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  • The Economist

The Great Unbundling

Does economics need a new theory of offshoring?

Globalisation is a big word but an old idea, most economists will say, with a jaded air. The phenomenon has kept the profession’s number-crunchers busy, counting the spoils and how they are divided. But it has left the blackboard theorists with relatively little to do. They are confident their traditional models of trade can handle it, even in its latest manifestations. For example, Greg Mankiw, of Harvard University, has concluded that “services offshoring fits comfortably within the intellectual framework of comparative advantage built on the insights of Adam Smith and David Ricardo.”

Ricardo illustrated his insights with the example of Portuguese wine trading for English cloth. But some trade theorists think this metaphor will no longer do. Indeed, two of them — Gene Grossman and Esteban Rossi-Hansberg, of Princeton University — published a paper last year (“The Rise of Offshoring”) subtitled “It’s not wine for cloth anymore”.

Ricardo, it seems, did only half the job. He described the first of two “great unbundlings” — as Richard Baldwin, of the Graduate Institute of International Studies in Geneva, has put it in a recent guide (“Globalisation: The Great Unbundling(s)”). Trade in wine, cloth and other goods allows production to be distanced from consumption. Countries do not need to grow grapes to enjoy the fruit of the vine; thanks to trade, they can transform cloth into wine instead.

But in Ricardo’s world, a country must still take care of all of the separate tasks required to finish the goods it makes. In a country of pinmakers, to take Adam Smith’s seminal example, someone must still cut, draw and straighten the wire; fashion and affix the head; then whiten and sheath the finished product, if any pins are to be made at all.

In the second great unbundling, production is spliced and diced into separate fragments that can be spread around the globe. Pin-whitening is done in one country; wire-cutting in another. Some theorists call this the “vertical disintegration of production across borders”. Thankfully, Messrs Grossman and Rossi-Hansberg have a more felicitous phrase: “trade in tasks”.

As globalisation has advanced, it has become easier to move some of these tasks offshore. For the workers who once carried them out, this has three possible consequences, two bad, one good. Start with the good news. Offshoring makes firms more productive. The tasks that are best kept close to home remain onshore; other tasks can be taken care of in cheaper places abroad. Everyone benefits from this gain in productivity, including the workers who have fewer tasks to perform. For example, Japanese electronics companies continue to flourish in American markets precisely because they have moved their assembly lines to China.

The second potential consequence of offshoring might be called the “Lou Dobbs effect”, after America’s most prominent television mercantilist. When some tasks are taken overseas, that leaves less work for patriotic Americans to do, right? Well, maybe. If a whole industry leaves America’s shores, demand for labour will ebb, and wages will fall. But in less extreme cases, relieving workers of some of their tasks (wire-cutting for example), allows the domestic industry to expand — and a bigger industry might find room for the displaced wire-cutters, at the same wage, albeit on different tasks.

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