Readers Question: I can’t work out how outsourcing, regardless of whether you outsource to bradford or bangalore improves the economy. Don’t the benefits in terms more money for shareholders or in lower assume demand remains constant. Shouldn’t aggregrate demand fall as the previous employed workers stop spending?
Or at the very least isn’t it just a transfer from the workers who used to be employed to the new workers alongside the increased profits ( from the reduction in wages) for shareholders without any actual increase in Agg demand.
Outsourcing is likely to have only a minimal (if any) impact on Aggregate Demand. The main benefits of Aggregate Demand will accrue from lower costs and greater efficiency. True some jobs will be lost, but, others will be gained as the efficiency savings are diffused around the economy.
For example, by outsourcing catering or cleaning a firm may be able to lower costs and concentrate on the area where it has expertise. True the the Lawyer firm may no longer employ a cleaner. But, an equivalent job should be created in the firm where the job is outsourced to.
Outsourcing means there is greater specialisation in the economy. This enables greater economies of scale. If you set up a law firm, you will probably have expertise in that area, but to also have to provide cleaning and catering would waste a lot of your time. There’s no point managing cleaners when you could be concentrating on managing lawyers. Thus the law firm benefits from being able to concentrate on what it does and the cleaning firm can use its knowledge and experience to provide an efficient service. There is merely a transfer of employment from law to cleaning company, but with greater efficiency.
Outsourcing to India
Outsourcing to another British firm is probably not controversial, but, when we hear jobs are being outsourced to India, generally it is perceived to be as a bad thing for UK economy, with jobs lost. For example, it is has been very popular to outsource call centres to India where firms can benefit from lower wage costs.
The British firm will benefit from lower costs. But, British workers will be made redundant.
However, if the British firm makes costs savings, this will lead to lower prices or higher profits for shareholders. With lower prices, consumers are able to purchase more goods which creates additional demand in the economy. Thus, jobs elsewhere will be created.
Also, Indian workers will benefit from increased wages, this may enable Indians to buy more imports from countries such as the UK.
So we may lose jobs in call centres, but, there are also opportunities to gain jobs in sectors of the economy where the UK has greater comparative advantage.
The law of comparative advantage states that net economic welfare can be increased if countries specialise in the areas where they have a lower opportunity cost. Thus, there is a net gain by outsourcing certain sections of the economy to other countries – if they have a comparative advantage in this area.
The problem is that the job losses are very visible and the benefits very hard to see because they are spread thinly. Whearas the job losses are very concentrated.
Outsourcing is not a completely new phenomenon. When we made cotton shirts at the start of the industrial revolution, we outsourced the growing of cotton to overseas companies who could obviously grow cotton much more efficiently than in the UK.
Evaluation of Outsourcing
Outsourcing isn’t always guaranteed to work. For example, customers may be not happy if there is lower quality service from an outsourced company. But, in principle outsourcing can work.