Tuesday, December 20, 2016

Moving Jobs to Mexico

         President-elect Trump and other critics of NAFTA seem especially concerned about U.S. firms moving manufacturing operations from the U.S. to Mexico and then exporting their products to the U.S.    U.S. domestic production is decreased and U.S. imports are increased.

        The concern is especially described as a transfer of jobs from the U.S. to Mexico.   U.S. workers lose their jobs and Mexican workers obtain jobs.   One of the common economic fallacies in the notion that "jobs" are a limited resource and this appears to redistribute some of the scarce jobs from Americans to foreigners.

         Of course, it is labor that is scarce rather than "jobs."    Shifting production of some good from the U.S. to Mexico is only efficient if there is a comparative advantage in Mexico relative to the U.S.   That means that the opportunity cost in Mexico is lower than the opportunity cost in the U.S.

         Perhaps it is a matter of too much abstraction in my thinking, but the process by which Mexican production of some good partially or fully displaces U.S. production of that good would involve entry by Mexican entrepreneurs with lower production costs  who then drive the higher cost U.S. producers out of business.     Having the U.S. producers promptly shut down and open a new facility in Mexico would seem to be a more efficient means of accomplishing the same end.

       The logic of comparative advantage is that the expansion of Mexican production comes at the expense of other Mexican industries with relatively higher opportunity costs.   Labor and other resources are pulled away from the production of products where Mexico does not have the comparative advantage.  

      Further, the contraction of this U.S. industry frees up labor and other resources to produce products with relatively lower opportunity costs.   Resources are pushed into the industries where the U.S. has the comparative advantage.

       However, the "moving jobs" to Mexico scenario combines this with a shift of capital resources from the U.S. to Mexico.    Imagine the factory is loaded onto a giant truck and hauled across the border.   Capital would literally move from the U.S. to Mexico.

       The shift of capital resources away from the U.S. would typically reduce the demand for complementary factors in the U.S., in particular U.S. labor.   While this would tend to lower wages and labor income, the reduction in the supply of capital in the U.S. would tend to result in a higher rate of return on capital in the U.S.   When combined with the earnings on foreign investment, total income would rise.   The result would tend to be lower U.S. GDP but higher U.S. GNP.

       This process of factor income equalization is not tied to the trade flows that depend on comparative advantage.   Suppose there were no trade in goods and services between Mexico and the U.S.    They could still put the factory on a truck and shift it over the border and sell their product in Mexico.   The remaining U.S. producers would earn more profit and there would still be lower U.S. wages.

       The primary effect of combining the two processes--shifting U.S. capital to Mexico while importing products from Mexico is that U.S. consumers and workers benefit from lower import prices while seeing some increase in imputed labor demand from export industries.    GDP is decreased by the shift of capital resources but increased due to the reallocation of resources according to comparative advantage.  The effect on domestic production and labor income is ambiguous while the effect on capital income, when including the return on foreign investment, is positive.

       Now, in reality, the U.S. has a net capital inflow.   While the shift of factories from the U.S. to Mexico is a capital outflow, it is more than offset by other shifts of capital to the U.S.   We know this from observing the U.S. trade deficit which is matched by a net capital inflow.   Real interest rates in  the U.S. are at historically low levels, suggesting that U.S. labor incomes are not suffering due to a process of international factor price equalization.

       The process of factor price equalization--the transfer of capital resources from where the returns are low to where they are high--raises world output and income.   It raises income from capital on the whole.   But it does tend to reduce labor incomes in those areas that had what in hindsight was an over-abundance of capital.  

        However, the phenomenon of convergence, by which lower income countries grow rapidly and approach the level of per capita income of high income countries, is not primarily a matter of comparative advantage or capital flows.  The key is rather adopting better technology.  This should be understood broadly to include new products and production techniques, but also methods of organization and even policies and social norms.   This allows what were desperately poor people to produce more, earn more, and consume more.  For the most part, they demand the added products they supply.
       

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