I wrote this over 15 years ago and it's a little outdated. Much less outdated is: Financial Collapse of U.S.
Not long ago I believed in free trade, meaning that the U.S. and other countries should not impose tariffs to impede the free exchange of goods in foreign trade. I believed in the model presented in most freshman economic textbooks showing that each country should specialize in what it does best. If one country is good at growing apples and another good at growing bananas, then they should exchange apples for bananas without any tariffs to restrict such trade. Elementary economic textbooks show that everyone is better off this way.
Unfortunately, the economic textbooks I read (including ones I looked at recently) don't consider the case of the transfer of capital from one country to another. In this case it can mean poverty (and even homelessness in the country that is losing capital.
This essay will analyze extreme cases in order to gain an understanding of what happens when the actual situation is not so extreme. Consider the following extreme example: Suppose that the population of a country consists of production workers, service workers, and dependents. Dependents include retired people receiving pensions since the other working people need to support them. The owners of production facilities (manufacturing, mining, farming) are included under "production workers" even though some of them don't do any actual production work. Production workers are divided into manufacturing and non-manufacturing productions workers. Non-manufacturing production workers would include farmers, miners, and oil extraction workers.
Assume that 10% of the manufacturing workers in this hypothetical country own all of the capital used in such manufacturing such as factories. This means that the remaining 90% of manufacturing workers are dependent on the capital of the rich 10% for their livelihood. Assume that all of this capital is readily mobile and can be transplanted to foreign countries where wages are low and thus such capital will garner more profit. If it is so moved to foreign countries, then the 90% of manufacturing workers that don't own the capital are deprived of their means of existence.
Not only that, but the people in the service sector which depended on the above 90% in the manufacturing sector are also out of work. Only the rich 10% of manufacturing "workers" that own the capital are better off since they now make more profit on it. They will also be able to support a larger service sector on their higher profits. But by no means will they be able to employ the huge service sector that lost their jobs due to the 90% of manufacturing workers loosing their jobs.
If this extreme example were the U.S., then nothing is produced in the US anymore and the profits made by the 10% are used to pay for imported foreign goods for these 10% and what remains of the service sector. The vast majority of Americans are unemployed and the 10% that make income from their ownership of capital (now deployed in foreign countries) just don't have enough income to pay sufficient taxes to support the unemployed with sufficient benefits or welfare. Thus the huge number of unemployed will have to do something drastic to survive such as be willing to work for the low wages close to that of third world countries so that capital will return to the US. These wages are so low that many workers will have to live in slum housing under crowded conditions or be homeless as is currently the case in many poor countries today. Crime is likely to be high. Even revolution is a possibility.
Of course the above scenario is extreme and will likely not happen here. But to a certain extent, some of it is already occurring. This example clearly shows that if one moves capital out of the US, then US workers become poorer. It is sometimes said that laid-off manufacturing workers should obtain jobs in the service sector, and many of them have done so. But the above model shows that as capital is exported, there is less real income from manufacturing to spend on the service sector. Thus if such a laid-off manufacturing worker does obtain work in the service sector, it is likely to result in someone else loosing a job in the service sector and/or in depressing wages in the service sector.
In a way, the above scenario is overly optimistic because in reality, foreigners own U.S. investments and take interest and profits out of the US resulting in the net value of profits returned to the U.S. from the foreign investments of rich Americans being about zero. More on this later.
In case the reader is not familiar with the dependence of the service sector on the production sector, here is a brief explanation. In order to live we must produce things, especially food, clothing, and shelter This includes the materials necessary to repair clothing and shelter. Some things we produce are not essential, but can be traded (or sold) for more essential goods (food, clothing, and shelter). The above is not intended to imply that it is usually better to produce new goods and throw away old goods but even repair requires production of new (or rebuilt) parts.
With modern technology, people who produce things create much more value of material goods than they themselves need. Thus their production (after exchanging it via money for other material goods) is shared with their non-working dependents and with people they employ directly and indirectly in the service sector. The owners of the capital often get a share too. If you hire a mechanic to work on your car or a plumber to work on your home, you are directly employing someone in the service sector (for a brief period of time of course). Sales clerks, doctors, lawyers, ministers, and maids are also in the service sector. Our taxes support many people in the service sector such as teachers, policemen, soldiers, bureaucrats, etc. Many occupations belong to both the service sector and the production sector. When a plumber repairs a pipe in a factory he is working in the production sector. When he works in your home his is working in the service sector. Government statics tend to overcount people in the service sector and would likely count the plumbing repair in a factory as a service if the plumber is not employed by the factory.
A rich person may support several people in the service sector while a poor person may support only a tiny fraction of a person in the service sector. On average, each person directly supports less than one other person in the service sector since otherwise there would have to be an infinite number of persons in the service sector. For example, if each and every person directly supported one other person in the service sector you would have the following impossible situation: person1 supports service person2; person2 in turn supports person3 (in the service sector); person3 supports person4, etc. There is no end to this series resulting in an infinite number of people in the service sector which is clearly impossible.
As shown above, people working in the service sector also need others in the service sector to provide services for them. If every person required 2/3 of a person in the service sector then it is trivial to show that there will be twice as many people in the service sector as in the production sector. Each production worker requires 2/3 of a service worker, but that 2/3 of a service worker in turn needs the services of 2/3 of a service worker and so on ad infinitum. The total number of service workers engendered by the production worker is thus the sum of an infinite geometric series which is equal to 2 in this case. Since incomes are far from equal such a simple example is far from realistic but it does give one the general idea.
As productivity increases, each production worker can support more service sector employees. Computers and automation contribute to increased productivity. However, fossil fuel energy resources are being depleted at a rapid rate. As a result, energy becomes more costly and productivity tends to drop. Reducing pollution also tends to decrease productivity (at least in the short run). Thus one can't assume that in the future we are bound to increase our productivity so that we can employ more people in the service sector. Now let's examine what happens if someone looses a job for various reasons.
If someone is not doing a good job and gets fired, someone else normally gets the job and there is no change in employment. Now suppose that due to an increase in productivity, someone is laid off. If the productivity increase is due to buying machinery to replace the worker, then jobs are created due to the work of manufacture and design of such machinery. But suppose that the person is laid off due to figuring out how to be more efficient without having to buy any more machinery. In this case production costs drop, and if the industry is competitive, prices (on average) should drop also. The lower prices mean that the public has more money to spend buying other goods and services and this gives someone else a job. If the industry is monopolistic, government regulation is supposed to force the lowering of prices when costs drop. Even if the cost savings go entirely to the owners in the form of increased profit, the owners now have more money to spend which should result in the creation of another job. Another outcome could be that due to lower prices, people decide to work less since they need less money. Someone may actually quit their job who doesn't really need to work and thus provide a job opening for someone who does need to work.
The above analysis is obviously oversimplified. Actually some combination of all of the above outcomes may take place due to someone losing their job due to productivity improvements. One also needs to consider wage rates. If a high wage worker gets laid off the savings may be enough to hire two or more lower paid workers. Exactly what the economic impact occurs when a certain person loses a job is unknown but one may attempt to estimate the approximate probability distribution of various possibilities. When you read here that a new job is created, it actually means that there is a significant probability that a job will be created. It is also possible that no new job will be created or that more than one new job will be created (including part-time jobs).
What the previous discussion implies is that productivity improvements which directly result in someone losing their job are likely to create a job somewhere else and thus be socially beneficial since more is being produced with less labor. Society now has more income to spend, hopefully on improving the quality of life such as more leisure time, more teachers, etc. Unfortunately the increased income might be spent on vices such as drugs and gambling. But hopefully it will be more wisely used.
Now let's look at what happens if someone is laid off due to moving the capital and machinery one works with out of the country resulting in hiring a foreigner working in a foreign country to do the same work for much less pay. If the price of the manufactured good drops, then consumers have some more money to spend in the service sector. But what happens to the money that is sent abroad to pay for the foreign made good? The US dollars that the foreigners get goes right back to the US to create a job here (or does it?). Actually much of this money comes back as loans to the U.S. But (contrary to current reality) assume that foreign trade is in balance and that the money comes back to the U.S. to buy our manufactured products.
Since capital has left the US there may be a lack of suitable capital in the US to create this new job. If the person laid off could sell his/her services to the foreigners who hold the US dollars, then a new job might be created here. But it's real goods that are readily exportable and not services.
What is likely to happen is that the person laid off winds up without work and almost ceases to consume. This reduction in consumption frees up capital machinery to permit it to be used for making goods for export which are then sold to the foreigners for the US dollars they hold. The net result is that there is one more American unemployed and less generation of real goods in America since the capital to produce them has been shipped abroad. Americans consume less of what is made in U.S.A. and foreigners consume more of it.
Even though the unemployed person may still consume some due to charity ,welfare, or unemployment insurance, others have to reduce their consumption in order to pay for these handouts. Thus America is worse off due to the transfer of capital out of the US. Of course the service jobs that depended on the income of this production worker are also lost. Note that the following has happened: exports and imports have increased but production in the US has decreased and someone (or a fraction of a person) is out of a job. Thus the claim often made that capital flight to foreign countries helps increase our exports is true and while one expects that an increase in exports will lead to an increase in employment, the opposite result is obtained. The increase in exports comes at the expense of a decrease in consumption inside the US and not from an increase in production.
As capital leaves the country, more of the capital that remains is put to work making goods for export that foreigners will enjoy. If this process were to be carried out to an extreme degree, eventually almost all production would be for export. If a plant is producing almost entirely for the export market, it become very enticing to move that plant abroad near its markets. Once all production is so moved the extreme example where nothing is made in the USA anymore (presented in the first part of this article) becomes true.
One may wonder how a new job is created when someone is laid off due to productivity improvements. Doesn't this also require new capital investment? The answer is "not necessarily" since the new job may be in the service sector where little new capital may be required.
In the past, unstable foreign governments in the third world, the threat of revolution there, and the existence of the second world (the Communist Block) which we didn't trust to invest in, deterred foreign investments. Events such as the taking over of US Oil Companies in Mexico took a long time to forget. Today the situation has changed and foreign investment is much more attractive. If some U.S. companies in an industry are able to produce goods in foreign countries at less cost, then the rest of the industry is forced to do the same in order to compete, all at the cost of American jobs.
The richness of America was due to the production of real goods which we both consumed and traded with the rest of the world. An unemployed individual can't just go into business and manufacture goods (or grow food) in a competitive manner without a great deal of capital. Thus most of us are dependent on using the capital of the rich to supply our livelihood. This is true also for the service sector since such jobs depend on the surplus produced in the production sector. It's thus desirable that this capital (and new capital made to replace it) remain in the US.
How can this be done? One way is restriction of foreign trade such as tariffs. This has a downside since it tends to keep out foreign goods of high quality and allow US manufacturers to neglect quality, efficiency, and technological innovation. Another way to encourage capital to remain in America is lower wages. Although this hurts the workers whose wages are reduced, it may be better that no job at all or a possibly lower paying job in the service sector. Lower wages in a competitive industry also means lower prices so that others obtain benefits from these lower wages. Another beneficial effect is the reduction of (or elimination of) inflation.
Is there any way to simply prohibit the moving of capital from the US to foreign countries? This is not easy since one method of moving it today is to simply let the plant and machinery wear out or become obsolete and then ship new modern machinery abroad or buy it from abroad. Would we want to restrict the export of newly made capital goods to other countries? Probably not, since much of our exports consist of such goods. One way to decrease the outflow of capital is by taxation. Taxing profits made in foreign countries at a higher rate will discourage the foreign investment which engenders such profits.
One problem has been the low rate of savings in the US. If we are to invest in America, we need to save up money to make these investments. High income people that have much more income than they need to live on often don't need much encouragement to save. One way to encourage savings by moderate income persons is to exempt a certain amount of interest/dividend income from taxation.
Another way is by "forced savings" where the government taxes money away from workers and saves it. We already have such a tax known as Social Security only most of the money the government take in for it is used to pay benefits to others and is not saved or invested. If Social Security had not been so generous in the past, it would have accumulated a huge investment fund which would have provided more capital (and jobs) in America.
Another policy that would help would be the reduction in world population so that there would not be the huge surplus of labor in foreign countries that drives down the wage rate.