April 26, 2004

The one lesson on outsourcing

By: James N. Markels

Whenever people start talking about an economic problem, like the current debate over the outsourcing of jobs from America to foreign nations, I always remind myself of the crucial lesson taught by Henry Hazlitt in his seminal work, Economics In One Lesson: “The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.” You would think that such a commonsense idea, articulated almost sixty years ago, would guide the public debate over every economic policy. Sadly, this is not the case.

When a company decides to hire 100 workers in India to do a job rather than 100 American workers at eight times the price, criticism is quick. Yet another greedy capitalist corporation seeks to maximize profit at the expense of American workers. But when we heed Hazlitt’s advice and expand our examining scope beyond the immediate effects, we see that this criticism is wholly unfounded.

For a simplified example, let’s say that I own a factory that produces ten widgets per year, and the entire widget industry produces 100 widgets per year. One day, sitting around in my office watching the factory humming along, I figure out a way I can produce twenty widgets per year without raising costs. Now I can make 20 widgets per year, and the industry will now produce 110 widgets per year as a whole.

If we assume demand for widgets doesn’t change, that means the price for the average widget will drop by about nine percent, as there are now 110 widgets for sale instead of 100. Consumers for widgets are doubtlessly happy, as now they can buy widgets at a lower price, leaving them more money to buy other things. Their standard of living has improved. And I’m happy because even though I’m making less per widget, I’m selling twice as many of them without raising my costs. Everybody’s happy, right?

Wrong. My competitors, the ones who are producing the other 90 widgets in the industry, aren’t happy at all. Because of my idea, they’ve lost about nine percent of their gross income. Unless they adopt my idea, their businesses are less profitable. Some might not be able to stay in the business anymore because the new price for widgets is below what it costs for them to produce a widget. My competitors might go bankrupt, resulting in lost jobs, or they might have to fire workers to lower overhead and stay profitable. Those laid-off workers probably aren’t happy, either.

So, taking all of this together, was my widget idea good for the economy?

Unquestionably yes. The essence of progress in any industry is to be able to produce more at a lower cost. It was progress when the plough enabled a field to be tilled in far fewer man-hours than it took doing it by hand, and it was progress again when the tractor tilled the field even quicker than that. The result of such progress is more goods at a cheaper price. This benefits those who buy goods–meaning everybody. Every tractor displaces a hundred workers who could be digging up a field by hand, but tens of thousands of consumers (including those displaced workers) are now getting more for their food dollar.

But what about unemployment? Some argue that lower prices are of little consolation to those who don’t have an income. But as Hazlitt pointed out, “In order that new industries may grow fast enough it is usually necessary that some old industries should be allowed to shrink or die. In doing this they help to release the necessary capital and labor for the new industries.”

In the widget example, the “new industry” is the one using my cost-saving method of production, while the “old industry” is the one my competitors are still using. If we fight to preserve the old industry with its overpriced widgets and higher overhead, not only are consumers made to pay more for widgets than they should have to–leaving less money for other needs–but we are preventing the new, better industry from flourishing. We are keeping workers in obsolete jobs, preventing them from moving into more productive jobs elsewhere. As Hazlitt said, “If we had tried to keep the horse-and-buggy trade artificially alive we would have slowed down the growth of the automobile industry and all the trades dependent on it. We would have lowered the production of wealth and retarded economic and scientific progress.” Shall we go back to the plough and the horse-and-buggy just because doing so will create jobs? Obviously not.

This principle is no less in force just because we consider things in a global rather than local context. If my widget factory is in India instead of the United States, and my method of increasing production without increasing overhead is by using Indian workers, the calculus doesn’t change. It is still progress because I have developed a way to produce more for less. Consumers still benefit.

Those who object to outsourcing still complain, arguing that we’re not considering the “human side” of the equation. But in fact that is precisely what they are doing by ignoring the great mass of consumers that benefit from economic progress and only paying attention to the small number of workers affected. They have weighed the effects of outsourcing for only one group, and not all groups. They have failed to learn Hazlitt’s one important lesson.

James N. Markels is a law student at George Mason University.

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