Outsourcing as vertical de-integration

Federal Judge Richard Posner, in his amazing joint blog with Nobel laureate Gary Becker, describes outsourcing as "a form of vertical 'de-integration.'" Although I doubt his is an original definition, it does clarify the nature of that overburdened term.

Modern market growth makes vertical integration inefficient. When the market for an input is small so that one large corporate buyer demands the the vast majority of the product, it is effective to merge the input supplier and purchaser. But a trend toward specialization due to larger markets increases the number of input demanders, making it sensible for input suppliers to exist independently of their customers. At root, the decision between integration and outsourcing is calibrated by, "the tradeoff ... between the agency costs involved in directing people’s work and the transaction costs involved in arms-length contracts." As Posner notes, nothing definitionally connects outsourcing and the export of domestic jobs to foreign nations. But labor outsourcing is a common manifestation of vertical de-integration.

The impact on American jobs is no different between outsourcing a component of an American company to an Indian contractor and hiring an Indian worker to work in India or the United States at that company. As the demand for cheaper foreign labor increases, the wages of foreign workers gradually reaches parity with their American counterparts. In fact, according to The Wall Street Journal, a few Silicon Valley companies recently brought jobs previously exported to India back to the United States, because it was cost-ineffective to keep them abroad.

Outsourcing, in the foreign labor sense, is a tremendous asset to the global economy. It is also nearly impossible to halt. An example that springs to mind is Napoleon's Continental System, the French embargo of British imports to Continental Europe. Although French cotton manufacturers flourished as a result of what can be thought of as an extreme protectionist policy, the Continental gap between supply and demand was compensated by smuggled British cotton goods. Much of the garb worn by la Grande Armee was manufactured across the Channel.

Many of the jobs the United States are outsourcing come from blue collar industries anachronistic to a modern economy. Why should the United States preserve iron-ore mining through tariffs when Brazilians can perform the same job for less cost? Why should Midwestern farmers receive billions of dollars in farm subsidies when impoverished agriculturally-oriented African nations can grow the crops instead? In those two cases, American subsidies and tariffs stifle sensible trades.

As a result of outsourcing, Americans collectively receive lower prices. That benefit is spread across a nation, while the negative aspects of outsourcing are borne by a small number of individuals left out of work. As a result, the incentive to pursue political action is greater for those left without a job than the masses who get cheaper goods. As Robert Reich advocated as President Clinton's Labor Secretary, the government can provide a useful service by financing job retraining. Although the labor market automatically corrects without it, minimizing the time required to change jobs improves market efficiency and lessens the growing pains of "vertical de-integration."