The Second Machine Age

Could [globalization]  be the reason that median wages have stagnated in the United States and other advanced economies? A number of thoughtful economists have made exactly that argument. The story is one of factor price equalization. This means that in any single market, competition will tend to bid the prices of the factors of production—such as labor or capital—to a single, common price. Over the past few decades, lower transaction in communication costs have helped create one big global market for many products and services.

Businesses can identify and hire workers with skills they need anywhere in the world. If a worker in China can do the same work as an American, then what economists call “the law of one price” demands that they earn essentially the same wages, because the market will arbitrage away differences just as it would for other commodities. That’s good news for the Chinese worker, and for overall economic efficiency. But is not good news for the American worker who now faces low-cost competition. A number of economists have made exactly this argument. Michael Spence, in his brilliant book The Next Convergence, explains how the integration of global markets is leading to enormous dislocations, especially in labor markets.

The factor price equalization story yields a testable prediction: American manufacturers would be expected to shift production overseas, where costs are lower. And indeed manufacturing employment in the United States has fallen over the past twenty years; economists David Autor, David Dorn, and Gordon Hanson estimate that competition from China can explain about a quarter of the decline in U.S. manufacturing employment.

However, when one looks more closely at the data, the globalization story becomes much less compelling. Since 1996, manufacturing employment in China itself has actually fallen as well, coincidentally by an estimated 25 percent. That’s over thirty million fewer Chinese workers in that sector, even while output soared by 70 percent. It’s not that American workers are being replaced by Chinese workers. It’s that both American and Chinese workers are being made more efficient by automation. As a result, both countries are producing more output with fewer workers.

In the long run, the biggest effect of automation is likely to be on workers not in America and other developed nations, but rather in developing nations that currently rely on low-cost labor for their competitive advantage.  If you take most of the costs of labor out of the equation by installing robots and other types of automation, then the competitive advantage of low wages largely disappears. This is already beginning to happen. Terry Guo of Foxconn has been aggressively installing hundreds of thousands of robots to replace an equivalent number of human workers. He says he plans to buy millions more robots in the coming years. The first wave is going into factories in China and Taiwan, but once an industry becomes largely automated, the case for locating a factory in a low-wage country becomes less compelling. There may still be logistical advantages if the local business ecosystem is strong, making it easier to get spare parts, supplies, and custom components. But over time inertia may be overcome by the advantages of reducing transit times for finished products and being closer to customers, engineers and designers, educated workers, or even regions where the rule of law is strong. This can bring manufacturing back to America, as entrepreneurs like Rod Brooks have been emphasizing.

A similar argument applies outside of manufacturing. For instance, interactive voice-response systems are automating jobs in call centers.  United Airlines has been successful in making such a transition. This can disproportionally affect low-cost workers in places like India and the Philippines. Similarly, many medical doctors used to have their dictation sent overseas to be transcribed. But an increasing number are now happy with computer transcription. In more and more domains, intelligent and flexible machines, not humans in other countries, are the most cost-effective source for ‘labor.’

If you look at the types of tasks that have been offshored in the past twenty years, you see that they tend to be relatively routine, well-structured tasks. Interestingly, these are precisely the tasks that are easiest to automate. If you can give precise instructions to someone else on exactly what needs to be done, you can often write a precise computer program to do the same task. In other words, offshoring is often only a way station on the road to automation.

In the long run, low wages will be no match for Moore’s Law. Trying to fend off advances in technology by cutting wages is only a temporary protection. It is no more sustainable than asking folk legend John Henry to lift weights to better compete with a steam-powered hammer.