As drycleaners, we’ll likely never know first hand what it feels like to be outsourced; the best we can do is understand what happens and why. A recent example in a business close to our own can be found in the US hanger market.

Although the very mention of outsourcing causes anxiety to American employees, the purpose of this column is to use economics as a tool to analyze our industry, our lives and our citizenship. Unfortunately, this often means examining issues that may cause discomfort.

I reused the Adam Smith quote above as a reminder that each of us must act in his own self-interest if capitalism is to flourish. This self-serving behavior is the necessary element that made Smith’s concept of “the invisible hand” work for society. Mentioned once in hundreds of pages, the concept says that if every person does what is best for him or her, our entire society will be able to improve its condition in concert.

This belief- along with certain inalienable rights- creates the freedoms and the wealth that made this country great. The freedom to act in our own self-interest does not, however stop at the individual level; it must extend to firms that exist to maximize profits.

Throughout history, nations have found it advantageous to outsource production of goods and services to other nations for financial reasons. The United States outsources and has been outsourced to, thanks to the comparative advantage (an edge in the marketplace) it holds in many industries.

The law of demand tells us that consumers will always choose the lowest priced goods (if equal). When they do so, they have more income to spend on that good, as well as others. Thus, a firms “job” is to provide customers with goods at the lowers possible price.

One aspect of prices that is useful to remember is they cannot and should not be expressed as monetary exclusively. Monetary expressions of price lead to confusion as to what a “cost” is. All cost are ultimately opportunity costs- the loss of doing the next best thing, in favor of the good, service or activity that was chosen.

Failing to recognize opportunity costs leaves us talking with grandpa about how bread cost only a penny when he was young, rather than realizing that we are surely better off now. A better question to ask in determining cost would be “How long did you work to pay for that?” Recently, I saw a family ledger book from 1887 that mentions a $15 dollar coat; lets ponder 15 dollars value in 1887 for a while.

MODEL SOCIETY
Economists often simplify life down to a “mode” to test their theories. To illustrate comparative advantage, I’m going to borrow from Todd Bucholts’ book, New Ideas from Dead Economists.

The place is Gillian’s Island, but the cast is reduced to the Skipper and Gilligan only. To further simplify, let’s have them produce only two “goods”- fish dinners and shelters. It shouldn’t surprise you that the Skipper is better than Gilligan at production of both of these goods. What with Gilligan constantly hooking himself on things and hammering his own thumb, it is all he can do to keep working. Let’s examine what might happen if they compared notes to make their “society” work more smoothly.

The Skipper can catch a fish dinner in 10 hours and make a hut in 20; it takes Gilligan 15 and 40 hours, respectively. Some people would tell the skipper to move away from Gilligan, because of the differences in efficiency. In a year, the Skipper may work 2,000 hours and order Gilligan to work 3,600. If they split their time 50/50 between the two activities, the Skipper would “earn” 100 fish dinners and 50 huts; Gilligans efforts thru his longer hours would give him 120 fish dinners and 40 huts. The Island now has a GDP of 220 fish dinners and 90 huts.

After much thought and reflection, (perhaps an econ book washed up), they decide to specialize guided by opportunity cost, how much is sacrificed for production. They decide that the Skipper will spend all his time making huts, earning 100 huts. Gilligan will concentrate on fishing, earning 240 dinners. The result of the specialization is additional 10 huts and 20 fish dinners- without adding any more labor. The castaways are now wealthier without working harder.

HANGERS- ON
Today we can see these principles in action among the nations wire hanger manufacturers. Just as we have seen in other steel related businesses, flat productivity in America combined with explosive economic growth and investment in China created an opportunity. Also worth noting is that the Chinese Yuan is pegged to the dollars at an artificially low exchange rate, giving Chinese goods an advantage in its exports to the US.

In 1997, China exported 28.8 million wire hangers to the U.S. Each consecutive year saw tremendous growth, and during the first nine months of 2002, 405 million hangers had already been imported. Hanger prices dropped as a result, and the incentive (and cash) necessary for domestic manufacturers to make machinery improvements was gone. Three US hanger firms Cleaner Hangers Co. (CHC), United Wire Hangers and M&B Hanger Co. -had seen enough, and joined forces to seek legal protection.

Since Congress moved to normalize trade relations with China in 2000, the countries World Trade Organization (WTO) accession package offered a provision that gave US companies hope. The three firms sought protection from the International Trade Commission (ITC), with a filing that only needed to demonstrate the importers material harm.

The three ITC commissioners unanimously agreed with the American hanger companies filing, and recommended to Pres. George W. Bush that he impose a 25% tax on the value of Chinese hanger imports- some 95% of all hanger imports. Laidlaw stood against the tariffs at the time, since it had seen the trend develop early on and had signed an agreement with one of the new Chinese companies.

The result of the ITC challenge was not what the three American companies would have wished. Bush went against the Commissions recommendations saying that the tariffs adverse effects would be greater than the relief that it provided. Since then, the largest of the three Cleaner Hanger Company filed for bankruptcy and liquidated its assets.

The import trend has continued in the years since, industry insiders estimate that Chinese hanger imports are up to 800 million per year (2005). What percentage of that number is coming from the state-of-the-art Shanghai Wells factory we don’t know, but in 2003, the company expected to export 500 million hangers to the U.S.

If the 25% ad valom tax suggested by the ITC commissioners had been adopted in 2002, the anticipated tax revenues for that year would have been approximately $3.4 million. What does this mean to the consumer? At 2005 import levels, drycleaners are saving $4 to $6.5 million per year.

Capital and human resources alike, (CHC had to lay off 600 workers), have been redistributed to more profitable enterprises. While I still believe that every consumer and every firm must act in their own interest for the invisible hand of capitalism to work, I am reminded of an expression I like to use “The marketplace works out problems well….but sometimes people get hurt”. Often, we study an issue only to find it much more complex than politicians might lead us to believe; I think this is such a case.