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It is this replacement of the US workforce by foreign workers that explains the extraordinary rise in CEO compensation and the flow of the income and wealth gains to the few people at the top. By offshoring their workforces, CEOs cut their costs and make or exceed their earnings forecasts, thus receiving bonuses that are many multiples of their salaries. Shareholders benefit from the rise in share prices. When plants are closed and jobs are offshored, American employees lose their livelihoods, but managements and shareholders prosper. Offshoring is causing an extraordinary increase in American income inequality.

The 2006 Council on Competitiveness report acknowledges that "for the first time in history, emerging economies, such as China, are loaning enormous amounts of money to the world's richest country." Historically, it was rich countries that lent to underdeveloped countries.

China's loans to the United States are a form of forced lending. China receives dollars from America's dependency on imports of manufactured and advanced technology products made in China by US and Chinese firms. China uses the dollars to purchase existing U.S. equity assets and to lend the dollars back to the United States by purchasing Treasury debt. With China's currency pegged to the dollar, China cannot dump the dollars into foreign exchange markets without initiating a run on the dollar and complaints that China is increasing its competitive advantage over the rest of the world by driving down the US dollar in order to devalue its own currency.

When I was Assistant Secretary of the U.S. Treasury in the early 1980s, U.S. foreign assets exceeded foreign-owned assets in the United States. By 2005 this had changed dramatically, with foreigners owning $2.7 trillion more of the U.S. than the U.S. owns abroad. For the first time since the United States was a developing country 90 years ago, the US is paying more to foreign creditors than it is receiving from its investments abroad.

Porter’s report downplays the trade and current account deficits on the grounds that "foreign affiliate sales" do not count against the trade deficit and "intra-firm trade" is a significant proportion of the trade deficit and "is due to trade within American companies."

"Intra-firm trade" is simply a company's offshored production produced in its offshore plants, and "foreign affiliate sales" is simply a company's overseas revenues from its production in foreign countries with foreign labor. Perhaps Porter is arguing that the output of an American subsidiary in Germany, for example, should be considered part of U.S. GDP. Such accounting would result in a magical increase in U.S. GDP and drop in German GDP. If success is defined in terms of the country in which the ownership of the profits of global firms resides, then a country can be successful with its labor force unemployed.

The competitiveness report owes much of its failure to an abstraction -- "the global labor supply." There is no global labor market that equilibrates wages in the different countries. There are only national labor markets in which wages reflect cost of living and labor supply.

For example, in China, the cost of living is low, and excess supplies of labor suppress manufacturing wages below labor’s contribution to output. In the United States, the cost of living and debt levels are high, and the labor market (except for those parts hardest hit by offshoring) is not confronted with large excess supplies of labor. The excess supply of labor in China has been estimated to equal the population of the US. It is possible for a US-based firm to hire someone living in China or India to deliver services over the Internet at a fraction of the cost of hiring an American employee. Alternatively, foreigners can be brought in on work visas to replace American employees. Manufacturing plants can be moved abroad where excess supplies of labor keep wages low. These are all examples of capital seeking absolute advantage in lowest factor cost (“factor” refers to factor of production, in this case labor).

Porter’s report claims that the future of U.S. competitiveness depends on education. Although the United States has 17 of the world's top 20 research universities, Porter sees education as the number-one weakness of the U.S. economic system. The report envisions a high-wage service economy based on imagination and ingenuity. Here the competitiveness report becomes self-delusion. Porter does not comprehend that all tradable services can be offshored.

As we have seen, in the 21st century, the U.S. economy has been able to create net new jobs
only
in non-tradable domestic services. The vast majority of jobs in the BLS ten-year jobs projections do not require a college education. The problem in 21st century America is not a lack of educated people, but a lack of jobs for educated people.

Many American software engineers, IT professionals, and scientists have been forced by jobs offshoring to abandon their professions. The November 6, 2006, issue of
Chemical & Engineering News
reports that "the percentage of American Chemical Society member chemists in the domestic workforce who did not have full-time jobs as of March of this year was 8.7 percent." There is no reason for Americans to pursue education in science and technology when career opportunities in those fields are declining due to offshoring.

Porter says the future for America cannot be found in manufacturing or tradable goods, but only in what he says are high-wage service skills in "expert thinking" and "complex communication." Porter does not identify these jobs. As we have seen, no sign of them can be found in the BLS jobs data.

Even economists who realize that there is a problem cannot get their minds around it. For example, disturbed by evidence that investment by US industry in research and development was declining, the National Association of Manufacturers commissioned a report, “US Manufacturing Innovation at Risk,” by economists Joel Popkin and Kathryn Kobe. In the report, released in February 2006, the economists find that U.S. industry’s investment in research and development is not languishing after all. It just appears to be languishing, because it is rapidly being shifted overseas: "Funds provided for foreign-performed R&D have grown by almost 73 percent between 1999 and 2003, with a 36 percent increase in the number of firms funding foreign R&D."

US industry is still investing in R&D after all; it is just not hiring Americans to do the research and development. U.S. manufacturers still make things, only less and less in America with American labor. U.S. manufacturers still hire engineers, only they are foreign ones, not American ones.

Everything is fine for U.S. manufacturers. It is their former American work force that is languishing. As these Americans, who are experiencing declining incomes, happen to be customers for U.S. manufacturers, U.S. brand names will gradually lose their U.S. market. U.S. household median income has been falling for years. Consumer demand has been kept alive by consumers’ spending their savings and home equity and going deeper into debt. As millions of Americans together with Greece, Spain, and Italy discovered, it is not possible for debt to forever rise faster than income.

Princeton University economist Alan Blinder, my former Business Week colleague and former vice chairman of the Federal Reserve, also has difficulty acknowledging the implications of his conclusions. Blinder writes that "we have so far barely seen the tip of the offshoring iceberg, the eventual dimensions of which may be staggering" (
Dallas Morning News
, January 7, 2007). Blinder has estimated that as many as 50 million jobs in tradable services are at risk of being offshored to lower-paid foreigners.

Like Porter and others, Blinder says that America's future lies in high-tech service jobs such as those delivering "creativity and imagination." Blinder understands that the education solution might be a pipe dream as such abilities "are notoriously difficult to teach in schools." Blinder also understands that "it is hard to imagine that truly creative positions will ever constitute anything close to the majority of jobs." Blinder asks: "What will everyone else do?"

Blinder understands that the wage differentials between the United States and India means that Americans will find employment only in services that are not deliverable electronically, such as janitors and crane operators. These hands-on service jobs do "not correspond to traditional distinctions between jobs that require high levels of education and jobs that do not."

Blinder's prediction of the future of American employment is in line with my own and that of the Bureau of Labor Statistics. But Blinder warns against saving US jobs with protectionist measures, and he does not realize the implication of these trends on the U.S. trade deficit. A country whose workforce is employed in domestic non-tradable services is a Third World country with little to export. How will the United States pay for its heavy dependence on imports of manufactured goods and energy?

As long as the dollar retains its reserve currency role, Americans can continue to hand over paper for real goods and services. But how long can the United States retain the reserve currency role when its economy does not make things to export, when its work force is employed in domestic services, and when its foreign creditors own its assets?

For developed economies, offshoring is a reversal of the development process. As offshoring progresses, the domestic economy becomes less developed, and there is less demand for university education. Economists cannot speak the obvious truth, because they confuse jobs offshoring with free trade, when in fact offshoring is a process of deindustrialization. The reformulation of trade theory achieved by Ralph Gomory and William Baumol was published by MIT Press six years prior to Porter’s report, but there is no mention of this seminal work in Porter’s report. Just as Porter’s report ignored the empirical evidence, it ignored the reformulation of trade theory.

Why are economists content with free trade policy that rests in fantastic error?

Perhaps the answer is that the corruption of the outside world has found its way into universities. Today, universities look upon "name" professors as rainmakers who bring in funds from well-heeled interest groups. Increasingly, research and reports serve the interests that finance them and not the truth. Money rules, and professors who bring money to universities find it increasingly difficult to avoid serving the agendas of donors. The same is true of think-tanks.

Economists other than myself
have warned that it is impossible for a country to remain prosperous when its economy is moved offshore. Herman Daly, Charles McMillion, and Ralph Gomory, for example, all saw the ruinous implications of offshoring. However, it was two billionaire businessmen, Roger Milliken and Sir James Goldsmith, who first warned that offshoring would destroy the position of First World labor.

Textile magnate Roger Milliken spent his time on Capitol Hill, not on yachts with Playboy centerfolds, trying to make Washington aware that America was losing its economy. Sir James Goldsmith made his fortune by correcting the mistakes of incompetent corporate CEOs by taking over companies and putting the assets to better use. Sir James spent his last years warning of the perils both of globalism and of merging the sovereignties of European countries and the UK into the EU.

Sir James's book,
The Trap
, was published as long ago as 1993. His book,
The Response
, in which he replied to the free trade ideologues in the financial press and academia who denigrated his warning, was published in 1995. In 1994 Sir James gave a speech to the U.S. Senate warning of the perils of globalism.

Both billionaires predicted that the working and middle classes in the United States and Europe would be ruined by the greed of Wall Street and corporations. Corporate earnings would be boosted by replacing domestic work forces with foreign labor, which could be paid a fraction of labor's contribution to output as a result of the foreign country's low living standard and large excess supply of labor. Anytime there is an excess supply of labor, or the ability of corporations to pay labor less than its worth, the corporations bank the difference. Share prices rise, and Wall Street and shareholders are happy.

In March, 2011, a Nobel prize-winning economist, Michael Spence, assisted by Sandile Hlatshwayo, a researcher at New York University, lent their authority to the 20th century conclusions of Milliken and Goldsmith and to those of myself, McMillion, Daly, and Gomory. Their research report, “The Evolving Structure of the American Economy and the Employment Challenge, was published by the Council on Foreign Relations, an organization of the American Establishment.
http://www.cfr.org/industrial-policy/evolving-structure-american-economy-employment-challenge/p24366

Here is what Spence and Hlatshwayo report:

"This paper examines the evolving structure of the American economy, specifically, the trends in employment, value added, and value added per employee from 1990 to 2008. These trends are closely connected with complementary trends in the size and structure of the global economy, particularly in the major emerging economies. Employing historical time series data from the Bureau of Labor Statistics and the Bureau of Economic Analysis, U.S. industries are separated into internationally tradable and non-tradable components, allowing for employment and value-added trends at both the industry and the aggregate level to be examined. Value added grew across the economy, but almost all of the incremental employment increase of 27.3 million jobs was on the non-tradable side. On the non-tradable side, government and health care are the largest employers and provided the largest increments (an additional 10.4 million jobs) over the past two decades. There are obvious questions about whether those trends can continue; without fast job creation in the non-tradable sector, the United States would already have faced a major employment challenge.