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The Two Forms of the Outsourcing Relationship

Production outsourcing takes two basic forms: foreign direct investment (FDI), where the production process is moved overseas but kept in-house, and arm’s-length outsourcing, when a firm outsources part or all of the production process to an independent supplier, independent in the sense that the “lead firm” owns none of it even though it may control its activities in many ways. Yet, according to the conventional definition, transnational corporations are “enterprises comprising parent enterprises and their foreign affiliates,”¹ in other words, enterprises that indulge in FDI. According to this definition Tesco and Walmart only count as TNCs to the extent that they operate retail outlets in other countries—Walmart’s 2.1 million global workforce (up from 2,600 in 1971) does not include any of the workers who produce the goods that fill its shelves.² Until the first decade of the twenty-first century, both mainstream and Marxist analysts tended, as William Milberg observed, “to see globalization through a foreign direct investment lens. Like the proverbial drunk who searches for his lost keys under the streetlight only because that is where he can see best, economists have overemphasized the relevance of foreign direct investment.”³ The rapid growth of arm’s-length outsourcing has made this approach increasingly anachronistic, and has also stimulated the rise of value-chain analysis and related approaches that see in-house FDI and arm’s-length contractual relations as two different types of links comprising global value chains. Similar considerations have led many analysts to propose a fundamental change to the definition of transnational corporation, which, instead of denoting a firm with wholly or partly owned subsidiaries in other countries, should be redefined as “a firm that has the power to coordinate and control operations in more than one country, even if it does not own them.”⁴

UNCTAD’s World Investment Report 2011 is a watershed in research into arm’s-length, contractual relationships, defining these as

a cross-border nonequity mode of TNC operation [in which] a TNC externalizes part of its operations to a host-country-based partner firm in which it has no ownership stake, while maintaining a level of control over the operation by contractually specifying the way it is to be conducted…. the defining feature of cross-border NEMs, as a form of governance of a TNC’s global value chain, is control over a host-country business entity by means other than equity holdings.⁵

The differences and commonality between these two forms of outsourcing can be seen with the help of a thought experiment. A TNC can, and often does, convert a direct in-house relation with a subsidiary into an arm’s-length relation with an independent supplier simply by signing some legal documents, erecting new signage, opening up a new bank account—without making any changes to the work regimes or to the labor processes, or to the price of inputs, or to the profits realized upon the sale of the output. The actual process of production and value creation/extraction would then be identical in every respect. Nothing would change except titles of ownership. Yet surface appearances would show a profound change: a visible South-North flow of repatriated profits from subsidiary to HQ would vanish without trace, even if the new arrangement turned out to be more effective in squeezing production costs and boosting the HQ’s profits. As we saw in the case of the three global commodities in chapter 1, in the arm’s-length relationship all of the lead firm’s profits appear to arise as a result of its own value-added activities in the countries where the commodities are consumed, while their suppliers and the super-exploited workers employed by them make no contribution whatsoever.

This chapter examines these two forms of the outsourcing relationship, first separately and then together, in order to further enrich our concept of the globalization of production, and in order to identify questions and paradoxes that both mainstream and heterodox approaches cannot explain.

FOREIGN DIRECT INVESTMENT

According to the internationally accepted UN definition, “FDI is made to establish a lasting interest in or effective management control over an enterprise in another country…. As a guideline, the IMF suggests that investments should account for at least 10 percent of voting stock to be counted as FDI.”⁶ However, the contrast between portfolio and FDI investment is not as clear-cut as this excerpt from the standard UN definition of FDI suggests. As Ricardo Hausmann and Eduardo Fernández-Arias note, “FDI is not bolted down, machines are. If a foreigner buys a machine and gives it as a capital contribution (FDI) to a local company, the machine may be bolted down. But the company’s treasurer can use the machine as collateral to get a local bank loan and take money out of the country.”⁷ This is not the only way that financial imperatives can override the production relation—retained profits may be reinvested in domestic government debt or other financial assets; alternatively, repatriated profits may exceed the affiliate’s earnings, signifying disinvestment.

FDI can be categorized into four different types according to the motive of the investor. “Efficiency-seeking” FDI is neoliberalism’s paradigmatic form—efficiency means cutting costs, in particular the cost of labor—and is the prime concern of this study. “Market-seeking” FDI was the dominant form in the years before neoliberal globalization, when protectionist barriers obliged TNCs to move production close to markets, and it is still important, as in the example of Japanese- and European-owned car plants in the United States. In contrast to efficiency-seeking FDI, market-seeking FDI typically does not involve the fragmentation of production processes but their replication in the host country. Since the most important markets for final goods are in the imperialist nations, market-seeking FDI is dominated by cross-border investments between imperialist countries—or, as a study by three UNCTAD economists put it, “Trade based on horizontal international production sharing occurs mainly between developed countries.”⁸

“Resource-seeking” FDI refers primarily to foreign investment in the extractive industries (hydrocarbons and minerals), but natural resources can include foodstuffs, ingredients of cosmetics, and much else. When these are not merely harvested or extracted but have first to be cultivated, they are regarded as agricultural products, not natural resources. Agriculture and natural resource extraction have important features in common: FDI in these sectors is primarily determined by the location of mineral, hydrocarbon deposits, and the like, or of fertile tracts of land, in contrast to efficiency-seeking production outsourcing, whose location is primarily determined by the location of pools of cheap, super-exploitable labor. To resource-seeking FDI the availability of low-wage labor is an added bonus. The shift from in-house to arm’s-length production arrangements is much less evident in extractive industries, because the collection of rents from rich deposits of ore or oil are much easier to protect when the lead firm directly owns the resources and the means of their extraction. The two forms of TNC exploitation of low-wage labor seen in manufacturing industry—in-house and arm’s length—are also evident in agriculture. Nestlé’s 800,000 contract farmers display many similarities to the arm’s-length relations in manufacturing value chains; while, in contrast, plantation capitalism in old and new forms correspond to FDI, in that they involve direct ownership of capital in the low-wage economy. Finally, “technology-seeking” FDI seeks access to scientific or technological knowledge available in the host location. This is rarely an important motive for FDI flows into poor countries.

Until the first decade of the new millennium, it was a widespread, almost universal view that FDI in developing nations was of peripheral importance to rich-nation TNCs. Thus David Held, the social democratic visionary, argued that “the vast majority of … FDI flows originate within, and move among, OECD countries.”⁹ Kavaljit Singh, writing from a radical-reformist perspective representative of many NGO critics of globalization, concurs: “The bulk of global FDI inflows move largely within the developed world…. This situation could be aptly described as investment by a developed country TNC in another developed country. The U.S. and the EU … continue to be the major recipients of FDI inflows.”¹⁰ Sam Ashman and Alex Callinicos, writing in the Marxist journal Historical Materialism, similarly conclude that “the transnational corporations that dominate global capitalism tend to concentrate their investment (and trade) in the advanced economies…. Capital continues largely to shun the Global South.”¹¹ Chris Harman, like Ashman and Callinicos, a partisan of the “International Socialist Tradition,” draws out the big implication of this: if N-S FDI is so weak, so too must N-S exploitation be: “Whatever may have been the case a century ago, it makes no sense to see the advanced countries as ‘parasitic,’ living off the former colonial world…. The centres of exploitation, as indicated by the FDI figures, are where industry already exists.”¹² Alex Callinicos, writing in 2009, similarly argued that data on FDI flows “are indicative of the judgments of relative profitability made by those controlling internationally mobile capital: these continue massively to favour the advanced economies,”¹³ flatly contradicting the finding of UNCTAD’s 2008 World Investment Report that TNC profits “are increasingly generated in developing countries rather than in developed countries.”¹⁴

The massive pre-crisis surge of outsourcing to low-wage countries, a trend that the global crisis has only intensified, has finally demolished this consensus view—in 2013 FDI flows to developing countries surpassed those to developed countries for the first time.¹⁵ But this consensus view was false even when Held et al. enunciated their words. The biggest problem with peering through an FDI lens is that arm’s-length outsourcing is rendered invisible, but even before we bring this into the picture, a cursory examination of the relevant UNCTAD data is sufficient to refute the Eurocentric consensus and demonstrate that in fact the opposite is true, that Northern capital is increasingly dependent on exploiting low-wage labor.

As soon as we look beneath the headline UNCTAD data on gross FDI stocks and flows and examine their composition, a different picture begins to emerge. Headline data on total FDI flows, on which the “capital is shunning the Global South” thesis rests, are misleading for three reasons. First, they take no account of the extent to which FDI flows between imperialist countries are puffed up by non-productive investments in finance and business services. Between 2001 and 2012, developing economies received $464bn in such flows, compared to $609bn flowing into developed countries, and in the most recent years reported, from 2010 to 2012, manufacturing FDI flows into developing countries reached $151bn, surpassing the $145bn received by developed countries.¹⁶ On the other hand, between 2001 and 2012 inward FDI in “Finance” and “Business Activities” in imperialist countries totalled $1.37 trillion in these years, more than twice the inward flow of manufacturing FDI into these countries, compared to $509bn in “Finance” and “Business Activities” FDI into developing countries.

Second, a much greater proportion of FDI flows between imperialist countries is made up of mergers and acquisitions (M&A), that is, FDI that transfers ownership of an existing firm, as opposed to “greenfield” FDI, that is, investment in new production facilities. M&A FDI reflects the accelerating concentration of capital, a process superbly documented in chapter 4 of The Endless Crisis by John Bellamy Foster and Robert McChesney, and is fundamentally different from the disintegration of production processes and their dispersal to low-wage countries, which are most clearly reflected in data on greenfield FDI. In 2007, for example, developed economies received 89 percent of the $1.64 trillion in M&A FDI, more than half of which (51.4 percent, to be exact) occurred in financial services. In that same year, total FDI flows were $1.83 trillion. Though differences in the way these figures are collated means they are not directly comparable, they starkly highlight the overwhelming weight of M&As in overall FDI flows on the eve of the crisis. M&A have markedly declined since the pre-crisis feeding frenzy, but the pattern persists—between 2008 and 2013, M&A formed 45 percent of total inward FDI flows into imperialist countries and just 14 percent of flows into developing countries. On the other hand, developing nations received 69 percent of total greenfield FDI between 2008 and 2013, accentuating a pattern that was clearly established in the five years before the outbreak of the global economic crisis—between 2003 and 2007, developing nations attracted 59 percent of global greenfield FDI flows.¹⁷ Overall, between 2003 and 2014 developing nations were the destination for $5.9 trillion in greenfield FDI, compared to $3.3tr in developed nations As Alexander Lehmann reported in a 2002 IMF working paper, “FDI in the developing world is predominantly in the form of so-called greenfield investment, rather than through the acquisitions of existing enterprises.”¹⁸

Third, and perhaps most important of all, much of what is counted as FDI flows between imperialist countries are investments in firms that have relocated some or all of their production processes to low-wage nations. To illustrate this, the 2005 restructuring of the world’s second-largest oil company, Royal Dutch Shell, increased the UK’s inward FDI by $100bn, causing it to leap above the United States to become that year’s prime destination for FDI. Yet, wherever they may book their sales and their profits, the great majority of the 98 countries hosting Shell affiliates (second only to Deutsche Post AG with majority-owned affiliates in 111 countries) are in Latin America, Africa, Central Asia, and the Middle East.¹⁹

The dangers of looking no further than headline figures on N-S FDI are highlighted by a cursory examination of the M&A data cited above. In conventional accounting, the merger or acquisition of one European, North American, or Japanese firm with or by another is regarded as an unambiguous instance of North-North FDI. A brief examination of the three largest M&A deals in 2007—which, like all but seven of the fifty largest M&A deals in that year, were between firms in imperialist nations—shows why such a reading of the data is simplistic and misleading. The largest cross-border M&A deal in 2007 was the illfated acquisition of the Dutch bank ABN-AMRO by the Royal Bank of Scotland for $98.2bn. Banks circulate titles to wealth, skimming off some of it for themselves, but produce none of it. In a multitude of ways—through their loans and investments, participation in hedge funds and futures markets, handling of flight capital, etc., and indirectly through the TNCs they finance—their tentacles are coiled around the Global South. Second on the list of the largest M&A deals in 2007 was the mining and packaging giant Alcan, purchased from its Canadian owners by the UK’s Rio Tinto. Alcan employs 65,000 workers in 61 countries, 28 percent of them outside of Europe and North America.²⁰ Number three was the acquisition of the Spanish-owned utilities giant Endesa SA by a group of Italian investors for $26.4bn. In that year, Endesa operated affiliates in Spain, Portugal, Italy, and France, and also in Morocco, Chile, Argentina, Colombia, Peru, Brazil, Central America, and the Caribbean. In 2007, it earned 18 percent, or €471m, of its operating profits from its business in Latin America and the Caribbean.²¹ Continuing down the list the picture becomes ever clearer. Every time a company or group of investors acquires or merges with a TNC headquartered in another imperialist country, counted as North-North FDI by the UNCTAD statisticians, they are likely to be buying into an entity with assets and activities spread on both sides of the North-South divide. No such ambiguity exists in the case of North-South FDI, since FDI originating from Southern nations is not only a small fraction of the FDI, but the bulk of it is in other emerging economies—UNCTAD reports that “FDI from developing economies has grown significantly over the last decade and now constitutes over a third of global flows…. [However,] most developing-economy investment tends to occur within each economy’s immediate geographic region.”²² Despite this recent rise of FDI by Southern TNCs, in 2014 79 percent of the $25.9 trillion global stock of FDI was owned by TNCs headquartered in imperialist countries.²³

The overwhelming weight of M&As in N-N FDI flows in the years before the onset of global economic crisis reflects a process of concentration and monopoly-formation among TNCs, in the financial sector and in all industrial sectors, proceeding in parallel to the shift of production processes to low-wage economies. These diverse phenomena are all lumped together as FDI. William Milberg is among those who have drawn attention to this dual process: “The global wave of merger and acquisition activity constituted a consolidation of the oligopoly position of lead firms who, in the process, focused their efforts on ‘core competence’ and outsourced other activities.”²⁴ Gary Gereffi has also pointed to these “two dramatic changes in the structure of the global economy. The first is a historic shift in the location of production, particularly in manufacturing, from the developed to the developing world…. The second is a change in the organization of the international economy. The global economy is increasingly concentrated at the top and fragmented at the bottom, both in terms of countries and firms.”²⁵

FDI statistics thus merge three very different trends: the concentration of imperialist banks and finance capital; a process of concentration among Northern industrial and commercial capitals, many of them lead firms in value chains in which the actual production is performed by workers for distant Southern suppliers; and a process of disintegration of production processes and their dispersal to Southern nations in the quest for super-exploitable labor.

TNC Employment, North and South

UNCTAD’s 2007 World Investment Report boasts a particular focus on the employment effects of foreign direct investment. Yet even here the amount of information is meager, providing data on total TNC employment in only a handful of developing countries. The most interesting and relevant part of this study was an analysis of the employment effects of foreign direct investment by U.S. TNCs. It reported that, in 2003, 9.8 workers were employed for each $1 million of FDI stock owned by U.S. TNCs in the manufacturing sector in developed countries, whereas the same stock of FDI in developing countries employed 23.8 workers, or 2.4 times as many.²⁶ As a result, a stock of $281bn in U.S. manufacturing FDI in developed countries employed 2.76 million workers, while a stock of $88bn in developing countries employed 2.1 million workers. The same quantity of investment in extractive industries (mining, quarrying, and petroleum) employs a much smaller number: 1.3 workers in developed countries per $1 million of FDI, compared to 2.5 workers in developing countries. To complete the picture, each $1 million invested in services leads to the employment of 2.1 workers in developed countries and 2.3 workers in developing countries.

However, this data underestimates TNC employment, since UNCTAD does not count temporary, casual, and subcontracted workers as employees, yet U.S. TNCs have led the way in casualizing Southern labor, as in the case of Coca-Cola, considered below. Counting all of these employees, it is reasonable to conclude that TNCs headquartered in the United States employ more workers in low-wage countries than they do domestically, and, by extension, the same is true of TNCs headquartered in Europe and Japan.²⁷

The Profits of FDI

Qualitative differences between N-N FDI and N-S FDI mean they cannot be simplistically compared. Flows of investment and repatriated profit between the United States, Europe, and Japan are symmetrical inasmuch as they invest in one another. In striking contrast, cross-border investments between the Global South and the Triad nations are extremely asymmetric: S-N FDI is negligible in comparison to N-S FDI. UNCTAD reported in 2008 that “the large gap between TNCs from the developed and developing groups remains. For instance, the total foreign assets of the top 50 TNCs from developing economies in 2005 amounted roughly to the amount of foreign assets of General Electric, the largest TNC in the world.”²⁸ In consequence, direct investment and profits flow in both directions between the United States, Europe, and Japan, but between these nations and the Global South the flow has been and continues to be overwhelmingly one-way. As the accumulated stock of FDI in the South has increased, so the return flow of profits has grown into a mighty torrent, which, as Figure 3.1 shows, are now of a similar magnitude to new N-S FDI flows. A particularly striking feature of Figure 3.1 is the steepness of the increase of both FDI flows and profits in the early years of the millennium, consistent with evidence cited elsewhere on the acceleration of outsourcing following the bursting of the dot-com bubble at the beginning of the new millennium.

According to UNCTAD’s 2008 World Investment Report, the world’s TNCs earned $1,130bn in 2007 in profits from their foreign subsidiaries, 406,967 of which are located in developing economies and 259,942 in developed economies.²⁹ The report provided no breakdown or detailed analysis of FDI profits by firm, sector or country, except for “Annex Table B.14,” which reports that in 2005, the most recent year for which data is available, U.S. TNCs earned $549bn in profits from what it elsewhere reports to be their $2.05 trillion stock of direct investments. Japan, the only other country to report profits from FDI, earned $87bn.

This UNCTAD table with just two entries exemplifies the scanty information on global profit flows in data provided by public bodies. Furthermore, there are many reasons to question the accuracy of the sparse data. FDI income has three components: repatriated profits, retained profits, and interest payments on loans extended to the affiliate by the parent company, but “many countries fail to report reinvested earnings, and the definition of long-term loans differs among countries.”³⁰ Alexander Lehmann, in a rare IMF working paper on the subject of corporate profits, says, “In practice, only few emerging markets adhere to these standards.”³¹ So poor were the data published by his employer, the IMF, Lehmann turned instead to the U.S. Department of Commerce and its data on FDI by U.S. firms, from which he concluded that the rate of return on FDI in developing countries in the 1995–98 period was at least twice as high as was reported by the IMF. He adds: “The estimates for the return on foreign direct investment suggest that profitability is widely underestimated. U.S. data show returns on total foreign direct investment in emerging markets in the order of 15 to 20 percent. An additional three percent on invested capital [is] paid to parent companies for royalties, license fees and other services.”³²

FIGURE 3.1: North-South Flows of FDI and Profits ($bn)

Source: FDI flows from UNCTAD (available at http://unctadstat.unctad.org/)

Twelve years on (Lehmann’s paper was published in 2002), neither the IMF, UNCTAD, or any other IFI has shed any further light on this murky and decidedly non-trivial matter—no further working papers, no studies, no “FDI profits” theme for any of the annual reports, no revision of the data discredited by Lehmann, no attempt to publish new, more credible data. Instead, some dubious estimates with minimal information about how they were compiled and none about how the problems identified in Lehmann’s paper have been addressed. However, what UNCTAD does report is interesting. Its 2013 World Investment Report informs us, “While the global average rate of return on FDI for 2006–2011 was 7.0 percent, the average inward rate for developed economies was 5.1 percent. In contrast, the average rates for developing and transition economies were 9.2 percent and 12.9 percent, respectively.”³³ In other words, the rate of return on FDI was twice as high in developing countries as in imperialist countries.

UNCTAD publishes no tabular data on income from FDI, even though FDI is central to its remit. This it leaves to the World Bank, which manages the “Primary Income on FDI” database, whose data is presented in Figure 3.1. For the reasons cited by Lehmann and others discussed here, this surely significantly underestimates the true flow of profits from FDI in developing countries. The figures it provides for the 1995–98 period suggest a rate of return of around 4 percent, just one-fifth of the rate of return discovered by Lehmann for this same period.

Lehmann pointed in particular to a general failure by national authorities to collect data on reinvested income, that is, FDI profits that are not repatriated but used to finance an expansion of the TNC’s affiliate. The World Investment Report of 2013 reported that around 40 percent of FDI profits in developing countries is retained in the host country, but “not all of this is turned into capital expenditure; the challenge for host governments is how to channel retained earnings into productive investment.”³⁴ This alludes to the fact that not all retained earnings are reinvested in the affiliate that generated this income. The TNC may use these funds to invest in domestic government debt, in portfolio investments, in domestic stock markets, or any other legal or illegal activity that it thinks will be profitable, yet there is no publicly available information on the extent to which TNCs use their foreign subsidiaries as financial conduits rather than production facilities.

Declared profits also ignore underreporting, transfer pricing, and other widespread practices of dubious legality. Jennifer Nordin and Raymond Baker, a leading authority on “the countless forms of financial chicanery … prevalent in international business,”³⁵ reported in the Financial Times that

over the past four decades or so, a structure has been perfected that facilitates illegal cross-border financial transactions…. Many multinational companies and international banks regularly use this structure, which functions by ignoring or skirting customs, tax, financial and money laundering laws. The result is nothing less than the legitimisation of illegality…. By our estimate, it moves some $500bn a year illegally out of developing and transitional economies into Western coffers.³⁶

The profits that firms repatriate from their foreign subsidiaries are very much smaller than the surplus value extracted from its employees in these low-wage nations. We saw in chapter 1 that this surplus value is shared among many capitals in the imperialist economies, and a large chunk of it is captured by their states. And leaving aside firms’ concealment of their actual profits, profit as such is what remains of surplus value after the subtraction of many unproductive yet necessary activities (necessary from the perspective of capitalists seeking to crystallize their profits, if not from the perspective of society as a whole), all of which consume surplus value extracted from exploited workers. Zero profits, or even large losses, are therefore quite compatible with major flows of surplus value and high rates of exploitation. The profits that are so imperfectly and partially described in statistics therefore suffer from much more fundamental problems than poor coverage and technical deficiencies, considerable as they are.

ARM’S-LENGTH OUTSOURCING

In contrast to FDI, where the production process and associated revevues are offshored but kept in-house, an outsourcing firm may choose to contract out some or all of production to an independent supplier while retaining effective control over both the final product and the process of its production. According to Gene Grossman and fellow Princeton economists, “It does not matter much whether the firm opens a subsidiary in a foreign country and employs workers there to undertake certain tasks within its corporate boundaries, or whether it contracts with a foreign purveyor under an outsourcing arrangement…. In either case the effects on production, wages and prices will be roughly the same.”³⁷ The Princeton professors neglect to mention the effect of outsourcing on profits—which is odd, since the maximization of profits is the whole point of the exercise. But what’s really odd is that, despite the fact that FDI generates a flow of repatriated profits while an arm’s-length relation does not, multinational corporations increasingly favor arm’s-length relationships over FDI. As Gary Gereffi points out, “While companies regularly decide whether they wish to produce goods and services ‘inhouse’ or buy them from outside vendors, the tendency in recent years has shifted in the direction of ‘buy.’”³⁸ Timothy Sturgeon, another leading researcher into global value chains, also “detect[s] a shift in the organization of global production toward external networks.”³⁹ William Milberg concurs: “Despite the stunning increase in the transnational activity of large firms … such firms find it increasingly desirable to outsource internationally in an arm’s length rather than non-arm’s length (intra-firm) relation.”⁴⁰

China provides an eloquent illustration of this. Grossman and Rossi-Hansberg report that intra-firm trade, as a proportion of total U.S. imports from China, rose from 11 percent in 1992 to 26 percent in 2005.⁴¹ But in 1992, following the relaxation of restrictions on inward FDI in 1991, the doors were only beginning to open to U.S. TNCs; since then they have built a giant exporting platform almost from scratch, resulting in annual imports into the United States from U.S.-owned TNC subsidiaries in China leaping from $3bn to $63bn, a thirty-fold increase that is exaggerated by the exceedingly low initial level. On the other hand, imports from independent suppliers in China increased “only” ninefold, from $22bn to $180bn.⁴² Thus, while China-U.S. intra-firm trade increased its share from a tiny base, arm’s-length outsourcing by U.S. companies in China greatly increased its absolute lead over direct U.S. investments in that country, accounting, on the eve of the global crisis, for three-quarters of total China-U.S. trade.

The Mysteries of Outsourcing

Milberg’s recognition of outsourcing’s growing preponderance leads him to rhetorically ask, “Why should arm’s-length outsourcing be of increasing importance in a world where transnational corporations play such a large role? … Why should cost reductions be increasingly prevalent externally rather than within firms?”⁴³ He answers, “The growing tendency toward externalization implies that the return on external outsourcing—implied by the cost reduction it brings to the buyer firm—must exceed that on internal vertical operations…. These cost savings constitute rents accruing abroad in the same sense that internal profit generation does for a multinational enterprise.”⁴⁴ This is a crucial insight, yet it poses a perplexing puzzle. As the three global commodities discussed in chapter 1 illustrate, “rents accruing abroad” appear, in company and national accounts, to accrue instead from the domestic design, branding, and marketing activities of the lead firm. We will return to this puzzle a few pages hence, but first we’ll consider some reasons why the arm’s-length relationship might be increasingly favored over FDI.

One reason why arm’s-length outsourcing may be more profitable than FDI is that, as Martin Wolf notes, “transnational companies pay more—and treat their workers better—than local companies do.”⁴⁵ Citing “detailed econometric evaluation” that takes into account “the educational levels of employees, plant size, location, and capital- and energy-intensity … the premium is 12 percent for ‘blue-collar’ workers and about 22 percent for the ‘white-collar’ workers.”⁴⁶ Jagdish Bhagwati also reports that TNCs “pay an average wage that exceeds the going rate, mostly up to 10 percent and exceeding it in some cases.”⁴⁷ Writing in The Economist, Clive Crook gives much higher estimates: he claims that wages in the affiliates of TNCs in “middle-income countries” are 80 percent higher than those paid by local employers, and in “low-income countries” their wages are 100 percent higher.⁴⁸ Thus one reason why TNCs increasingly prefer to externalize their operations is that forcing outsourced producers into intense competition with one another is a more effective way of driving down wages and intensifying labor than doing so in-house through appointed managers.

A further incentive to “deverticalize”—that is, to move from a vertical parent-subsidiary relationship to a horizontal contractual relation between formally equal partners—is that arm’s length also means “hands clean”—the outsourcing firm externalizes not only commercial risk and low value-added production processes, it also externalizes direct responsibility for pollution, poverty wages, and suppression of trade unions. One notorious example is Coca-Cola’s operations in Colombia, the hub of its Latin American soft drinks empire, where the food workers’ union, SINALTRAINAL, accuses company management of colluding with death squads who have assassinated nine union members and leaders since 1990 and forced many others into exile. “Eighty percent of the Coca-Cola workforce is now composed of non-union, temporary workers, and wages for these individuals are only a quarter of those earned by their unionized counterparts…. Coca-Cola is in fact a stridently anti-union company, and the destruction of SINALTRAINAL, as well as the capacity to drive wages into the ground, is one of the primary goals of the extra-judicial violence directed against workers.”⁴⁹ Coca-Cola’s Atlanta-based international directors wash their hands of any responsibility either for the poverty wages paid to their workers or for the violent repression of their efforts to remedy this, on the grounds that its Colombian bottling plants are independent companies operating under a franchise, enabling it to make the legally precise claim that “Coca-Cola does not own or operate any bottling plants in Colombia.”⁵⁰ Mark Thomas, an investigative journalist, commented that this is

the “Coca-Cola system,” operating as an entity but claiming no legal lines of accountability to the Coca-Cola Company…. The case here is similar to that of Gap and Nike in the 90s … [who] outsourced their production to factories in the developing world that operated sweatshop conditions. It was not Nike or Gap that forced the workers to do long hours for poor pay, it was the contractors.⁵¹

The “Coca-Cola system” not only distances TNCs from direct responsibility for super-exploitation, pollution, etc., during normal times, they don’t have to take responsibility for imposing mass layoffs during times of crisis. Though the arm’s-length relationship may have political or public relations benefits, the bottom line is its effect on TNC profits and asset values. A third reason is that arms’s-length relationships also allow TNCs to offload many of the costs and risks associated with cyclical fluctuations in demand and with much larger disruptions in world markets, as exemplified by the whiplash effect felt in the lowest rungs of global value chains following the collapse of Lehman Brothers in 2008. As UNCTAD reports, “Jobs in labor-intensive NEMs [Non-Equity Modes] are highly sensitive to the business cycle in GVCs [Global Value Chains], and can be shed quickly at times of economic downturn.”⁵²

Finally, not only does the arm’s-length relationship not generate any S-N flows of repatriated profits, it does not involve any N-S capital flows, enabling Northern firms to divert investment funds into what Silver et al. call “financial intermediation and speculation.”⁵³ In other words, the increased profits delivered by outsourcing are not invested in production either at home or as FDI, and can be entirely devoted to leveraging asset values, through share buyback schemes and generous dividend payments, or invested in financial markets in order to reap speculative profits, thereby feeding the financialization of the imperialist economies.

In sum, it is possible to identify four major reasons why outsourcing firms might favor an arm’s-length relationship with their low-wage suppliers: 1) foreign investors find it necessary to pay higher wages than domestic employers, limiting the desired reduction in costs; 2) arm’s-length means hands clean; 3) transference of risk; 4) avoidance of FDI in favor of what UNCTAD calls a “non-equity mode” releases funds for investment in financial markets or to finance acquisitions and share buy-backs (two ways in which the fragmentation of production can accelerate the concentration of capital).⁵⁴

The puzzle posed by Milberg’s insight that a large portion of the profits of firms in imperialist countries (he does not call them this) is accrued in distant production processes can be restated as follows. The foreign direct investments of northern TNCs generate a gigantic S-N flow of repatriated profits, but in complete contrast, between Southern firms and Northern lead firms there is, in the data on financial flows, neither sign nor shadow of any S-N profit flows or value transfers. Furthermore, the various subterfuges indulged in by transnational corporations to conceal part of this flow from tax authorities (transfer pricing, under-invoicing, etc.) are not available in arm’s-length relationships. These are large benefits to forgo—yet TNCs increasingly find the arm’s-length relationship to be more profitable than in-house FDI. Does the fact that the S-N flow of value and profit is invisible mean that this flow doesn’t exist? If not, what becomes of the profit-flows that are visible in the case of an in-house relationship but completely disappear when this is replaced by an outsourcing relationship?

This is the question left unanswered by Milberg, Gereffi, etc., a conundrum that cannot be resolved without breaking free of the neoclassical framework, which presumes markets to be the “ultimate arbiter of value” and price to be its ideal measure,⁵⁵ precluding the possibility of hidden flows or transfers of values between capitals prior to their condensation as prices. This calls to mind the physical phenomenon known as sublimation—when the application of heat to a visible solid turns it into a flow of invisible vapor, only for it to rematerialize as a visible solid at a different relocation. Similarly, the flow of value from Southern producers to Northern capitalists is invisible—that is, there’s no sign of it in standard data on global capital and commodity flows. According to the bourgeois economists, if it’s not visible it doesn’t exist; and since value can only appear in the form of price, this, to positivist economics, is its measure.⁵⁶ This, the central premise of neoclassical economics, crassly precludes the possibility that value is transferred or redistributed between capitals in order to achieve equilibrium prices that equalize profits. Conversely, to recognize the existence of such flows is to dislodge the keystone of the ruling economic theory, causing the entire edifice to collapse. Renaming “profit’ as “rent,” as do Milberg, Kaplinsky, Gereffi, and others studying this phenomenon, does not clarify this question. In fact, it blurs the important distinction between profit and rent.⁵⁷ Milberg’s notion of “rents accruing abroad” implies that the South-North flow continues; and simply calling it rent says nothing about a really interesting implication of this. These “rents accruing abroad” appear in the GDP—the gross domestic product—of the importing nation—even though they were “accrued abroad.” The solution of this paradox, which we have been hinting at so far, will be presented in chapter 9, “The GDP Illusion.”

THE STRUCTURE OF WORLD TRADE

A most striking feature of the imperialist world economy is that, as we have seen, Northern firms do not compete with Southern firms, they compete with other Northern firms, including to see who can most rapidly and effectively outsource production to low-wage countries. Meanwhile, Southern nations fiercely compete with one another to pimp their cheap labor to Northern “lead firms.” We therefore have N-N competition, and we have cutthroat S-S competition, but no N-S competition—that is, between firms, if not between workers. Of course, important exceptions can be identified and qualifications can be made, but the overall pattern is clear: Apple competes with Samsung and Nokia, but not with FoxConn, Taiwan Semiconductor Manufacturing Company (TSMC), and its other suppliers. Similarly, British Home Stores (BHS) and Marks & Spencer (M&S) compete with each other but not with their Bangladeshi suppliers, and the same goes for Tesco, General Motors, or any other TNC sourcing its final goods or intermediate inputs from suppliers in low-wage countries. The lead firms’ relationship with their suppliers is therefore complementary, not competitive, even if it is highly unequal. This important point was underlined by Richard Herd, head of the China division at the Organisation for Economic Co-operation and Development (OECD), who noted that “at the moment, China is not a threat to Japan’s core industries”; on the contrary, outsourcing laborintensive production tasks to China has given many Japanese firms “a new lease on life … if you look at Chinese exports and Japanese exports they are not competing, they are complementary.”⁵⁸

The complementary relation between Japanese and Chinese firms can be applied to relations between firms in imperialist and oppressed nations in general. China’s manufacturing industry is no more a threat to the supremacy of U.S. TNCs than are the maquiladoras along the U.S.-Mexican border. Not only do the headline figures that show a huge deficit in trade with China actually reflect the importation of intermediate inputs produced in Japan, Malaysia, South Korea, and elsewhere, a great deal of it results directly from the decision of U.S. firms to move their production to take advantage of low Chinese wages. There cannot be anything more absurd nor more disingenuous than the nationalist-protectionist hoopla over the U.S. trade deficit with China!

The same is true of Europe’s TNCs. As Ari Van Assche, Chang Hong, and Veerle Slootmaekers explain in a study of EU-Chinese trade, “Europe’s importers and retailers … increasingly rely on cheap inputs and goods from Asia…. EU companies are now also producing in low-cost countries, and not simply importing inputs.”⁵⁹ Far from being locked in competition with China, “the possibility of offshoring the more labor-intensive production and assembly activities to China provides an opportunity to our own companies to survive and grow in an increasingly competitive environment,”⁶⁰ and they conclude, “Our direct competitors in the tasks in which we have a comparative advantage are not located in China, but continue to be the usual suspects: the United States, Western Europe and a handful of High-Income East Asian economies.”⁶¹

Competition between firms in imperialist and developing countries does exist. Even in the garment sector, where the global shift of production to low-wage countries is most advanced, low-end producers have not entirely disappeared from imperialist countries and residual competition with firms in low-wage countries persists. Competition between firms on both sides of the global divide is much more intense in branches and sectors where the global shift is still under way, as in the automobile industry. Finally, great significance must be attached to rising competition between imperialist firms and firms in China, South Korea, and Taiwan and elsewhere that are beginning to directly compete with them in strategic and/or higher value-added products. A prime example of the latter is China’s rapid rise to dominance of solar panel and wind turbine production; another is the rise of Chinese civil engineering behemoths now regularly undercutting their European and North American rivals in tenders for railway, port, and power station construction; companies such as HTC, Samsung, and Xiaomi are challenging Apple’s supremacy in smartphone production. The pharmaceutical industry is another important terrain of competition, with firms based in imperialist countries with Indian firms like Cipla and Ranbaxy challenging the supremacy of the West’s “big pharma.” This is an important trend, a real exception to the dominant pattern of trade established during the era of neoliberal globalization, and is part of the evidence that, in some sectors at least, the grip of imperialist capital is being loosened by Southern competitors

Nevertheless, despite these and other high-profile examples of N-S competition, the overwhelmingly dominant form of interaction between firms in imperialist and low-wage economies is synergetic and complementary. The general absence of head-to-head competition between firms on opposite sides of the N-S divide is brought into sharp focus by the “complexity index” developed by Arnelyn Abdon, Marife Bacate, Jesus Felipe, and Utsav Kumar at the Asian Development Bank and by Harvard’s Ricardo Hausmann and César Hidalgo. This approach classifies both national economies and individual commodities according to their complexity, “complex economies” being “those that can weave vast quantities of relevant knowledge together, across large networks of people, to generate a diverse mix of knowledge-intensive products,” while complex products, for example, “medical imaging devices or jet engines, embed large amounts of knowledge and are the results of very large networks of people and organizations. By contrast, wood logs or coffee embed much less knowledge, and the networks required to support these operations do not need to be as large.”⁶²

The “Index of Complexity”

To explain the idea of complexity, Abdon et al. use the simile of a Lego bucket to represent a country and various kinds of Lego pieces to represent the capabilities available in the country:

The different Lego models that we can build (i.e., different products) depend on the kind, diversity, and exclusiveness of the Lego pieces that we have in a bucket…. A Lego bucket that contains pieces that can only build a bicycle most likely does not contain the pieces to create an airplane model. However, a Lego bucket that contains pieces that can build an airplane model may also have the necessary pieces needed to build a bicycle model…. Hence, determining the complexity of an economy by looking at the products it produces amounts to determining the “diversity and exclusivity” of the pieces in a Lego bucket by simply looking at the Lego models it can build.⁶³

Hausmann and Hidalgo provide a useful illustration of the number-crunching methodology used to generate their Index of Complexity:

Consider the case of Singapore and Pakistan. The population of Pakistan is 34 times larger than that of Singapore. At market prices their GDPs are similar since Singapore is 38 times richer than Pakistan in per capita terms…. They both export a similar number of different products, about 133. How can products tell us about the conspicuous differences in the level of development that exist between these two countries? Pakistan exports products that are on average exported by 28 other countries (placing Pakistan in the 60th percentile of countries in terms of the average ubiquity of their products), while Singapore exports products that are exported on average by 17 other countries (1st percentile). Moreover, the products that Singapore exports are exported by highly diversified countries, while those that Pakistan exports are exported by poorly diversified countries. Our mathematical approach exploits these second, third and higher order differences to create measures that approximate the amount of productive knowledge held in each of these countries.⁶⁴

TABLE 3.1: Total Exports, by Product Complexity Percent of total exports in each Product Complexity Level (1 = highest; 6 = lowest)

Source: Table 6 in Arnelyn Abdon, Marife Bacate, Jesus Felipe and Utsav Kumar, Product Complexity and Economic Development, Levy Economics Institute Working Paper No. 616 (2010).

“Diversity” is here defined as the number of products that a country exports with “revealed comparative advantage,” that is, where their share of the global market in that good is greater than their share of global population, the idea being that countries specialize in what they do best, thereby exploiting their comparative advantage, and this is revealed in the composition of their exports.

One deficiency of complexity theory is that unavailability of data prevents its extension to trade in services. More serious, in the context of the present discussion, is that, in the words of World Bank researchers, “The technological sophistication and competitive stature of an exporter’s industrial base can be exaggerated when exports are used as a measure of industrial capability.”⁶⁵ Thus China’s complexity score will be exaggerated by its export of iPhones and other electronic goods that are assembled, but not manufactured, in that country. Complexity theorists are aware of this problem, but their remedy is ineffective: “Countries may also export things they do not make. To circumvent this issue we require that countries export a fair share of the products we connect them to.”⁶⁶ “Fair share” means when the share of a given commodity in a country’s total exports is greater than the global share of this commodity in global exports as a whole, that is, when its revealed comparative advantage (RCA) is greater than one—but iPhones, etc., will all pass this test and thus lead to an overestimation of China’s complexity score.

Abdon et al.’s Complexity Ranking lists 124 nations according to the complexity of their exports (see Table 3.2), while Hausmann and Hidalgo generate an Economic Complexity Index comprising 128 countries. Both present a broadly similar picture rich with fascinating details. In Abdon et al.’s ranking, all of the ten most complex nations are imperialist nations. In Hausmann and Hidalgo’s table Singapore, Slovenia, and the Czech Republic make it into the top ten most economically complex nations. Norway, Australia, and New Zealand, also members of this exclusive club, appear much further down among a slew of middle-income Southern nations, their position depressed by the large share of primary commodities in their exports. Also notable is the lowly position of Greece and Portugal, the two countries most battered by the Eurozone crisis, indicating that these nations directly compete not with core Eurozone countries, but with China and other low-wage nations.⁶⁷ Pakistan, Sri Lanka, Bangladesh, and Cambodia, four countries whose exports consist mostly of garments, languish at the bottom of the table among the poorest nations on earth.

There is a broad consensus among economists and policy makers that the loss of competitiveness by peripheral countries in the Eurozone vis-à-vis Germany and other core countries is at the heart of the forces tearing Europe apart. Unable to restore their competitiveness through currency devaluation, their only option is savage cuts in nominal wages, including that part of it received in the form of social benefits. Contemplating the divergence between German and Mediterranean productivity, Financial Times journalist Samuel Brittan commented that “even the Greek colonels, Franco, Mussolini or Salazar would have been hard put to reduce nominal wages on the scale required.”⁶⁸ But this broad consensus rests on a false premise—that Germany is Greece’s, Spain’s, etc., principal rival. As Jesus Felipe and Utsav Kumar have pointed out:

Ireland, Spain, Portugal, and Greece do not compete directly with Germany in many products that they export and hence comparing their aggregate unit labor costs and drawing conclusions is probably misleading…. German exports are concentrated in the most-complex products of the complexity scale … in the case of Greece and Portugal, their exports are concentrated in the least-complex groups…. Their export shares (by complexity groups) are similar to those of China. If China were the correct comparator, then perhaps the situation of the European countries would be significantly worse. We believe that this is where the real problem of the peripheral countries lies…. The problem is that they are stuck at middle levels of technology and they are caught in a trap. Reducing wages would not solve the problem.⁶⁹

TABLE 3.2: Complexity Ranking

Source: Appendix C in Arnelyn Abdon, Marife Bacate, Jesus Felipe, and Utsav Kumar, Product Complexity and Economic Development, Levy Economics Institute Working Paper No. 616 (2010).

The European Union is a club of imperialist nations, part of the united front with other imperialist powers against so-called emerging nations, and which during the neoliberal era has considerably deepened its exploitative and parasitic relation with the Global South. Spain, Portugal, and Greece are minor imperialist nations whose economies, banking systems, political structures, and military forces are an integral part of Europe and whose history is of marauding, oppressor nations. The short list of core nations, Fred Halliday reminds us, has “remained the same for a century and a half, with the single addition of Japan.”⁷⁰ But now at least one of them—Greece—is threatened with ejection from this club, and finds itself increasingly in competition with China and other low-wage countries, a competition that it is unable to win because of its much higher wages and its lack of a technological edge.

The Index of Complexity suggests that a Grexit from the EU would merely formalize its demotion from this imperialist club. In 1978, Greece’s complexity index was 0.64, the lowest in Western Europe. By 2008 this had collapsed to 0.21, on a par with China, as can be seen from Greece’s ranking in Table 3.2. In contrast, the indices of Portugal and Spain which in 1978 stood at 0.85 and 1.05 respectively, have suffered a much gentler decline, to 0.70 and 0.93.⁷¹ In other words, though Europe’s core nations have a complementary relation with Chinese firms, using them in the competitive battle against each other and with those in Japan and North America, Greek firms increasingly find themselves in direct competition with Chinese firms. It is no surprise to find Greece in the relegation zone. Relegation, that is, from the club of imperialist nations. Consumption levels are declining rapidly, but ejection from the Eurozone will very likely result in Greece’s precipitous collapse. Bourgeois democracy would be unlikely to survive such an eventuality, with the return of military dictatorship a distinct mediumterm possibility. Should Greek workers show signs of challenging Greece’s capitalist rulers for power, fascist violence will be mobilized against them, opening the possibility of a fully fledged fascist government taking power on the mainland of Europe.

Asymmetric Market Structures: Monopolistic “Lead Firms” in the North, Cutthroat Competition in the South

The Index of Complexity, whose most striking feature, according to Abdon et al., is that “richer countries are the major exporters of the more complex products while the poorer countries are the major exporters of the less complex products,”⁷² reveals with remarkable clarity the extent to which poor countries, and therefore firms in poor countries, do not compete with firms in rich countries. The enormous significance of this for the operation of the law of value in the contemporary global economy will be considered in chapter 8. The aim of this and the preceding chapter is to to identify and analyze the most important empirically observable features of the outsourcing relationship, in particular the fact that, in the words of UNCTAD economists, “developing country exports tend to be increasingly concentrated in … labor-intensive production processes.” This raises the “risk that the simultaneous drive in a great number of developing countries … to export such dynamic products may cause the benefits of any increased volume of exports to be more than offset by losses due to lower export prices.⁷³ In other words, what has become known as “the race to the bottom.”

William Cline was one of the first to warn of the danger that “first mover” advantage would not be available to latecomers:

Other developing countries would be … ill-advised to expect free-market policies to yield the same results that were achieved by the East Asian economies, which took advantage of the open economy strategy before the export field became crowded by competition from other developing countries, and did so when the world economy was in a phase of prolonged buoyancy…. Elevator salesmen must attach a warning label that their product is safe only if not overloaded with too many passengers at one time: advocates of the East Asian model would do well to attach a similar caveat to their prescription.⁷⁴

The success of the “first movers,” especially South Korea, Taiwan, and Singapore (often termed the Newly Industrializing Countries), seemed to show the path for other poor and underdeveloped to follow, but, as Raphael Kaplinsky and many others have noted, “the so-called gains from outward-oriented manufacturing may reflect a fallacy of composition. In other words, it may make sense for an individual country such as China to expand massively its exports of manufactures, but if the same path is adopted by all low-income economies, everyone will lose.”⁷⁵ Kaplinsky bleakly concludes that for every winner there will inevitably be many losers, and that firms occupying lower links in the chain can only escape the race to the bottom if they succeed in erecting some form of barrier to competition, that is, some degree of monopoly. “When barriers to entry are eroded … the best option may be to vacate the chain altogether” and find something else to do.⁷⁶

Intense competition between Southern producers, combined with what Kaplinsky has called a “fierce oligopsony”⁷⁷ of global buyers, drains wealth from Southern producers and supports profits and asset values of firms in imperialist countries. Gary Gereffi identifies the root cause of these unequal outcomes to lie in “the fundamental asymmetry in the organisation of the global economy between more and less developed nations. To a great extent, the concentrated higher-value-added portion of the value chain is located in developed countries, while the lower-value-added portion of the value chain is in developing economies.”⁷⁸ Robert Feenstra and Gordon Hanson, two other leading lights of value-chain research, give a similar description of asymmetry:

The asymmetry of market structures in global production networks, with oligopoly firms in lead positions and competition among first- and certainly second-tier suppliers, has meant intense pressure on suppliers who, in seeking to maintain markups, must keep wages low and resist improvements in labor standards that might lead to a shift … to another firm or country.⁷⁹

The acknowledgment by these researchers that the promised level playing field is in fact steeply sloping leads them to pessimistic conclusions. In particular, Southern suppliers “have no rents to share with employees, and can survive only if wages are kept at a minimum. The increased use of sweatshop labor today, which has come with the rise in arm’s-length outsourcing, can be seen as tied to global production sharing.”⁸⁰

There is a high degree of unanimity among these researchers about the pernicious combination of oligopolistic global buyers and unbridled competition among Southern producers. They accurately describe some important facts in plain view about the unequal relations between the Northern and Southern links of the value chains, but their explanatory power is limited, because, in line with the value-chain literature in general, “asymmetry in market structures in global production networks” includes product and capital markets in its gaze, but ignores the role of asymmetry in labor market structures, including the suppression of labor mobility, the vast reserve army of unemployed workers, repressive labor regimes, etc., in determining the distribution of value added. To explain anything about real relationships and actual outcomes—superprofits, swollen asset values, and high(er) wages at one end of the chain; sweatshops and starvation wages at the other—our concept of asymmetry must be extended far beyond product market structures to include all asymmetries of wealth and power.

UPGRADING, OR “MOVING UP THE VALUE CHAIN”

Export-oriented industrialization was presented as the route out of the impoverishment resulting from dependence on the export of primary commodities suffering chronically declining terms of trade vis-à-vis manufactured goods. However, as UNCTAD reported in 1999:

Terms-of-trade losses are no longer confined to commodity exporters. Many manufactures exported by developing countries are now beginning to behave more like primary commodities as a growing number of countries simultaneously attempt to raise their exports in the relatively stagnant and protected markets of industrial countries. For example, the prices of manufactures exported by developing countries fell relative to those exported by the European Union by 2.2 percent per annum from 1979 to 1994.⁸¹

Three years later, UNCTAD delivered a damning verdict on the results of two decades of export-oriented industrialization: “Of the economies examined here, none of those which pursued rapid liberalization of trade and investment over the past two decades achieved a significant increase in its share in world manufacturing income, although some of them experienced a rapid growth in manufacturing exports.”⁸² Faced with this harsh reality, “upgrading,” which means capturing a bigger share of the total value of the finished commodity by moving into higher value-added activities, has become the mantra of development economics, or as Milberg and Winkler put it, “Economic development has increasingly become synonymous with ‘economic upgrading’ within global production networks.”⁸³ In other words, adoption of the export-oriented industrialization strategy is an insufficient condition for the attainment of development. But if overcrowding has stranded the EOI elevator in the basement, the upgrading elevator, which has a much smaller capacity, suffers even bigger problems. Before we examine the evidence for this and consider its implications, we should note the major problem that the upgrading imperative poses for mainstream economic theory: upgrading contradicts dominant models of international trade, which stress that, rather than trying to do things that they presently cannot do, countries should concentrate on what they are able to do best and employ the resources they are most generously endowed with, that is, they should exercise their “comparative advantage.” Milberg and Winkler add,

The general perspective of upgrading is anathema to traditional theories of trade based on comparative advantage. The notion of economic upgrading is largely about gaining competitiveness in higher value-added processes, a strategy that may conflict with the dictates of the principle of comparative advantage in which an “optimal” pattern of trade may call for countries remaining specialized in low value-added goods.⁸⁴

The implication is that “traditional theories of trade”, that is, the modern variants of the theory of comparative advantage that occupy a sacrosanct place in mainstream economic theory, are useless as a guide to nations seeking development. (Mainstream trade theory will be discussed in later chapters.) Milberg and Winkler propose that “absolute upgrading” occurs when “value added per worker engaged” rises faster than the value of exports; “weak upgrading” when it rises, but more slowly than exports, and if value added per worker rose less than a quarter as fast as exports, no upgrading is taking place. The logic of this approach is that there are two possible conditions that might cause the value of exports to rise faster than domestic value added per worker: a rise in the import composition of those exports, or an increase in the size of the workforce producing them. In the first case, the shrinking domestic contribution to the value of exports is symptomatic of race-to-the-bottom competition; in the second case the developing country is doing more of the same thing but with diminishing returns. In their sample of thirty developing countries drawn from three continents, not one achieved absolute upgrading and just nine of the thirty countries experienced “weak upgrading.”⁸⁵

Milberg and Winkler see this as “a contemporary version of the Prebisch-Singer dilemma,”⁸⁶ in other words, a repetition of the deteriorating terms of trade suffered by the South’s traditional primary exports over much of the twentieth century, now as then blighting hopes of development and depriving producers of the fruits of their labor.⁸⁷ Thus they argue that “the export-led growth strategy adopted by most developing countries following the debt crisis in the 1980s (in place of the previous strategy of import substitution industrialization) has suffered from a ‘fallacy of composition’ problem…. The result can be a disproportionately small rise in value added, implying minimal economic upgrading.”⁸⁸ Their conclusions are apt, as is their tinge of scorn for the failure of analysts to challenge the hyperbole and false promises of the proponents of neoliberal reforms: “There is a need for a theory of ‘downgrading.’ Our cross-country results are consistent with many findings that most countries and sectors are not experiencing upgrading by acceptable definitions. Since these instances predominate, it would be useful to theorize this rather than simply label them as instances where upgrading does not occur.”⁸⁹ A “theory of downgrading,” that is, a new version of dependency theory, is precisely what the present work is seeking to develop.

SLOW GROWTH IN THE SOUTH’S SHARE OF GLOBAL MANUFACTURING VALUE ADDED

Manufacturing value added (MVA) is often only a small fraction of the value of Southern manufactured exports and has been growing much more slowly than employment, trade, or just about any other measure of globalization.⁹⁰ Had the IMF used this measure in place of gross exports, instead of reporting the dynamic growth of the globally integrated Southern workforce, it would have had the embarrassing task of explaining why this growth has been so lackluster.

The long-running decline in MVA’s share of GDP in imperialist nations is widely interpreted to mean a corresponding decline in the importance of manufacturing production, giving rise to notions of a transition to a “post-industrial society” or a “knowledge economy,” notions that are Eurocentric in that industry hasn’t diminished, it has moved, out of sight and out of mind, and reflect the petit-bourgeois social milieu of their proponents, far distant from the sphere of production. Industry’s real contribution to GDP is far greater than the statistics appear to show, since it is the source of the value consumed by non-productive sectors of the economy and misread as their contribution to GDP. Indeed, once we dispense with crude physicalist definitions of industry and services, and reclassify so-called service tasks intrinsic to the production process as “industry,” industry is then, by definition, the source of all value, and therefore of all value added, in an economy.

Two factors account for the apparent decline of industry’s contribution to GDP: the substitution of workers by machines resulting in the rising productivity of industrial labor, and the substitution of higher-paid domestic workers with low-wage workers in poor countries. The latter is analyzed in depth in this book. Considering by itself the effect of the introduction of labor-saving technology, advancing productivity means industry supports an ever-more complex society with fewer workers—yet this shows up in standard economic data as a decline in industry’s importance, leading to the simplistic and misleading notion that we now live in a “post-industrial society.”

The World Bank’s World Development Indicators provide data on MVA growth (for 1990 and 2002) and on growth in export of manufactures (for 1990 and 2004) for 55 low- and middle-income nations and 16 high-income’ nations.⁹¹ Manufactured exports from the 55 low-wage nations increased by 329 percent between 1990 and 2004 (434 percent if China is included), while their combined MVA grew by just 46.3 percent.⁹² During this decade and a half of intense globalization, the 16 high-income nations increased their exports of manufactures by 127.4 percent, while their combined MVA grew by 14.2 percent, and by just 1 percent if the United States is omitted—the United States’ 40.6 percent growth in MVA accounted for nearly all of the MVA growth of high-income nations, boosting its share of all 71 nations’ MVA from 29 percent to 34 percent.

AS THE PORTION OF GDP CONTRIBUTED by manufacturing has declined in imperialist economies so it has increased in many Southern nations, yet the leap in the South’s share of global manufacturing trade is not reflected in its share of global MVA, which has increased by a much smaller amount.⁹³ The continuing global shift in production is indicated by WDI data reporting that between 1996 and 2005 high-income nations’ share in global MVA declined from 80 percent to 74 percent, with the share of low- and middle-income nations rising from 20 percent to 26 percent. Given the qualitative advances in the globalization of production this is, to some extent, to be expected. It also reflects the shrinking share of the value of the final product that is captured by the Southern producer. Thus, in 1990, the MVA of the 55 low- and middle-income nations was 1.8 times the value of its exports of manufactures; by 2002 this had fallen sharply, to 0.6. This major decline has three main components: the demise of ISI-protected industry, increased imported value-added content of exports, and deteriorating terms of trade (falls in relative prices) of manufactured exports.

Mexico offers the most extreme example of booming manufactured exports and bombing MVA. Boosted by membership of the NAFTA free trade area with the United States and Canada and by the collapse of the peso in 1994, which made Mexican labor even cheaper, between 1990 and 1998 Mexico’s manufactured exports increased nearly tenfold, yet total value-added in its manufacturing sector increased by barely 50 percent and its share of world MVA actually fell. High-income nations present a mirror image: their ratio of MVA to manufactured exports doubled, from par in 1990 to 2.0 in 2002. As UNCTAD has pointed out, “in relative terms, industrial countries appear to be trading less but earning more in manufacturing activity.”⁹⁴

Despite the enormous increase in the global south’s manufactured exports from 1980 onwards, the rate of growth of MVA in these nations slowed down compared to the pre-.globalization period. Figure 3.2 compares the growth of MVA during the first two decades of export-oriented industrialization with the previous crisis-ridden decade of import substitution industrialization in four Latin American nations and six Asian nations at the forefront of the EOI stampede. Remarkably, only Chile saw an improvement in MVA growth.

FIGURE 3.2: Annual Growth in Manufacturing Value-Added Percent for Selected Developing Nations

Source: Özlem Onaran: The Effect of Neoliberal Globalization on Labor’s Share in Developing Countries, Table 1, p. 31, http://www.univie.ac.at/ie/alt/files/lva/artikel.pdf.