[Paleopsych] NYTBR: 'Three Billion New Capitalists': Consider the Outsource

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'Three Billion New Capitalists': Consider the Outsource
New York Times Book Review, 5.7.3
[First chapter appended.]

The Great Shift of Wealth and Power to the East.
By Clyde Prestowitz.
321 pp. Basic Books. $26.95.


    IF you've managed to ignore the alarm bells on the outlook for
    American economic leadership -- and you enjoy dreaming -- don't read
    Clyde Prestowitz's ''Three Billion New Capitalists: The Great Shift of
    Wealth and Power to the East.'' It argues that the United States faces
    such serious fiscal and competitive challenges that we may be headed
    not only for a declining standard of living but for a 1930's-style
    depression with a capital D.

    Here's the story. In the golden age, 1950-73, we had it all --
    low-cost manufacturing, rising wages, technological dominance, a
    highly educated and motivated work force, a trade surplus. Until 1971,
    our reserve currency was backed by gold, forcing us to be responsible.
    We had control over our economic destiny. Since then, bit by bit,
    we've lost much of our strength and are in danger of losing the rest.

    Our first problem is the surge in competitiveness on the part of the
    rest of the world, especially China and India, a trend Thomas L.
    Friedman analyzes in detail in [3]''The World Is Flat.'' Even if the
    playing field were level -- which it isn't -- we would not be able to
    compete with the combination of low-cost labor, talent and fire in the
    belly of these two behemoths. Our second problem is that we still
    think we're living in the golden age. In fact, we suffer from a
    misguided sense of superiority, profligate spending habits, a weak
    education system, mammoth debts, a ballooning trade deficit and a
    religious devotion to free-trade theories developed before the
    Industrial Revolution.

    Each of these issues could consume a book, but Prestowitz, president
    of the Economic Strategy Institute and a trade negotiator in the
    Reagan administration, packs them into one. The heart of the question,
    as he sees it, is that we are not defending the jewel in our economic
    crown -- our technology and manufacturing capabilities -- but are
    instead waxing poetic about the virtues of free trade while more
    practical countries walk off with our loot. This, he contends, will
    lead to the gutting of our economy, with well-paid skilled jobs
    replaced by low-paid menial ones, and an America in hock to the
    world's next economic leaders.

    Globalization, of course, is nothing new. The ''hollowing out'' debate
    hinges on whether the United States can replace the jobs it loses with
    equal or better ones. Capitalism is fueled by Schumpeter's creative
    destruction -- new forever displacing old -- and this country has
    thrived through transitions from agriculture to manufacturing to
    automation to outsourcing to services. Free-trade advocates argue that
    globalization is just the latest phase of a continuing evolution.
    Trade hawks like Prestowitz argue that now is different because of the
    sheer size of India and China and our inadequate response to the new

    Globalization has always been a touchy subject (after all, Americans
    lose jobs when companies move production and services overseas) -- so
    touchy that most popular discussion of it is inflammatory or inane or
    both. Last year, John Kerry branded corporations and executives who
    send jobs offshore ''Benedict Arnold companies and C.E.O.'s,'' and a
    White House adviser, N. Gregory Mankiw, provoked many a storm by
    suggesting that offshoring was actually beneficial because, among
    other things, it lowers prices and makes labor available for new
    opportunities. Mankiw may have been impolitic, but Kerry was just
    pandering. If the choice is go offshore or go out of business, a chief
    executive doesn't have a choice.

    Prestowitz acknowledges that many companies can't survive today
    without offshoring, but argues that we often abandon industries we
    could continue to dominate and so lose the ability to lead the next
    wave of innovation. He lays the blame on government, not the private
    sector. ''Whether it recognizes the fact or not,'' he declares, ''the
    United States has a de facto economic strategy, and right now it is to
    send the country's most important industries overseas.'' He observes,
    moreover, that the benefits of offshoring go beyond cost:

    ''You do save money,'' a senior manager at the semiconductor equipment
    maker KLA-Tencor says about sending work to India. ''But pretty soon,
    you realize the work is getting done faster and better, and you start
    sending more and more of it. You also start sending more advanced work
    and then have to figure out what, if anything, you really don't want
    to send.''

    The work is getting done faster and better, Prestowitz argues, because
    Indians are not only hungrier than we are, but better educated. China,
    India, Japan and Europe all churn out more science and engineering
    degrees than we do. Worse -- and downright embarrassing -- is the
    state of American education. Globally, our 12th-graders rank only in
    the 10th percentile in math (that's 10th percentile, not 10th). Our
    students also rank first in their assessment of their own performance:
    we're not only poorly prepared, we have delusions of grandeur.

    One common argument against the hollowing-out theory is that we can
    afford to lose jobs in low-tech manufacturing because we retain our
    high-tech design and manufacturing capabilities. Prestowitz counters
    that China's and India's incentives and resources are so compelling
    that the high-tech work is leaving, too.

    Another argument is that a revaluation of the yuan will curb imports
    and stimulate exports, thus repairing the trade deficit. In fact,
    Prestowitz asserts, our manufacturing capacity has been so gutted that
    we can't export our way out, even if the dollar's value drops to zero.
    The only path is to cut spending.

    But Prestowitz risks sounding like Chicken Little when he pronounces
    the globalization of today more than just another ''gale of creative
    destruction'' to which our economy will eventually adapt.
    Manufacturing has long been declining as a percentage of the United
    States economy, but the jobs lost have been more than offset by growth
    in services (in health care, financial services, law, retailing, and
    so on). Prestowitz points out that services are now being offshored,
    too, but not (yet) at a rate threatening our main growth industries.
    The McKinsey Global Institute, for example, reports that while 24
    million Americans switch jobs each year, only 3 million jobs are
    estimated to go offshore by 2015.

    The critical question, still to be satisfactorily answered, is whether
    offshoring produces net economic gain or loss. Prestowitz deconstructs
    an oft-cited McKinsey study concluding that each $1 of spending sent
    offshore results in an overall gain in the gross domestic product of
    $1.12 to $1.14. He points out the study relies on data suggesting that
    69 percent of displaced workers found jobs at an average of 97 percent
    of their former pay. This leaves 31 percent who didn't find new jobs.
    Not only that, ''if employers took McKinsey's advice to increase their
    offshoring,'' he says, the gain would quickly become a loss.

    In America's boom time, government-business cooperation was considered
    anathema to free-market principles -- ''Politicians shouldn't pick
    winners and losers!'' In Prestowitz's view, the laissez-faire trade
    theories of the 19th century have no place in 2005; since he holds
    that many of our successes have resulted from public-private
    collaboration, most of his proposals for maintaining American
    competitiveness boil down to government taking a more active role. Pay
    teachers more. Help workers move between jobs by offering wage
    insurance and portable health coverage. Reduce oil consumption by
    providing incentives for efficient cars (and include S.U.V.'s in
    mileage regulations). Tax spending, not saving. Help strategic
    industries with federal loan guarantees and grants. Call ''a new
    Bretton Woods Conference'' to set steps for reducing the role of the
    dollar in the world economy and so defuse the trade-deficit bomb.
    Whatever you think about offshoring, most of these ideas are

    Henry Blodget, a former securities analyst, writes frequently for
    Slate and New York magazine.


First chapter of 'Three Billion New Capitalists'


    As the headlines listed in the prologue attest, many world figures now
    fear that a crisis scenario may no longer be a fantasy. American
    leaders are not concerned. None other than former Secretary of State
    Colin Powell recently told the Atlantic Monthly that, "The United
    States cannot be touched in this generation by anyone in terms of
    military power, economic power, the strength of our political system,
    and our values system."

    There are good reasons for Powell's confidence. With just 5 percent of
    the world's population, the United States accounts for over 30 percent
    of its production and almost 40 percent of its consumption. At $11
    trillion, America's gross domestic product is more than twice as big
    as that of the next largest national economy, and its real per capita
    income is far above that of any other major country. Its language,
    American English, is the language of commerce worldwide, and the U.S.
    dollar is the world's money. Go anywhere in the world and people will
    tell you how much something costs in dollars and will accept dollars
    without hesitation. Indeed, Americans have a special privilege in this
    regard: whereas others must first earn dollars in order to buy oil or
    wheat or Toyotas on the international market, Americans only need to
    print more dollars. Of the world's 1,000 largest corporations, 423 are
    American, and the New York and Nasdaq stock exchanges account for 44
    percent of the value of all the stocks in the world. The United States
    is home to the world's finest universities and the overwhelming
    majority of its leading research centers, and it spends more on
    research and development than the next five countries combined. It is,
    quite simply, the richest, most powerful nation the world has ever

    Americans long ago adopted the view that helping the rest of the world
    get rich is good for America. And thus, for the past half century, the
    United States has-through the process of globalization-orchestrated
    the growing integration of national economies to create an
    international exchange of goods, services, money, technology, and
    people. The results have been as intended and expected. This
    globalization has largely been directed by America, but it has
    enhanced American wealth and power by enabling others, particularly
    our allies, to flourish. It was this process, not military threats,
    that won the Cold War by lifting billions in the free world out of
    poverty and creating centers of wealth and power around the planet. In
    Asia, Japan became the world's second largest economy; other countries
    like Singapore and South Korea flourished so greatly that they became
    known as "tigers." Across the Atlantic, the European Union grew from
    six to twenty-five countries and introduced the euro, the first common
    European currency since Roman times. In Latin America, Mexico has
    attracted huge foreign investment by becoming a virtual extension of
    the American economy, and Brazil is flourishing by dint of American
    and other foreign investment.

    Although American corporations initially led globalization, they are
    no longer the only or even the dominant players. Sony, Nokia, Cemex,
    and Samsung are just a few of the growing numbers of non-American
    companies that have become global household names. Of course, American
    influence has not disappeared. American music, clothing styles, sports
    stars, and movies are not the only entries, but they set the pace, as
    have Silicon Valley entrepreneurs and the Nobel Prize winners of great
    American universities like MIT, Harvard, Stanford, and Caltech. Some
    people and countries have been uncomfortable with the American flavor
    of this system and have criticized globalization as a euphemism for
    Americanization. Yet they have found it hard to resist-one of
    McDonald's most successful restaurants being on the Champs Elysées in
    Paris, for example.

    In the end everybody seems to want to join, and in fact almost
    everybody has joined. "Globalization" was an odd term to use during
    the Cold War because half the world was socialist or communist and not
    playing. A citizen of the communist bloc who dared to even suggest
    playing risked being purged (or worse) as a hated "capitalist roader."

    Over the past two decades, however, China, India, and the former
    Soviet Union all decided to leave their respective socialist workers'
    paradises and drive with their combined 3 billion citizens onto the
    once despised capitalist road. Although these people are mostly poor,
    the number having an advanced education and sophisticated skills is
    larger than the populations of many first world countries. They are
    arriving on the scene in the context of revolutionary changes. A
    series of global treaties, concluded largely at American behest, has
    dramatically lowered trade and investment barriers, making the old
    rutted capitalist road a lot smoother. With contract manufacturers
    that can produce anywhere in the world and express delivery companies
    like FedEx and UPS that can deliver anywhere in the world in
    thirty-six hours, the road has become a highway. Finally, the global
    deployment of the Internet negated time and distance for transactions
    that can be done in bits instead of atoms. Now the highway is a
    high-speed capitalist raceway, and those 3 billion new people driving
    on it are, effectively, in your office and living room, and you are in
    theirs. All of this has generated a whole new wave and model of
    globalization that is turning the world upside down.

    The global economic system was designed during the Cold War to attract
    these newcomers to capitalism, but no one actually anticipated that
    they would join or what their absorption into it would mean. Although
    this new wave of globalization has many potential advantages for
    everyone, it also poses serious challenges. It comes at a time when a
    fundamental flaw in the international economic structure has combined
    with American self-indulgence and Asian mercantilism to stress the
    system and make it vulnerable. The irony here is that the winners of
    the Cold War were less prepared for victory than the losers were for
    defeat. Thus the impact of the new wave, if not handled carefully,
    could bring the whole system crashing down.

    They Can't Move the Snow to India

    It was in the winter of 2003 that my oldest son, Chummy, gave me my
    first glimpse of the powerful forces being unleashed by the new
    capitalists and how they might interact with the old system and
    structures. We were skiing on the north side of Lake Tahoe in
    California, where he lives. On the lift he asked if I would consider
    coinvesting with him in a local snow-removal company.

    "What do you mean by snow removal?" I asked, somewhat surprised
    because my son is a high-level software developer.

    "Well," he explained, "the company has contracts to plow the parking
    lots and access roads of the hotels and vacation condominiums around
    here whenever it snows, and that happens pretty frequently between
    November and May."

    "But what on earth are you doing," I exclaimed, "going into something
    as mundane as snow plowing?"

    "Dad," he said, "they can't move the snow to India."

    It took a minute for that to sink in. It had never occurred to me that
    my son had anything to fear from India or anywhere else in terms of
    his career path. It was I, after all, who had advised him to go into
    computer science, secure in the knowledge that it would put him in a
    position to write his own ticket. When I asked if his job was in any
    danger, he thought it unlikely but noted that "outsourcing" is the new
    management buzzword.

    "You can never be sure," he said, "that some MBA hotshot with little
    knowledge of the technology but a big need to impress top management
    with his or her sophistication won't decide to move the whole
    operation offshore to India or elsewhere."

    My son further explained that all the big consulting and service firms
    like Bearing Point, IBM, Deloitte, and others were making daily
    pitches to top management on how much they could save by outsourcing
    to India.

    After asking about the snow removal company's financial status and
    agreeing to put in a few dollars, I decided to add India (where I
    hadn't been in twenty years) to the countries in Asia I was scheduled
    to visit over the next four weeks.

    At my first stop in Tokyo, discussion centered almost exclusively on
    China. The tone of the talk was somewhat schizophrenic. Several years
    ago the Japanese had feared being "hollowed out" as China took over
    production of steel, machine tools, and electronic components, but now
    they were talking of China as an opportunity. They even spoke of China
    possibly replacing America as the world's growth engine and of Japan
    orienting itself more toward China and less toward America. They were
    proud of their corporate and national strategy for maintaining a
    strong manufacturing base that allowed them-unlike the United States,
    which they said had little to sell-to capitalize on the China boom.
    Yet in the hon-ne, or real truth, of quiet conversation after a few
    drinks, Japanese corporate and government leaders alike wondered how
    Japan would be able to compete with China in the future.

    In Beijing and Shanghai I was struck again, as I have always been
    during my visits over the past twenty years, by the rapidity of
    China's continuing modernization. Stay away from China for six months
    and you no longer recognize the place when you return. As I took the
    twelve-minute ride from the airport to downtown on Shanghai's new
    maglev bullet train, I couldn't help thinking how nice it would be to
    have something like this in America. That thought recurred over the
    next few days as I made my rounds of factories, government offices,
    consulting firms, and think tanks. By now everyone knows that China is
    the world's location of choice for low-cost commodity manufacturing.
    But what I kept hearing and seeing was that it is also rapidly
    becoming the location of choice for high-tech manufacturing and even
    research and development.

    This impression was greatly strengthened by my visit with old friends
    at Motorola in Beijing. In the 1980s, as the U.S. trade deficit began
    to soar, Motorola was a prime leader in an effort to ensure continued
    high-tech production in the United States through a coordinated
    industry-government program to improve U.S. high-tech competitiveness.
    Now, I was told, Motorola had just moved a big part of its
    manufacturing and R&D to China.

    I winged on to Singapore, where I was scheduled to meet with the
    senior minister and father of his country, Lee Kuan Yew. I knew that
    Lee, having foreseen that China would displace Singapore as a low-cost
    manufacturing location, had been urging a new high-tech and
    service-oriented strategy for the now wealthy and high-cost
    city-state. How did he view the future? With concern, was the answer.
    China was moving much faster than even he had anticipated, and India's
    domination of services was completely unexpected.

    In India, after a tour of Delhi, Hyderabad, Chennai, and Bangalore, I
    realized I was seeing a revolution-a different, more exciting, and
    more challenging future than I had imagined. In the "accent
    neutralization" classes at call center training schools, I listened to
    English-speaking Indian young people learn to sound like people in
    Kansas or Ottawa. Thus, if you're a customer of Dell Computer or
    United Airlines or some other U.S. company phoning a call center to
    get tech support or make reservations for a trip, you will think
    you're talking to someone across town or in another American city; you
    won't realize that India is at the other end of your line. In
    Hyderabad I met with Raju Ramalinga, the founder of Indian infotech
    services provider Satyam, and I listened as he explained how in 1972
    he had started sending programmers to U.S. clients for limited
    software writing contracts. Now, at their request, he has taken over
    complete management of those clients' back offices all over the world.
    By doing the work at the Satyam campus outside of town, he cuts client
    costs by 70 percent. In Bangalore I saw 1800 Indians with Ph.D.s in
    electrical engineering and computer science designing Intel's latest
    chips. Again, the cost savings were huge; more importantly, Intel
    couldn't find the same number of equally qualified people in the
    United States. In Chennai I visited the new biotech industrial park to
    be directed by Krishna Ella, a University of Michigan Ph.D. who, after
    several years at the leading edge of biotechnology in the United
    States, has come home to India, where costs are 20 percent of those in
    the U.S. market. By the end of my tour, I understood my son's interest
    in snow removal. I also understood why the notion of outsourcing was
    sending shivers down the spines of millions of formerly secure
    upper-middle-class professionals who were beginning to appreciate how
    blue-collar workers feel about visiting the unemployment office.

    I flew home via Frankfurt and Paris. On the Lufthansa flight from
    Delhi, I read the cover story in Der Spiegel about whether, in
    response to global competition, Europeans could bring themselves to
    change from their current thirty-five-hour work week to a forty-hour
    one. After what I had seen over the past three weeks, the question
    seemed trivial. Can Europe survive? is more appropriate, I thought.
    But then I remembered that the maglev trains in Shanghai were built in
    Europe, that Finland has a trade surplus with China, and in Europe my
    cell phone would work everywhere, instead of only in certain
    locations, as it does in the United States.

    At Charles de Gaulle Airport in Paris, I bought a pile of newspapers
    and magazines for the flight to Washington Dulles. The Guardian of
    London had a front-page story about how the deficit-ridden British
    National Health Service was thinking about air-expressing blood
    samples to India for analysis to save money. Lab results would be
    returned via e-mail.

    As I arrived in Washington, tax time was fast approaching. So I booked
    a quick appointment with my tax accountant at a medium-size local
    firm. As we chatted about my expenses, donations, and deductions, I
    happened to mention that I was just back from India.

    "India!" he exclaimed. "We just did a deal to move our whole data
    processing operation to Bangalore. Your taxes will actually be
    calculated there." He explained that the move was saving the firm 80
    percent on its processing costs. (I wondered why my bill was not being
    reduced, but that's another book.)

    That night I phoned my daughter to let her know I was back and to get
    caught up on the grandchildren. . . .

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