THE BIG SQUEEZE

Meantime, India and China are teeming with tech talent. India turns out about 150,000 engineering grads every year, and China 250,000. Diana Farrell, the director of the McKinsey Global Institute, McKinsey's economic think tank, notes that most of those grads do not have the English-language skills and training that multinationals typically seek. Maybe not, but India is becoming a favored outsourcing destination for high-end telecommunications, software development and R&D work. French telecom giant Alcatel is doing the R&D work on its 4G cell-phone technology in Bangalore. In the past five years, more than 100 multinationals, including General Electric, Boeing and Exxon-Mobil have set up R&D centers in India. Microsoft is steadily moving most of its customer-service functions, except those for its "premier" corporate customers, to India. Sangeeta Gupta, a vice president of the National Association of Software and Service Companies, predicts that India's IT and business-operations outsourcing business will be a $50 billion industry by 2008.

Says Harvard economist Richard Freeman: "We knew the Chinese would make cheap toys, and the Indians would maybe do data input, but they certainly don't do sophisticated engineering. In fact, it turns out the Indians and Chinese are pretty smart. Almost any economic theory would say, 'If there's a whole lot of guys who do the same work as you can, that's not so good for you. If the labor supply is big, you're going to be in trouble.' "

America's strengths--innovation and entrepreneurship--remain formidable and should keep its middle class relatively prosperous, despite the gains being made by other nations. When Japanese and South Korean companies began to dominate the low-end memory-chip market in late 1980s, U.S. competitors like Intel and Motorola shifted gears and began to specialize in the production of more sophisticated, higher-margin semiconductors. That same process of climbing the value-added product ladder will have to continue.

Daniel Trefler, a University of Toronto professor, is sanguine for another reason. He notes that currency appreciation and rising wages will eventually work against China, India and other ascendant developing countries, though it may take a long time. "Japan in 1959 was not that different from China today," Trefler said recently at a conference on offshoring at the Brookings Institution in Washington. "It had a skilled and disciplined labor force that was paid 10 percent of U.S. wages. Yet Japan was never able to dominate world manufacturing. Why? Because Japan succumbed to the comparative-advantage police by steadily revaluing the yen." He asserts that the same thing will happen to China. "It does not matter that they have hundreds of millions of citizens willing to work for next to nothing. If the yuan strengthens, Chinese wages will rise to a point that they are no longer dominantly competitive." Trefler also argues that institutional handicaps--corruption, weak legal and financial systems--could hamper the rise of new corporate powerhouses.

Even so, say analysts, Europe and America must develop better strategies to compensate the workers who lose in the global trade game--and crucially, boost education and training efforts so that their workers acquire the "skill premium" they'll need to get or stay ahead. Given the speed with which globalization is unfolding, there's little time to lose. "The premium on having an effective policy response is greater than it's ever been before, and nobody seems to be paying attention to it," says Catherine Mann, an economist with the International Institute of Economics in Washington.

Europe still needs more fundamental structural change. In 2000, at the Lisbon Agenda for structural reform, EU leaders essentially agreed to liberalize their labor markets. Five years later, that hasn't happened, mostly due to opposition from trade unions and others who cling to the notion of job security rather than employment security--which means the ability to find a new job. Europe's seemingly endless struggle to define its priorities only heightens the stakes--and the risk. Globalization is real, and the competition is coming.

WITH R. M. SCHNEIDERMAN IN NEW YORK, KAREN LOWRY MILLER IN BRUSSELS AND RON MOREAU AND SUDIP MAZUMDAR IN NEW DELHI

© 2005