Freeman

IT JUST AIN'T SO

Outsourcing Is Bad for the Economy?

OCTOBER 18, 2012 by TYLER WATTS

Presidential campaign demagoguery hit full stride when President Obama released ads accusing Mitt Romney of “shipping jobs overseas” as CEO of private-equity firm Bain Capital. Romney responded not by denying this aspect of Bain’s operations, but rather by insisting that he was no longer actively managing the company at the time the alleged outsourcing occurred.

I can understand why a politician would downplay such charges. After all, “the economy” is supposedly the top issue this year, and many voters buy into the rhetoric that companies involved in outsourcing are somehow responsible for a net loss of employment opportunities in the United States.

But outsourcing, far from being a cause of economic trouble, is actually part of any highly developed market economy. Outsourcing, in a fundamental sense, is the source of all wealth.

To tackle the misconceptions surrounding this controversy, let’s start with a definition. In the Bain Capital case, outsourcing means “hiring foreign workers to do a particular task, as opposed to hiring domestic workers.” Now why would an entrepreneur do this? It should be pretty obvious that the foreign labor costs less. Outsourcing therefore generates some combination of lower prices for the company’s products and higher profits for its owners—indicating that the company is creating more value with the resources it uses. So, as a corporate executive might say in defense of an outsourcing announcement, “it just makes economic sense for our customers and shareholders.”

But what about the workers? The media focus on the horrid “shipping American jobs overseas” aspect of outsourcing. Even if they acknowledge the gains for consumers (lower prices) and shareholders (higher business profits), many commentators will complain these are offset by the losses to American workers.

First off, let’s recognize that, in a free society, workers aren’t entitled to their jobs; most employment is an arrangement subject to termination by either party at any time for any reason. Individual workers are always losing jobs for all manner of reasons and finding new ones—even in a recession. The mass layoffs associated with outsourcing are not economically different, just more noticeable, and therefore more subject to political demagoguery—especially in a recession.

We shouldn’t ignore this kind of labor upheaval, whatever its cause. There is obviously going to be some pain associated with the adjustment process. It’s never easy for people to find new employment opportunities, let alone a large pool of workers released onto the market at the same time. Readjustment costs are especially acute for people with strong local ties, such as family obligations. Underwater mortgages make it difficult for some people to migrate. Retraining for new industries is especially tough for older folks, and so on. Sad stories abound, which politicians artfully manipulate in order to enact laws and programs aimed at interrupting the normal market process in order to “save American jobs.”

But economic change happens for a reason. In a free market, when outsourcing becomes viable, market forces are telling entrepreneurs, workers, and resource owners, essentially, “The old ways of doing things, the old places, the old patterns that you were so accustomed to—they’re not working so well anymore. There are better ways, better places, and better patterns available. For the good of all mankind, to take advantage of the greatest possible global opportunities, we need some rearranging. A large group of people in place Z will now be able to do what people in place F used to do, but at lower costs. That means people in F need to find something else to do, whether that involves moving to place Q, joining industry Y, retraining, or what-have-you.”

Of course the market is not a person and has no motives. What we call markets are just the systematic patterns of exchange, production, and specialization that take place between and among countless individuals across the world. Yet the core insight of economics is that while people tend to pursue only their own narrow interests, “market forces” act as if they are trying to maximize the value of what is being produced across the entire market space—in our case, the whole world. Long-distance business transactions are a natural and important part of this market process. It’s only labeled “outsourcing” when it’s done by a large corporation and involves a noticeable transfer of a certain production process across an arbitrary national boundary. The term invokes images of Gordon Gekko-like corporate executives in smoke-filled boardrooms, chuckling about the fat profits to be had by transferring widget production from Chicago to Shanghai.

But in reality all economic advances involve one form or another of outsourcing. We’re all doing it all the time. When a shopper selects German beer or Colombian coffee, few people accuse her of outsourcing (hardcore “buy-local” activists notwithstanding). Yet the consumer is engaging in trade in which some production took place in a far-off location. Is it any less outsourcing when I go online and buy a book from Boston, or a suit from Seattle? Outsourcing is everywhere!

Consider what a world of no outsourcing would look like. Everything you use—and I mean everything!—must be acquired within a few miles of where you live. As economist Russ Roberts said, we’ve already tried that. It was called the Middle Ages, and life was “nasty, brutish, and short.” Indeed, economic progress in recent centuries has been marked by ever-increasing outsourcing—what Adam Smith called an ever-extending “division of labor.” We have outsourced most of our food production from the field behind our own huts to the huge farms of the corn and wheat belts, with their great farming machinery, genetic engineering, and chemical marvels, themselves all dependent on highly specialized production processes that are outsourced across the globe.

We outsourced our clothing needs from the backyard flock and the spinning wheel to the textile mill, which itself was progressively outsourced from northern England in the 1700s to New England in the 1800s, then to the southern United States in the early 1900s, and presently to parts of Asia. We outsourced entertainment from the occasional village troubadour to the big recording studios and now, with the Internet, to specialists all over the world.

I could go on, but you get the point: Throughout history the rise in outsourcing has paralleled a rise in productivity, a rise in human opportunities and accomplishments, and a rise in global living standards. This is not a coincidence; economics indicates that outsourcing is not a bane to our economic health, but a core component of economic progress.

Nothing said here, however, is meant to countenance the many government interventions, here and abroad, that distort the patterns of global commerce, making them different from those the free market would have generated.

Economics makes clear that outsourcing is not the problem; the problem is scarcity. Outsourcing is (part of) the solution. Presidential candidates or anyone interested in promoting economic progress should think about policy changes that would allow American entrepreneurs, workers, and resource owners to better integrate themselves into an increasingly interconnected global economy.

Find a Portuguese translation of this article here.

ASSOCIATED ISSUE

November 2012

ABOUT

TYLER WATTS

Tyler Watts is an assistant professor of economics at Ball State University and the winner of the 2012 Beth A. Hoffman Memorial Prize for Economic Writing.

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