Outsourcing: Economic Logic Protectionists Forget

by CXOtoday Staff    Nov 17, 2008

Outsourcing is an economic reality of the new economic order, and it embraces two important concepts of the free market, the theories of absolute and comparative advantage.

The logic that free trade could be advantageous for countries was based on the concept of absolute advantages in production. Renowned economist Adam Smith realizing this way back in the 19th century said, “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.”

That idea espouses a clear and simple logic. If a country can produce some set of goods at lower cost than a foreign country, and if the foreign country can produce some other set of goods at a lower cost than the other country can produce them, then clearly it would be best for both to trade their relatively cheaper goods with each other. In this way both countries may gain from trade.

So whether it is managing IT infrastructure remotely, providing other managed-IT services, writing parts of software or just producing commodities to be branded and sold by other entities, if it can be done at a lower cost in another geography, companies and nations have the right to avail of that benefit to improve their productivity.

According to a popular story, when a skeptic asked Nobel laureate Paul Samuelson to cite a significant result from the economics discipline, he promptly replied “comparative advantage”.

The theory of comparative advantage was laid down by Ricardo. He suggested that if the opportunity cost of producing a commodity was less in a particular nation, that nation should produce that commodity even though another nation may have an absolute advantage in producing that commodity.

Take for instance A that produces both entire software programs and bits of code more efficiently than B, but B produces only bits of code with high efficiency. A may devote part resources to overall software programming and part to bits of coding. But if A were to devote resources entirely to software programming, outsourcing bits of coding to B, it would benefit by making more software programs that are of higher-value, while B will benefit by producing and trading more bits of code now.

Apply that if you will to the logic to outsourcing. A simplistic explanation but the most complex economic realities today have rather simple economic explanations behind them.

The choice for companies to allocate resources in the most prudent and productive manner is one of the cornerstones of free trade. Nations that espouse the cause of open markets and free trade sound hypocritical when they oppose outsourcing in services on the one hand and demand more open markets for commodities on the other.