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Aug 03

Why corporations may not care about the domestic economy

Posted by Ron F in recoveryrecessionoutsourcingoffshorejoblessnessglobal economyemployment growthemploymentemerging marketseconomyearningsdemandcutting costscorporations

Ron F

Paul Krugman today once again bemoans the lack of Keynesianism in what passes for economic policymaking discussions these days, and I share that complaint.

However, Krugman may be missing part of the problem here, which is that those who pooh-pooh the prospect of deflation may actually not much care if it materializes, though they would be mistaken to do so.

Yves Smith gets at this today in a post of her own in connection with a Robert Frank piece in the Wall Street Journal that goes after the wealthy.

So I'll focus on the corporate angle that Krugman makes, where he notes that "sticky" wages during deflationary periods make for lower profits, at least for firms doing business where the deflation occurs.

But the fact is, increasing parts of corporate America are mislabeled in so far as they actually could care less about domestic economic trends. And that is because of the simple fact that US-based multinational corporations are doing fine elsewhere, thank you very much, and for that reason are misnamed. They are US-based only in so far as they are subject to US laws. But US economics? Not so much.

In fact, their business models are driven by growth in emerging markets, and that's where they are hiring and investing.

Doesn't that benefit the US? Only to the degree that they pay taxes and hire US workers at their headquarters. But the fact is these companies, which are more accurately described as "transnational" or maybe "post-national" are indeed global, and therefore rootless, and go where the action is.

The problem, at least for the rest of us, is that this trend eventually leads to a hollowing out of the more developed world, including the US, as jobs permanently disappear.  Yet this phenomenon make broad Keynesian concepts such as "aggregate demand" somewhat irrelevant. (Yes, new jobs are created here as a result of multinationals' profits, but where is the evidence that they replace most, leave aside all, of the lost ones?)

The problem for the companies themselves is, sooner or later, their ability to exploit low labor costs in emerging markets will no longer work, as competition for that labor will drive up those costs. Yes, the gap between wage levels there and here may be so huge as to make that a distant concern. But if deflation here really takes hold while domestic economies in the developing world thrive, that day may arrive sooner than such companies expect.

This concern isn't just theoretical. Last May, when I interviewed Steward Glendinning, the CFO of Molson Coors, at the Hackett Group's annual best practices conference in Atlanta about the pros and cons of outsourcing, he admitted that this threat to companies' ability to engage in labor arbitrage was a serious concern. After all, any company that makes a significant commitment within a developing country only to see labor costs rise sooner or faster than it expected, as other companies follow them there, will have to move to an even less developed country to maintain its profits, and how frequently is it prepared to do that?

Glendinning admitted to having no answer to that, which was one reason he was skeptical about the benefits of outsourcing. And I heard the same concern privately expressed by a divisional CFO of a major US-based industrial conglomerate with major operations in India several years ago. 

Then there's the question of what domestic companies are supposed to do when demand fails, besides get global as fast as they can. But how a small business is supposed to do that is beyond me.

I'll also leave aside the socio-political aspects of this question, simply because they are better addressed by sites not devoted to finance. Suffice it to say that they cannot be completely ignored, since, as the cliché has it, everything's connected.

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