The most embarrassing question to answer when an American tourist travels in China is how much he gets paid in terms of Chinese currency. In a country where most workers earn less than $200 a month, even the pay of someone working full-time at a fast-food restaurant in America can seem like a big sum.

The most puzzling fact to them is why a garment worker in America gets paid a lot more than a garment worker of equal skill using the same sewing machines producing the same garments in China.

The simple answer is that labor is paid according to its opportunity cost in its own country. No matter how productive in terms of physical output a garment worker in China is, she will be paid according to her opportunity cost in China only. An American worker, on the other hand, will be paid according to her opportunity cost in America. In fact, her real pay will generally go up together with the general labor productivity in America, even if she does not produce any more garments an hour.

In other words, American workers are paid more in terms of purchasing power because labor productivity in America in general is higher. Even though it still takes 4 musicians to play a string quartet in America (Baumol 1967), American musicians are paid more because they work in the same labor market as other American workers whose physical output per hour has improved substantially through time. This improvement has resulted from combining a lot of technology-embedded capital with scarce labor.

If product prices in America are set relative to American labor productivity in general and labor productivity is comparable in America and China in some industries when similar technology-embedded capital is used, a lot of money is left on the table for the global price arbitragers. Why not move some capital to China to invest in labor-intensive industries paying China wages and export the finished goods back to America selling them at American prices?

That is exactly what a lot of American companies have been doing. In the upscale market, companies with high-end consumer brands (such as Nike and Armani) are pocketing the high profit margin by sourcing cheap and selling high. In the down-scale market, the potential profit is shared with consumers by sourcing cheap and selling at everyday low prices (such as Wal-Mart).

By tapping the global labor market, American companies have threatened to lower the opportunity cost of some American labor to the level of Chinese labor. Specifically, any American labor which cannot produce more physical output per unit labor using the same technology and whose service is not location specific will be susceptible to such threats. Some jobs that used to be location specific have been transformed into location non-specific by the Internet, which offers low-cost real-time connectivity. A new study from the McKinsey Global Institute predicts that industries that are based on bits and bytes of information could be changed beyond recognition. For example, in packaged software worldwide, 49% of jobs could be outsourced to low-wage countries; in InfoTech services, 44%; in engineering jobs, 52%; and in accounting jobs, 31%.

Henceforth, only jobs that are location-specific and jobs that require rare skills will be safe from low-wage foreign competition. Fortunately, close to 90% of jobs in the US require geographic proximity (Foreign Affairs).