Nostradoofus

I thought Eric and I were the only ones who thought Aristotle and Plato were lame.  Turns out Lucius Seneca beat us by 2000 years, referring to Greek syllogistic game-playing as “childish fatuities.”

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Speaking of the frictional costs of outsourcing, consider that a big reason for offshoring is simply to eliminate red tape.

Let’s say I want to outsource a $1000 job to a specialist, such as a computer programmer.

If I contract it to an American, in addition to the job itself, I must also:

• Have a system in place to remember to file a 1099 next year.
• Have a system in place to recall the paid amount next year.
• Re-read Forms 1099 and 1096, which change a bit every year.
• Fill out and mail Form 1099.
• Fill out and mail Form 1096.
• Risk making a mistake, incurring penalties.
• Risk being late, incurring penalties.

This consumes hours of work, but more importantly consumes valuable attention.  Another half dozen things to worry about.  But it all goes away if I send the work offshore.  Poof.

Yet we really do need 1099s, or something like them, to limit tax evasion.  A reasonable simplification might be:

• Enter data directly at IRS website — eliminate paper and PDF filings.
• IRS Web API for financial app integration.
• PayPal and QuickBooks auto-report to the IRS Web API whenever you send a payment (assuming you set them to do so).
• Eliminate form 1096.
• Stop changing the 1099 every year.

I’ve suspected this for years, but after recent experiments with administrative offshoring, now have direct anecdotal evidence:  low wages are partly a lazy substitute for creative, productivity-increasing management.

This is at once obvious and subtle.  The obvious part is that I, as a manager, have little incentive to produce efficiently if I can produce inefficiently, for less, with cheap labor. The subtle part is to reconcile this with (suddenly unpopular) laissez-faire economic policy, which has a compelling argument for free global labor markets (see comparative advantage).

Here is a micro-anecdote.  Prior to 2008, I did bookkeeping for Company X.  In 2008, I outsourced it.  This was super cheap, just $300 for an entire year of data entry, and that was not even the low bid.  They did good work.

Of course, it was not frictionless.  It took several hours of my time to bid out the job, choose a winner, collect and send the year’s statements, check the results, etc.  But a big improvement over doing it all myself.

Still, for Q1 2009, I decided to see what could be better automated, rather than outsourced. After surprisingly much research (Intuit is stuck in 20th-century communications mode), turns out Company X’s bank still can export transaction data to my arcane old Mac version of Quickbooks.  Yesterday, I reconciled most of Company X’s first quarter financials by myself in an hour.  This included my time to prepare data and check results, and eliminated the friction of working with a counterparty.  Result:  automation beats outsourcing in bookkeeping for Company X.

So is comparative advantage the wrong paradigm for labor?

I assert it is not wrong, but overstated, limited in application, in areas where labor productivity can improve rapidly by just thinking or learning.

Since low wages are easily measurable and easily implemented, there is a tendency to just outsource and be done with it.  But it’s not the only solution, nor the best solution, from the business owner’s perspective.  Even in the short run.

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Wonder why the market is up 25% in a single month, despite no improvement in fundamentals?  Consider this interesting coincidence.

The recent huge market rally began March 10, the same day Barney Frank announced the imminent, nearly certain elimination of the short uptick rule.  Berkshire Hathaway, a popular short in recent months, rose 19% that day.

Meanwhile, judging from what clients tell me, a lot of big funds lately are simply speculating on short-term momentum.

Connect these two dots:  massive short covering began March 10, anticipating the end of the uptick rule.  This caused a mini-rally.  Big momentum investors reacted to that, and to each other, creating self-sustaining momentum.

Result:  sustained rally on no fundamentals.

Not saying that’s definitely what happened, but it is a simple and plausible interpretation of events.  More plausible, in fact, than an abrupt improvement in the economy or financial system.