely substituting cheaper Indian labor for the expensive and recalcitrant British workforce. To the extent that expensive automobiles still require more labor than cheap ones, it is in such areas as finishing, skills that can quickly be learned by an intelligent and diligent Indian community. As for marketing, Tata will have a substantial domestic market among the emerging Indian wealthy, for whom British nostalgia still represents quality – a lingering and very valuable dividend from the Empire – while internationally it can either play down its national origin or start a marketing campaign based on the vast fleet of Jaguars no doubt owned by the Maharajah of Patiala in the 1930s. Design and research can through modern communications easily be subcontracted to Western boutiques, but after a few years’ Indian experience with the marque there will be every possibility of carrying out those functions also using Indian labor.

In summary therefore, there is no sector of the automobile industry that cannot be mastered by an Indian manufacturer of adequate skill in modern manufacturing and inventive marketing. Since Indian labor costs less than a tenth of British, German or U.S. labor, it is likely if the ethos of globalization and free trade remains that after a moderate period of transition the vast majority of automobiles, cheap, mid-priced and expensive will be designed, manufactured and marketed from India, China or similar economies that retain large skilled workforces and relatively low wage rates.

The idea that, by subcontracting manufacturing to a low-wage-cost country, a wealthy country might be extinguishing its own business contravenes David Ricardo’s 1817 Doctrine of Comparative Advantage. This states that every product should be manufactured in the country where its comparative costs of manufacture are lowest, and that both rich and poor countries gain from enabling this. However, Ricardo’s theorem assumes a static world. In reality the world was not quite static even in 1817, and it has been growing progressively less static ever since.

In Ricardo’s time, it might have taken a Third World manufacturer a couple of generations to acquire not only the manufacturing techniques but also the design, control and marketing know-how of its Western counterpart. Today however, with modern business education, widespread travel and ubiquitous communications, that process can be accomplished in well under a decade. Hence the calculus of comparative advantage changes quickly once outsourcing and technology transfer are undertaken, generally substantially to the disadvantage of the wealthier country’s workforce.

The example of the automobile sector strongly suggests that there are few manufacturing businesses in which Western workforces are truly competitive in the long run. In some areas, such as pharmaceuticals, conventional wisdom has held that new drug advances come only from the well funded laboratories of the majors, or from entrepreneurial biotech companies that rely on the uniquely innovation-friendly California environment to thrive.

However companies such as the Indian Dr. Reddy’s and the Eastern European Pliva and Richter Gedeon suggest that innovation can easily come from out-of-the-mainstream areas.

The belief in large research and development facilities may have been a 1950s fantasy; it is notable that Bell Laboratories, the quintessential such operation, has been progressively downsized and is now owned by the French Alcatel.  

Nevertheless, the education facilities of advanced countries represent a huge physical and intellectual capital, which appears likely to continue paying dividends. Virtual communication across the Internet remains less effective than physical communication over a coffee in the Faculty Lounge, and this is unlikely to change. At the very sharp end of innovation therefore, it seems likely that the most skilled Westerners will continue to give their countries a comparative advantage against emerging markets. However, there is no guarantee that these research-intensive sectors are likely to support the entire Western population, far from it. They are highly cyclical, benefiting hugely from an active stock market and venture capital market. Further there is no evidence that innovation itself, as distinct from the fruits of recent past innovations, is significantly expanding as a percentage of output -- indeed, research expenditure has if anything declined.

A number of service sectors also seem likely to survive. Financial services, like Scotch whisky manufacture, require ample supplies of cheap capital, which would normally give an advantage to wealthier countries. That advantage has been squandered by the decade of excessively low interest rates worldwide, which both eliminated the comparative financing cost advantage of rich countries and forced their citizens’ savings rates down to derisory levels. At this stage, the rich world’s banking systems are in trouble while developing countries have piled up record levels of foreign exchange reserves. It thus seems likely that the financial services business will also migrate to cheap-labor markets, although possibly to a lesser extent than automobiles.

At the bottom of the scale, there are a wide range of services that are location dependent, so impossible to outsource. A haircut in Boston will be essentially identical to one in Bangalore, but will cost much more and employ a correspondingly better-paid barber. Construction by definition takes place where facilities are being constructed. Hotel and retail services are also location-dependent, hence can employ large numbers of low-skill workers in rich countries at wages far above those available in Africa.

Since the majority of location-dependent jobs in Western countries are low-skill it therefore follows that if governments wish to protect local living standards, they need to discourage low-skill immigration. Except in Japan, they have not been doing so; both in the EU and the United States low-skill immigration, frequently illegal immigration, has got completely out of control and is immiserating the working classes. The Economist and the Wall Street Journal calling for looser immigration laws are like Reform Bill-era Whig grandees calling for the workhouse; their urgings are theoretically driven by aristocratic concern for the poor, but in practice betray a complete lack of understanding of what the poor actually want and need.

From the summary above, it is pretty clear that income levels in the West are converging with those in the more competently run emerging markets. The bad news is that in the years ahead this is likely to happen through an absolute decline in Western living standards. The populations of India and China greatly exceed those of all the rich countries put together. Further, as discussed above, the greater part of Western economies is vulnerable to low-wage competition. Thus the economic histories of a high proportion of the Western population under 30, except the very highly skilled, will involve repeated bouts of unemployment, with job changes involving not a move to higher living standards but an angry acceptance of lower ones.

By 2030, it is possible that the median real income in the United States and Western Europe may be no more than 50-60% of its level today.

A number of factors will exacerbate this trend. High low-skill immigration will introduce domestic as well as international competition for low and medium skill jobs, thus quickening the decline in their wage levels. The gigantic baby factories of the poorest Third World countries will provide an ugly Malthusian competition at the very bottom, forcing living standards down still further.

Expansive governments will employ ever higher proportions of Western populations in unproductive ways, thus increasing exponentially the burden on their unfortunate taxpayers and quickening the exit of jobs.

The solution oddly enough lies among the very poorest countries, sub-Saharan Africa, Bangladesh and the worse run areas of Latin America. If their governance can be brought up to an acceptable standard, they too will participate as recipients in the outsourcing of Western industry. However in becoming richer they will inevitably reduce their rate of population growth, as well as increasing demand for Western luxury goods, a sector that seems likely to migrate only slowly to lower-wage countries.  Once the world competes once again on a level playing field, with high quality education and infrastructure as available in Bangladesh as in Baltimore, and no gigantic surplus mob of the unskilled, living standards will begin to increase in tandem worldwide, with both the ex-rich countries and ex-poor countries benefiting. However, until the Malthusian pressure from low-end overpopulation is broken, that desirable point will not be reached.

Thus a combination of improving governance and population control at the very bottom and enlightened economic and social policy in rich countries could both raise world growth rates and slow the convergence of Western living standards with the Third World. This would lessen the drop in Western living standards that must occur before equilibrium has been reached. One is not optimistic however that enlightenment will win out.



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