Michael Mandel has written a very good, provocative article on the role of offshoring in creating a misleading portrait of U.S. manufacturing productivity:

[M]ost manufactured goods these days are the product of global supply chains, which may include multiple countries and border crossings. Your smartphone, for example, is assembled from components that were manufactured all over the world. On a less high-tech note, the cedar hangers that organically keep your suits and dresses free of pests may be made of wood grown in the U.S., shipped to China for manufacture, and then shipped back to the U.S. again.

Given the dominance of global supply chains, manufacturers and distributers both have two very different strategies available to them for cutting costs. On the one hand, they can invest in raising productivity in their domestic operations. A midwestern auto factory can rearrange its assembly line to produce more cars with fewer workers; a retailer can shift more sales to its online division; a real estate agency can invest in contact-management software to help fewer brokers manage more potential buyers and sellers.

Alternatively, companies can cut costs by seeking out cheaper suppliers around the world—to use the business school term, they can engage in global supply chain management. A U.S.-based computer company can lower its costs by moving its customer call center from South Dakota to India, Walmart can shift its clothing purchases from a Chinese shirt manufacturer to a cheaper supplier in Vietnam. Apple can find a cheaper offshore supplier for its iPhone display screen.

But here’s the rub: both of these corporate strategies— domestic productivity improvements and global supply chain management—show up as productivity gains in U.S. economic records. When federal statisticians calculate the nation’s economic output, what they are actually measuring is domestic “value added”—the dollar value of all sales minus the dollar value of all imports. “Productivity” is then calculated by dividing the quantity of value added by the number of American workers. American workers, however, often have little to do with the gains in productivity attributed to them. For instance, if Company A saves $250,000 simply by switching from a Japanese sprocket supplier to a much cheaper Chinese sprocket supplier, that change shows up as an increase in American productivity—just as if the company had saved $250,000 by making its warehouse operation in Chicago more efficient.

My only problem with Mandel’s article is that he never mentions that a manufacturing powerhouse like Germany may suffer from the same problem. A few months ago, he wrote the following:

Reihan raises a very interesting point which I hadn’t considered. Remember that our recent paper, “Not all productivity gains are the same. Here’s why”, we divided measured productivity growth into three types:

*Improvements in domestic production processes

*Gains in global supply chain efficiency

*Productivity gains at foreign suppliers.

As we noted in the paper, these different types of productivity growth cannot be told apart in the conventional economic statistics. However, the type of productivity growth matters for domestic wages and jobs. For example,  productivity gains from improvements in domestic production processes are more likely to result in rising real wages for domestic factory workers.

We made our argument in terms of the U.S., but it potentially applies to other countries as well. I hadn’t considered Germany until Reihan raised the point, but in fact Germany appears to use a similar import price methodology as the U.S. (see for example Silver 2007) with the potential for similar problems, though I need to take a closer look to make sure.

Here’s something to think about: In a global economy, measured productivity growth in an industrialized countrypotentially may not measure only the strength of that country’s domestic economy, but also its ability to successfully offshore production to cheaper countries, with implications for domestic wages and jobs.

Mandel was referring to a post in which I noted the role of Germany’s integration into a central European supply chain in its success as an exporter of manufactured goods. It is possible that he determined that Germany does not suffer from the same measurement problem, though I’d be curious to learn more. I hope to discuss Mandel’s article at greater length. I will be addressing related issues in a forthcoming essay.