Offshoring: Week 12, Part Two Transcript PDF

SPEAKER 0 Moving on now from the service economy to offshoring our second lecture of the week, I want to explain how these two lectures are related. But first, I wanted to give you some definitions. So we're all reading from the same page. A good definition of offshoring is the location of producti...

SPEAKER 0 Moving on now from the service economy to offshoring our second lecture of the week, I want to explain how these two lectures are related. But first, I wanted to give you some definitions. So we're all reading from the same page. A good definition of offshoring is the location of productive facilities outside a firm's home market for the purpose of making goods to be sold in that home market. So Canadian company producing something outside of Canada to be sold back in Canada essentially is one good example. It's a one way it differs from foreign direct investment is that offshore facilities aren't built to produce goods for sale in the country where they are located. Instead, the goods are typically part of a global production process where offshore production, distribution and sales are often managed entirely within a single multinational enterprise rather than through transactions between independent parties. Offshoring is also not the same as outsourcing. Although they are closely related outsourcing occurs when a company purchases goods or services from an independent foreign supplier that could have been procured domestically. The primary difference lies in corporate control. Offshoring involves a company establishing and managing its own facilities in a foreign location. While outsourcing relies on an external supplier in that location. All that said in practice offshoring and outsourcing often overlap with one another and one can lead to the other and it goes both ways, one can lead to one and, and vice versa. In some cases, both practices overlap within the same industry or within the same area. The other sense of offshore that I'll discuss is the offshoring of banking and finance and the creation of tax havens. And this was most famous in Panama where the Panama papers leak in 2016 was a huge scandal in business terms. It's quite different from offshoring production, but the two came about for very similar reasons as we'll see. So how are they related? Well, the first is that as manufacturing jobs moved offshore to places with lower labor costs, advanced economies experienced deindustrialization as we saw more service sector jobs and economies reoriented towards things like finance, health care, education. And it, the second is that the competitive pressures created by globalization and offshoring and manufacturing were also applied to services. So companies would outsource things like non core functions of customer service. It support payroll processing and things like that to reduce costs. So how did offshoring become a thing? Anyway, starting in the 15 hundreds, as we've seen Europeans began to grow and ship many things from the Americas in Asia, like sugar, from the Caribbean cotton from North America or later on, oil from the Middle East, they did that because they couldn't produce those commodities at home due to things like climate or soil or things like that. So there is a long history of this, but there's also some very important differences in why it's not all just the same offshoring really took off after world war two and it was driven by a combination of several factors and it first took off in the US. The first of these is institutions which we've discussed already in this course. So the general agreement on tariffs and trade facilitated reductions in trade barriers. The IMF promoted currency stability and encouraged international capital flows. And the World Bank supported economic development in the countries of the global South. This is, in other words, the end of Bretton Woods technology also played a significant role in improving transportation and communications. So in transportation, post-war improvements in shipping, things like better ship design, streamlined port logistics, air travel with jet planes and radar overall created a faster and more efficient global freight network in communications advances in telecommunications, made managing overseas operations, easier improvements in undersea cables, teletype technology, direct dialing and transatlantic telephone cables reduced communication costs and increased reliability. By the 19 sixties satellite technology further expanded international phone networks. What this all meant was it had laid the groundwork for businesses to manage operations across borders more effectively and efficiently and enabling production to spread across the globe. Let's turn now to our first example and really where offshoring started. So it's a very good example to look at and that's the electronics industry, it really began around 1960. With East Asia being the primary destination for manufacturing. Japan led the way on this. Starting with consumer electronics like radios and semiconductors. The US had been importing large quantities of these products which led us firms and unions to push for protectionism to bypass these trade restrictions. Japanese companies began setting up factories in East Asia, particularly Hong Kong later in Taiwan where wages wages were much lower than the US. And Japan in Hong Kong, Japanese firms like Sony and Sanyo took advantage of British colonial trade preferences to export products to the US by the millions. By the mid 19 sixties, other countries followed with Taiwanese companies assembling radios from components made from Japan made in Japan US. Companies also move production offshore to places like Hong Kong to lower labor costs. For example, transair a small American radio maker set up a factory in Hong Kong in 1962 and quickly expanded as the success of offshoring grew. Other US. Electronics companies followed suit setting up plants in other low wage countries. This shift to offshore manufacturing became a standard practice in many electronic sectors. By the 19 seventies, the semiconductor industry which started offshoring in 1963 expanded rapidly with many American semiconductor companies setting up operations in East Asia overall by the late 19 seventies, a clear global production structure had emerged with high tech tasks like design and fabrication remaining in developed countries. While labor intensive tasks like assembly were outsourced to low wage countries in East Asia. Over time, more and more complex tasks like testing some amount of design work moved offshore to countries like Taiwan, South Korea and Singapore. By the 19 eighties, companies had shifted to more complex international production strategies. While some still relied on traditional methods like backward integration and establishing facilities in low wage countries, many firms embraced something called global production. What this meant was a strategy of spreading different stages of production across multiple countries. Often based on that country's market conditions, their politics, their stability and the technology available in that country. The goal overall was to make the production process more efficient by placing each phase in the most suitable location for it. It resulted in this disbursement of the process. So one question that often gets asked about offshoring, given this process um is does that mean that the entire world is heading toward fully globalized production? And it's a prediction some people have made over time, but it's really hard to say, it's hard to predict the future. And part of that is that companies face a tough choice. It's not always so simple or so easy as just offshoring production, spreading it out lowering costs. There's a tough choice to be made. Should they run one big global production system or should they keep separate factories for different markets? A global system sounds very efficient but it can also be fragile. If something goes wrong in one part of the process, like a strike or a plant breakdown, it can mess up the whole thing. Plus even though paying low wages can boost profits, splitting up production stages can cause inefficiencies. And it's really hard to coordinate. It's also very difficult to offshore research and development. Uh especially when products are new and being fine tuned. Most high value things like research and development tends to stay in the home country as we saw more and more of it is being done abroad to find the best talent, but it's still mostly done at home. Another factor is that many companies prefer being close to their customers. Some companies go abroad not to find cheap labor, but to tap into specific skills or technology that aren't available at home. And this is really the subject of one of the articles you're reading this week. There's also more and more focus on custom products and variety instead of mass producing the same thing. And when quality and customization matters, labor costs aren't always the biggest factor in choosing where to set up shop. And again, you see another issue with the idea of spreading production around and yeah, it sounds great to lower labor costs, but it can make other things more expensive. Like it makes it harder to use the same technology in every factory to be consistent. So what have been the effects of offshoring? It is a very controversial practice to say the least. Many critics of the practice say that companies use this practice to cut costs by lowering wages, weakening unions and avoiding all kinds of regulations. Some countries like Taiwan and Hong Kong have benefited from offshoring with higher wages but often at the cost of poor working conditions. The idea behind global production was that higher skilled jobs would stay in rich nations and lower skilled jobs in poorer countries. But that didn't always happen. In reality, most offshoring has only happened in a few countries and many developing nations have failed to benefit from this. The US lost millions of manufacturing jobs. So we saw in the first lecture and while some wages rose for skilled workers, inequality has increased overall and offshoring also made it easier for companies to move jobs to places with weaker worker protections, meaning that labor has less bargaining power. And what's happened is that wage and wealth gaps remain. And this idea that the whole global economy, the whole world would converge that just hasn't happened. At least not yet. Moving on to the the other offshore of this week. It's not always literal but often is um it's offshore finance and I want to start with a historical legal case that sounds dry but really makes clear what the practice is. And and how it came about and this decision is still often cited in law. So in 1906, the British House of Lords heard a legal case that would have important implications for matters of international taxation. In the following decades, de beers consolidated mines still the same de Beers that we know today was founded in South Africa in 1888 and formed under South African law and its head offices and mining activities in South Africa where they held all of their general meetings. But in their decision, the lords argued that directors meeting still took place in London. And accordingly, they said this was where the real control was exercised and where important business decisions were made. And even though the company was not a British person under corporate law, it was still considered resident in Britain and liable to British tax on all of its income wherever it had been produced. What happened was other quickly, other companies very quickly caught on to this. And they said, ok, well, we're just going to move our headquarters somewhere else. So the next year, the Egyptian Delta Land and Investment Company which had been set up in 1904 in London, moved its headquarters to Cairo and this just sparked a whole exodus. So offshoring finance essentially means moving banking out of the control and regulation of the country. It was in often for minimizing or avoiding taxes and escaping regulations on any number of things. One formal word for this, the way it's organized by tax is tax neutral. Meaning that let's say the Cayman Islands that when money goes there and then leaves that country doesn't levy any corporation taxes, no duties or any withholding taxes as the money goes out. Because this gets complicated in practice to say who is, which country is an offshore financial center. I think the IMF definition is a good one and that is a country or jurisdiction that provides financial services to non-residents on a scale that is incommensurate with the size and the financing of its domestic economy. In other words, a country like Panama where not a huge country, but there's a huge financial center uh mostly to serve as foreign money, not domestic. So as I said, things have really accelerated substantially since the de beers case and especially since the 19 seventies, one measure of this to give you a sense and it's, it's really hard to find accurate statistics on all of this. But one measure is cross border banking assets which in the 19 seventies were a trillion dollars and by 2020 had grown to $30 trillion and currently about 8 to 10% of global GDP is now held offshore. So what have been the effects of offshoring finance? It has again been a very controversial practice. It is 11 big thing that has happened is lost tax revenue to governments around the world because um one advantage of offshore banking is often secrecy. So it's hard to say again how much tax revenue is lost. One estimate for the US is that 55% of us foreign corporate profits are earned in low tax countries with the help of accounting maneuverings resulting in 100 and $30 billion and lost corporate income tax each year worldwide. It's estimated that it's something like 500 to 600 billion offshore finance most infamously sparked controversy in 2016 with the Panama papers which was millions of leaked documents from a Panamanian law firm that serviced uh this industry. And it showed how all kinds of wealthy individuals, corporations, political figures worldwide used these offshore entities to hide assets evade taxes and launder money. There was ultimately an investigation which implicated over 100 and 40 politicians and public officials from 50 countries and the result was a global debate on financial transparency and tax justice. And since then, there has been some small movement to clamp down and to increase transparency. So how are the two offshore related? Besides the word, the important thing I wanna stress here is that both of these offshoring practices really accelerated at the same time in the 19 seventies with the end of the Bretton Woods system of currency controls, as well as the end of a process of decolonization in much of Africa and Asia, where De Beers had simply moved their directors headquarters to South Africa. Which was British territory. At the time. In the 19 seventies, few imperial possessions remained and companies found new places like the Channel islands that were very small former possessions to serve a similar purpose. The other connection is that many people from newly independent countries were now seeking tax havens of their own. In short, I hope you can see some common threads here in the histories of offshoring the importance of the end of Bretton Woods growing globalization, the role, multinational enterprise display and the role of technology. Both versions of offshoring were affected by the same currents of history.