Does outsourcing create purchasing power? If not, then what is the long term effect?
Asked by
PhiNotPi (
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)
April 26th, 2012
When comparing currency in different parts of the world, there are two different things to consider: the exchange rate between the currencies, and the purchasing power of the currencies.
The purchasing power of a person is the amount of goods/services a person can buy with all of his money.
Purchasing power of a currency describes how much a certain amount of money can buy.
If a group is paid half as much, but the cost of living is half as much, then the purchasing power of the people stays the same. The purchasing power of their currency is twice as much becuase a single unit can buy twice as many goods/services.
So, here’s the scenario:
Persons 1 & 2 have a salary of $100,000 and a cost of living of $90,000 (just to use some nice round numbers). Person 3 has a salary of $90,000 and a cost of living of $81,000. Comparing the cost of living to the salary, all three people have the same purchasing power. However, a $1 bill can buy more where person 3 lives compared to where the other two people live.
Let’s say that historically person 1 has been buying $100 of goods from person 2. Just recently, a better means of transportation allows person 1 to buy $100 of goods from person 3 for the price of only $90. Compared to person 3’s cost of living, this seems like an appropriate amount of money, since $90 is the equivalent of $100 to him in terms of how much it can buy.
Here’s the question: Since person 3 received a fair trade ($90 for what would be worth $90 in his area) but person 1 made some profit ($90 for what would be worth $100 in his area), where does this extra money come from? Obviously, no physical dollar bills were made, but in terms of the total value of all of the goods and currency, it seems like more value has been created.
Another question is: Assuming that the extra purchasing power was actually created from nothingness, how will it be destroyed? Is this the creation of a bubble, which will then pop and destroy the extra value?
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13 Answers
It’s cheaper to hire poorer people for menial jobs.
@XOIIO One of the main points is that person 3 is not actually any poorer than the other two people. He gets paid less, but everything in his area costs less.
@PhiNotPi But a lot of currrencies are cheaper than american money, making it cheaper to pay them, so they are actually giving them less.
The money comes from person 2, who loses his business. He then must buy all of his goods from person 3, like clever person 1 did, as he cannot afford to pay full price.
Person 3, if intelligent, will invest in R&D in order to keep his production costs low and slowly raise his own salary. His currency will raise in value until it is at parity with 1&2, and unless productivity has risen at the same rate as the currency and his wages, person 1&2 will buy from a new person, person 4. Person 3 will then lose his business and need to buy from person 4, and the cycle repeats, searching desperately for the lowest cost per unit. This is mercantilism, which modern economic theorists confuse with capitalism, because they imagine that Gordon Gecko is cool.
Capitalism is when person 2 asks person 1 for a loan to increase her productivity, and person 1 gives her a loan, gaining the interest and cheaper goods, and improving their own currency.
The whole theory of Purchasing Power Parity is based on fluctuating exchange rates resulting in equilibrium.
As the scenario continues, demand increases for products from Person C, which will increase the price of the currency in country C. Thus, the dollar will devalue to the point that cost of goods from C are the same as the cost of goods from B.
Also, with the shift of sourcing from country A/B to country C, the A/B economy contracts to the point where B sells for a lower price.
In my opinion, outsourcing hurts our local economy, temporarily; but eventually will lead to the cheap workers demanding more money, and the price of all goods will then go up.
I think if you munge together what @Imadethisupwithnoforethought, @zenvelo and @YARNLADY said, you have your answer. There are several complicating factors, though. The US has less than 5% of the world’s energy resources but consumes 25% of the energy production. Given limits of energy and other resources, the whole world can’t possibly live like the US. A far more likely outcome of outsourcing is that the US increasingly lives like the third world. Increasingly, the “value” created by outsourcing flows only to the multinational corporations doing the trading, and their investors.
@ETpro that is only true if you do not count the world’s coal reserves.
@WestRiverrat It is true of how we are using fossil fuels right now. We’d have to do some leaps in technology to figure out how to power everything running off of diesel, gasoline and natural gas from coal. But we do stack up much better in percentages of the world’s coal reserves than in crude oil. And while it’s possible to clean up the air pollution from a coal-fired power plant, it’s costly. Coal burns very dirty. It leaves behind a huge supply of fly ash as well. Disposing of the pollutants from individual automobiles and trucks would be a technological challenge of some magnitude.
Nazi Germany’s war machine was running largely on gas made from coal in WW2. If they could do it with 1940s technology, we should be able to come up with something now.
We are supposed to be getting reliable efficient electric vehicles in the near future. Didn’t most of the Tarp 2 money go to producing electric vehicles?
How do you make gas from coal? It can’t be terribly effecient.
@WestRiverrat & @XOIIO Nazi Germany hadn’t even heard of global warming. They were utterly unconcerned with environmental issues. And even though we do know how to make gas from coal, that;s only part of the problem. We need a nationwide infrastructure to fuel gas-driven cars—just as we would need to use natural gas (another relatively abundant energy resource in the US). What’s the cost or retrofitting every filling station in the nation?
It is my understanding that net investment of a country is equal to the inverse of the trade balance.
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