Mises Daily Articles
The Economics of Outsourcing
The latest political fallout of the current "outsourcing" debate came recently when the Bush Administration's designated "manufacturing czar" turned out to be Anthony F. Raimondo, whose "crime" was to be the head of a firm that recently opened a factory in
Of course, the idea that the United States needs a "manufacturing czar" continues the misguided policies that gave us a "drug czar" and, during the 1970s, an "energy czar." (At least the first "energy czar," William Simon, had the good sense to note that the very presence of his office was counterproductive and downright dictatorial and dangerous. Subsequent "czars" have, instead, reveled in their powers and have continued the deception.)
This is not a discussion about the necessity of "czars" to guide public policy – unless the "czar" calls for laissez-faire and closes up shop. (Unfortunately, "czars" labor under the delusion, as do the political classes and the general public, that their labors are the only thing between prosperity and chaos.)
Instead, I directly address the issue of "outsourcing," from an Austrian point of view. Now, in the current political climate, "outsourcing" is bad and is blamed for unemployment and other social evils, and already Congress has jumped into the fray, framing legislation that will deny firms to do business with the federal government if the companies have invested in overseas operations that Congress deems having "cost" American jobs.
Others writers have dealt with the issue, and there is no need to repeat their arguments, as sound as they have been. What I look to do is to point out how Austrian Theory not only debunks the fallacies that the anti-outsourcing advocates have been spawning, but also points out why the process makes sense economically, and not just for the countries where the investment takes place, but also the nations where the final goods are sold.
In defending his company's decision, Raimondo declared that the goods his factory built in
This point of view, not surprisingly, has many adherents in Congress from both parties. When George W. Bush's chief economic advisor Gregory Mankiew said in testimony before Congress that the "outsourcing" practice ultimately would be good for the
Members of Congress have no problem when firms headquartered in other countries invest in operations located in the
One of the most important contributions made by Austrians and especially the "founder" of the
From this point of view, the notion of "value added" at each stage of production becomes vital in describing how the final product receives its value. In this way of thinking, value is "added" whenever the factors undergo change. For example, when crude oil comes from the ground, it is in an unusable form until it goes through a refinery, where the petroleum is "cracked" and made into a number of products, from fuel oil to gasoline to an intermediate good used in the making of synthetic threads like nylon and polyester (that are intermediate products for goods as diverse as artificial turf to ready-to-wear clothing.)
Thus, the value of the final good, in this way of thinking, simply is the sum of the various valuations that are made at each production stage. Prices of goods are derived from that summation of previous prices of production. (Thus, we hear advocates of government medicine claim that marketing done by private medical firms simply "drives up" the cost of medicine. Eliminating private medicine, they argue, would lower final costs because government health care providers would not need to engage in marketing. The quality of care, they claim, ultimately would improve.)
If that description of economic processes were true, then the outsourcing critics would be correct, since they argue that whatever savings consumers might gain from cheaper products imported from "cheaper labor" countries overseas are more than offset by the losses incurred by the disappearance of the various stages of "value added." However, there is a problem in that analysis, one that even the Classicals, including Adam Smith, recognized. It was Smith who noted that the purpose of production is consumption. To put it another way, the only way the anti-outsourcing advocates could be correct would be if production were an activity carried on for its own sake.
One of the (many) fallacies of the communist paradigm was that the centerpiece of economic society was the "worker." As a production-oriented ideology, communism was based upon the fallacy of production itself being the ultimate purpose of economic activity. Therefore, factories were seen as the logical center for political organizing and activity; what actually was made and how it was made and the quality of the final product took second stage (actually being completely off stage) to the issue of employment – any employment. Apologists for communism in the western nations praised the fact that everyone in communist countries was assigned a job, thus eliminating dread unemployment, which leftists claim is the Achilles Heel of the capitalist system.
Menger's contribution in this particular arena of economic analysis is vital to understanding why the anti-outsourcing crowd is just plain wrong. The value of a final product did not arise from the series of "added value" that occurred at the different stages of production. Instead, the valuation of the factors of production ultimately came from the value that consumers placed upon the final product itself. To put it another way, the imputation of value did not run upward first from the factors and ultimately to the final product; instead it occurred the other way around. Consumers, through their valuation of a good, indirectly determined the value of each factor of production and each intermediate stage of manufacturing.
This insight is the antidote against the claim that "outsourcing" harms the
One manifestation of this fallacy is the notion that Henry Ford, when he doubled the pay to his employees at his
Such a claim, however, is absurd, since what they are actually saying is that by doubling his labor costs, Ford was able to sell more cars. In reality, Ford increased employee pay in order to retain his workers, correctly assessing that the high costs associated with employee turnover and constant training of new employees who were not enamored by the boredom of the conveyor-belt assembly lines, or at least not enamored with putting up with such boredom for $2.50 per day. Ford's actions ultimately lowered his total production costs, something that the "Ford created the consumer" advocates miss entirely.
Yet, there is something that is seemingly disturbing when a company closes a plant in the
As compelling as this argument sounds – and it certainly is going to be compelling to the families of individuals who lose high-paid jobs and cannot find comparable compensation for their skills – it still is based upon the "value added," production for its own sake fallacy. Before they can make their case that the practice of outsourcing is harmful to the
The Mengarian analysis hardly begins and ends with international trade, as one can easily apply it within an economy. For example, I currently live in an area (
When this locality was in its manufacturing heyday, places like
Application of Menger's principle here is that when a less-costly way to make a good is discovered, whether it be through the application of new capital or through lower wages, then the value of the factors used for that good has changed as well. An economy cannot gain when the state attempts for force up the price of some factors so that the owners of those factors of production are able to gain an advantage. We are dealing here with the hoary fallacy of protectionism, period.
For all of the popularity of their arguments at this time – something that is being repeated by both major political parties in this current election season – the anti-outsourcing advocates have not discovered anything new. In the end, they repeat the Classical fallacy of goods deriving their value from the costs of production. Should they succeed in forcing their views into law, we can be sure that the ultimate outcome will that which befalls any society that gives into protectionism: a lower standard of living and, in the end, even more joblessness.