Saturday, August 20, 2005

Benefits of Outsourcing and the Myopic Visionaries

From Budapest (apologies - the source was accidentally deleted)

Matthew Higginson in an article “Knowing why, how, when and what to outsource”, quotes economists’, Mary Amiti and Shang-Jin Wei, who argue in a 2004 IMF paper on outsourcing, that there is nothing new in the concept:

“The growing outsourcing of services in industrial countries is simply a reflection of the benefits from the greater division of labor and trade that have been described for manufactured goods since the time of Adam Smith and David Ricardo.”

The main difference is that the division of labour through outsourcing is now encompassing services, which labour sees as moving jobs from a higher wage economy to lower wage economies. The idea that no work should be outsourced to a lower wage economy until wages in that economy are comparable to the wages of the higher wage economy, plus all the attendant add-ons in health and safety regulations, health and pension benefits, and such like, is at best a hopeless utopian requirement and at worst a reactionary anti-development stance. That trade unions are among those clamouring for such draconian measures should not surprise anybody because unions exist to enhance the wages and conditions of their members only and their veneer of international solidarity often runs shallow when their members’ interests conflict with the interests of foreigners.

Of great relevance in this debate, the classic paper by Ronald Coase, “The Nature of the Firm”, 1937, is probably the best source for understanding it. Work remains inside the firm while the transaction costs of its organisation remains lower within the organisation than the costs of the acquisition of goods or services outside the firm from markets. Suppliers of outsourced services can achieve economies from supplying such services to several customers, a market which is unreachable for in-house departments whose expenditures, capital and labour, are spread heavily on the organisation’s local requirements.

When a firm finds that the costs of an outsourced service (wages, management plus the outsourced form’s profit element) exceeds the internal costs (wages, overheads, transaction costs), the outsourcing option becomes viable. The difference in wage rates may only be one factor in an outsourcing decision, and may not be a permanent factor, as wages in lower wage sectors and countries tend to converge, particularly when the labour moves into highly skilled and better trained jobs. Outsourcing between firms in the same economy is already a feature of the division of labour. Specialist firms gain from economies of scale (breadth and depth) and wage differentials may be non-existent.

Outsourcing between countries with different current levels of development is part of the process of development. As the developing country receives high-tech outsourced jobs, its lower wage levels also begin to rise, which raises its ability to pay for imports from other economies, including from developing and developed countries.

These are benefits of ‘globalisation’, which affluent demonstrators march against; it seems the ‘myopic visionaries’ are always with us.


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