Flat earthers

At Vox EU, three professors write that distance makes a surprising amount of difference to trade in services:

Pundits regularly invoke the notion of a world economy that is either “shrinking” or becoming “flat.” Explanations of this alleged flattening include technological innovations in transportation and communication that have enabled goods and ideas to flow more freely. The offshoring of service jobs, particularly call centers and computer software in India, has grabbed recent media attention. In his bestseller The World is Flat, New York Times columnist Thomas Friedman (2005) wrote of how he had “interviewed Indian entrepreneurs who wanted to prepare my taxes from Bangalore, read my X-rays from Bangalore, trace my lost luggage from Bangalore and write my new software from Bangalore.”

Most economists, cognizant of the gains from trade, do not view a “flat” world as an alarming prospect. As the 2004 Economic Report of the President remarked sanguinely, “When a good or service is produced more cheaply abroad, it makes more sense to import it than to make or provide it domestically” (p. 229). In a press conference after the release of the report, the Chair of the Council of Economic Advisors at that time, Gregory Mankiw, elaborated on the remarks in the report saying, “Whether things of value, whether imports from abroad, come over the Internet or come on ships, the basic economic forces are the same.” As Mankiw and Swagel (2006) describe in their insideraccount, these seemingly innocuous remarks about outsourcing managed to arouse a controversy. This was partly because of election-year sentiments but also because the threat of service offshoring raises serious concerns for many onlookers. How will we maintain our standard of living, people wonder, when we have to compete with highly skilled foreigners who are willing to do our jobs for a fraction of our wages?

Just as mainstream trade theory identifies gains from trade, it also shows that real wages of some workers tend to fall as a consequence of freer trade. Mankiw and Swagel (2006) respond to these concerns by arguing that the accumulated statistical evidence on the offshoring of services demonstrates that the magnitudes remain quite small compared to the size of the labour market. This case for complacency recalls a debate between Leamer and Krugman over whether rising imports from low-wage manufacturers were responsible for rising wage inequality in the US. Leamer (2000) pointed out that prices are determined on the margin and the volume of trade is irrelevant for wage determination. Krugman (2000) argued that, on the contrary, trade volumes were crucial evidence on the changes in factor prices that can be attributed to trade. However, if recent growth of service imports continues unabated, the current trickle of offshoring could turn into a flood. Mankiw and Swagel’s argument would be more persuasive if there were strong reasons to believe that economic impediments to offshoring will curb its future growth.

Our research investigates whether geographic separation limits offshoring trade, thereby shielding domestic workers from direct competition with their foreign counterparts. We develop a model that envisions employers searching globally for the most suitable workers for any given task and posits that distance raises the costs of using foreign workers. These higher costs reflect travel, training, or translation time associated with using workers that reside far from where their services will be consumed. Firms choose workers that offer the lowest costs after adjusting wages for productivity and distance-based service delivery costs.

. . . Using theory and estimated distance effects, we are able to measure the extent to which geographic separation insulates local workers from foreign competition. The calculations reveal that, from the point of view of a London service purchaser, workers in Oxford can be paid 99% to 373% more than workers in Bangalore in productivity-adjusted wages and yet still be more attractive, once service-delivery costs are taken into account. This is because the Bangalore workers are 100 times more distant from London than the Oxford workers.

I find this outcome surprising, but of course the closer you are geographically, the more likely you are to have substantial immigration flows and cultural and institutional exchanges that make trade in services easier.

On a side note, why on earth is anyone using this dreadful "flat earth" metaphor? It makes absolutely no sense. If the earth were a flat plane, would it actually be any less far from Osaka to Los Angeles? Indeed, it would seem to me that a flat earth would make things farther from each other, since presumably, it would mean unrolling the surface of the globe. That would put some two points on the earth that are currently next to each other literally a whole world away.