In defense of outsourcing.

• Jurisdiction: United States
• Date: 22 March 2005
• Author: Taylor, Timothy

You probably did not sew the clothes you are wearing as you read this, nor did you grow the food you will eat today. You also didn't build your own home, manufacture your own car, perform your own dentistry, or cut your own hair. You may not clean your own house or mow your own lawn. If you're single you may opt for a dating service to find romance, and once you've found it you may delegate part of your child rearing to a day-care service.

In other words, you outsource in your personal life. Everyone does, and with good reason. I am not grotesquely less competent at the ordinary tasks of life than my fellow citizens. But if I tried to produce personally all or most of what my family consumes, my family would face a dirt-poor standard of living. Adam Smith ([1776] 1994: 485-86), patron saint of economists, recognized this lesson two centuries ago, writing, "It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy." Smith also noted that the logic of outsourcing applied to nations as well as householders. He continued: "What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom."

Modern technological developments have opened the door to outsourcing of an unprecedented type and scale, and in the process, "outsourcing" became a political dirty word during the 2004 election campaign. It conjures up images of low-paid workers from India taking service jobs from U.S. workers in a wide range of decently paid occupations: telephone call centers, payroll and accounting departments, medical and legal transcription services, software writing and maintenance, preparation of standard tax forms, and reading routine medical x-rays. This article offers a primer on the economics of outsourcing: the evolving economic meaning of outsourcing, how outsourcing brings economic gains, why it is so deeply implausible that outsourcing is to blame for U.S. economic woes in recent years, and how the controversy over outsourcing reflects some deep structural changes in the U.S. economy.

Trade By Any Other Name

Outsourcing first became an explicit controversy in disputes between big American auto producers and the autoworkers union in the early 1980s. The union feared that the automakers were going to purchase an increasing number of components for cars like window cranks and seat fabrics from foreign and nonunion suppliers, rather than having them made by unionized workers (see, e.g., "A Deal That Could Put a Brake on Car Costs" 1982 and Flax 1983).

When outsourcing is defined in this way, it effectively includes all imports. In fact, this definition also includes purchases from non-unionized American firms. After all, almost everything that the U.S. economy imports, with the exception of some rare raw materials, could at least theoretically be produced within its borders. During the election campaign of 2004, a number of ads used this broad definition of "outsourcing" when they referred to products with labels that said "Made in China" or "Made in Mexico" and implied that these imports were the reason for America's stagnant job growth. If outsourcing is defined to cover all imports of goods and services, then the debate over outsourcing is just another chorus in the familiar arguments over whether or how an economy benefits from international trade, and whether or how those who gain from international trade should compensate those who lose. New lyrics, perhaps, but the same old tune.

But the outsourcing debate in 2004 offered a variation on the traditional arguments about trade. This time outsourcing did not refer to all imports of goods and services, but instead focused on imports of certain business services. For example, in February 9.004, the members of President Bush's Council of Economic Advisers (2004: 25) stated in their annual Economic Report of the President: "Outsourcing of professional services is a prominent example of a new type of trade." The chairman of the CEA at the time, Harvard economist N. Gregory Mankiw, followed up in an interview that caused a public relations squall (Andrews 2004):

I think outsourcing is a growing phenomenon, but it's something that we should realize is probably a plus for the economy in the long run. We're very used to goods being produced abroad and being shipped here on ships or planes. What we are not used to is services being produced abroad and being sent here over the Internet or telephone wires. But does it matter from an economic standpoint whether values of items produced abroad come on planes and ships or over fiber-optic cables? Well, no, the economics is basically the same. Even some of those who accept the argument that international trade in goods can benefit an economy overall when--all costs and benefits are taken into account--have expressed uncertainty about Mankiw's claim. After all, five-sixths of American jobs are in service-producing industries, and only one-sixth involve goods-producing industries (Council of Economic Advisers 2005: Table B-46). Isn't there some difference between importing goods like television sets or machine tools and outsourcing service jobs? As a starting place for answering that question, let's first consider why outsourcing provides economic gains at all.

Core Competencies and Make-or-Buy Decisions

Every firm faces make-or-buy decisions. Should a car company make windshields and seat covers and door panels itself, or should it buy them from outside suppliers? Should a company run its own lunchroom, clean its own building, and trim its own trees, or should it outsource these tasks to firms that specialize in catering, janitorial services, and grounds-keeping?

Ronald Coase (1937), University of Chicago economist and 1993 Nobel laureate, first tackled this...