The Deflationary Impact of Outsourcing

I recently re-read an old book that’s been lying around the office for more than a decade. It’s a little out of date, and contains a few factual errors, but Chris Farrell’s “Deflation: What Happens When Prices Fall” is an interesting look at the relationship between market prices and national (and global) economic health. As I read it, I noted that one of the contributory factors referenced is outsourcing.

Before getting into that, take a step back and consider what deflation is. In principle, it’s simple – when the price associated with a “representative basket of goods and services” decreases over a specific period of time, typically a calendar quarter. On the surface that sounds like a good thing. Falling prices mean higher consumer spending power and fuel for economic growth. However, most economists agree that although small reductions in prices have economic benefit, persistent falling prices have substantial negative effects.

In his book, Farrell identifies between ‘good’ and ‘bad’ deflation. Good, is driven by competition, outsourcing and the emergence of a global marketplace that drives down the cost of goods and services while increasing the standard of living. Bad is driven by a sustained reduction in demand and a resulting pressure on interest rates and money supply, which is what happened during the Great Depression.

Reflecting on the role of outsourcing, I hadn’t previously thought about its impact from a macroeconomic perspective. Yet it’s obvious. If outsourcing part of a business makes it more efficient it will have an economic impact. When lots of organizations do it, it will have a substantial economic impact.

But, it’s worth noting that cost reduction is (typically) only one goal of outsourcing. In fact, organizations that outsource for purely economic reasons often end up being disappointed in the long-term. Modern outsourcing agreements extend far beyond purely financial motivations and customers also look for better quality and/or increased flexibility and/or stronger security and/or broader impact and/or … something else.

The reality is, cost savings (and a role in contributing to ‘good’ deflation) is just one of the many benefits of effective outsourcing.

– John Pirtle, May 2018 – [bio]