In Defense of Outsourcing

The following article appears in the spring 2002 issue of IMPACT!, the quarterly newsletter of the Mackinac Center for Public Policy.  It originally appeared on, the web site of the Ludwig von Mises Institute in Auburn, Ala., and is reprinted with permission.

A year ago, Harvard students occupied a university building to demand that all Harvard employees be paid a wage that reflects the cost of a decent lifestyle in the city of Cambridge, Mass.  The outcome of this six-week charade was a series of committee hearings led by Harvard economist Lawrence Katz.  And these hearings have, in turn, produced the "Katz Report."  One of the supposedly damning conclusions of this report is that Harvard has been outsourcing its employees to avoid paying above-market wages and benefits.

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There is no denying that the argument against outsourcing has a certain amount of appeal when applied to Harvard University, whose $14 billion endowment has been acquired, at least partially, at taxpayer expense.   However, it is quite another thing altogether to believe that outsourcing is, in general, a "deplorable" practice, as a writer for the Harvard Crimson recently suggested.

After all, why shouldn't firms outsource?  Why shouldn't the worker who is willing to render the best services for the least pay be the one who gets the job?  Instinctively, most of us recoil in disgust at the suggestion that wages should reflect nothing more than the cold calculus of supply and demand.  Yet few of us realize just how essential this "cold calculus" is for the long-run welfare of laborers themselves.

In a free market, wages reflect the scarcity of those services that different workers can perform.  In other words, suppose Bill is a good computer programmer but an excellent web designer. Which job should Bill take?  At first, the answer seems obvious.  Bill should design web pages.  However, what if good computer programmers are hard to come by, and web designers are a dime a dozen?

In this case, the ruthless forces of supply and demand ensure that the wages of computer programmers are higher than the wages of web designers.  As a result, Bill gets the "signal" that taking a job as a web designer would be a waste of his highly valuable computer programming talents.

Or, consider the example of a company deciding which of two applicants, Smith or Jones, to hire as a package deliveryman.  Smith is slightly more qualified, but Smith is also qualified to take a more productive job as, say, an airline mechanic.  Smith should really become an airline mechanic and leave the package delivery job for Jones, who has a more limited skill set.  However, only the free market can ensure that the more urgent need for airline mechanics is reflected in a higher wage.

Both of these examples illustrate how, thanks to the price system, prospective employers and employees can unknowingly take into account information about scarcities and preferences they could not possibly know any other way.  Without honest market determination of wages, this information would simply be lost.  Workers would unwittingly accept jobs they were overqualified to hold, and companies would unwittingly hire individuals who, under a free market, would know their services are more highly valued elsewhere. The poor, of course, would be the greatest losers of all.  Without the right to accept lower wages, they would be deprived of their only competitive advantage over more highly skilled workers.

Though it sounds nice to say that each laborer's compensation should reflect his needs, the implementation of this view would entail losing all of the benefits of the division of labor.  Instead of flowing to those jobs that will produce the most valuable goods for consumers, labor would be allocated according to the politicized vagaries of some kind of official bargaining process.  Who would gain under this framework?  If the experience of Cuba, North Korea, Soviet Russia, and Communist China is any guide, no one.

The fallacy of the outsourcing-is-always-wrong crowd is essentially a fallacy of composition.  Well-intentioned activists look at a particular business and, correctly, see that its employees would be better off if the company were forced to pay a wage that reflects some benchmark living standard rather than the principles of supply and demand.  The resulting misdirection of labor and underemployment, however, means that overall real wages tend to fall, not rise.

What labor activists see as a victory for labor is typically a victory for relatively overpaid, underemployed, union-protected workers over unskilled, unprotected workers and consumers.  Nor can these unintended consequences be ameliorated by extending the same "protection" from market forces to labor as a whole.  Instead, such a policy would utterly destroy the very market-determined division of labor that accounts for the "first world" nature of our society.

While there are specific, ethical arguments that can be used against the practice of outsourcing at an extremely rich institution like Harvard, these arguments cannot be extended to labor as a whole.  Ignorance of this truth explains why some campus activists may have become dupes of the narrow, antisocial interests of union labor.

"Most of us recoil in disgust at the suggestion that wages should reflect nothing more than the cold calculus of supply and demand. Yet few of us realize just how essential this 'cold calculus' is for the long-run welfare of laborers themselves."