“How to Run a Cheap Foreign Labor Economic Model”

Yves here. In a bit of “cart before the horse,” I’m featuring this post on an approach to labor arbitrage that despite having a certain internal logic, serves to illustrate how far out of whack the debate over unregulated international trade has become. I hope to have a bigger-picture post on this topic in the next week or so.

What Llewellyn-Smith describes is carving a portion of Australia to serve the role of an old-fashioned colony.

Aside from not considering that Australia as a currency issuer has more degrees of freedom budget-wise than conventionally trained economists do, the article tacitly accepts the corporate outsourcing/offshoring canard of the importance of low level labor costs in total product costs of manufactured goods. As we’ve said repeatedly, in most large companies, the case for offshoring/outsourcing is weak to non-existant, particularly if you adjust for risk. Any savings at the bottom of the food chain is offset by higher coordination costs (as in time of much more costly manufacturers), increased transportation and financing costs, greater inventory risks, more business system rigidity, and loss of key skills (knowing about factory floor issues can be critical intel in designing and launching new products). We’ve repeatedly said that offshoring is best regarded as a transfer from low level workers to supervisory and C-level personnel, rather than a net cost saving.

By David Llewellyn-Smith, founding publisher and former editor-in-chief of The Diplomat magazine, now the Asia Pacific’s leading geo-politics website. Originally published at MacroBusiness

Given that’s what we’re doing, and screwing ourselves royally in the process, here’s some advice on how to do it properly.

First, you set up a special economic zone where the normal rules do not apply. This should include lower taxes and no industrial relations laws. Put it somewhere out of the way of the press but as close as possible to your target markets. Northern Australia or even our far flung refugee gulags are ideal.

Then invite capital in by building the infrastructure needed to turn it into a low-end manufacturing dynamo. Build ports and large domiciles where underpaid foreign workers can be packed in like sardines. Import gas and power from Indonesia given Australian is now cartel-priced and add real local area NBN (as opposed to our national joke). Roads aren’t needed. Nobody is going anywhere.

The money will flow in as all sorts of cheap assembly outfits see the upside. We’ll repatriate all kinds of businesses that were long ago lost to China and South East Asia. Moreover, the zone will run enormous current account surpluses with such low costs and high exports, contributing an off balance sheet boost to the national external account.

Local profits will soar for the listed firms engaged, the tax take will rise and wider income growth will get a boost from the extra demand, rising share prices and tax cuts.

This can be contrasted with what we’re actually doing, which is importing cheap foreign labor into our formerly high wages services economy.

When you do that what happens is wages get systemically undermined. Profits for those businesses that are exposed to the rising volume of demand and the falling wages enjoy a margin boost. These will include property developers, banks and some retailers (though certainly not all). That’s because the wider economy gets bogged down as wages growth stalls and falls.

Inequality begins to rise as those exposed to the upsides of the cheap labor imports gallop ahead of the vast majority. Indeed, most see falling living standards as the people flood overwhelms infrastructure and public services, in tandem with their falling wages. This is exacerbated by rising asset prices, which also serves to drive youthful talent offshore.

The tax take begins to crumble as its largest source – income taxes – gets hammered. Government in general begins to destabilise as standards of living fall without explanation.  That, in turn, further upsets confidence, lowering investment and consumption. The economy bogs down even more.

Yet despite the weakness, the external account deteriorates as externally funded banks and government borrow to fund the mortgages and a build-out for all of those imported folks who consume more but add little to exports, given they all now work in sectors servicing their own booming numbers.

Eventually, an increasingly desperate population used to rising standards of living turns to cranks and nut jobs for solutions instead of established parties. At least they point to the elephant in the room and express grievance. Politics disintegrates.

I mean, really, if you’re going run an economy on cheap foreign labor, there is only one way to do it sensibly.

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