Paul Krugman

Last week the Los Angeles Times helped Boeing make cautionary case study history with its investigation of what went wrong with the aerospace manufacturer’s three-years-late new plane: “787 Dreamliner teaches Boeing costly lesson on outsourcing.”

Then New York Times columnist Paul Krugman picked up on the story, “Thank you, Boeing,” using it as an economics lesson: 

In Boeing’s case, they outsourced far too much, only to find that they were getting parts that didn’t do what they were supposed to–and also to find that the subcontractors were seizing a lot of the rents. They discovered, in effect, that there are times when it’s better to rely on central planning than to leave things up to the market.

(Krugman says he threw in the “central planning” reference as bait for Stalinist-sniffer-outers–it worked. Peruse the comment thread.)

The L.A. Times story references a talk that Boeing commercial airplanes CEO Jim Albaugh gave to Seattle University business students, titled “There Are No Shortcuts”:

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We gave work to people that had never really done this kind of technology before, and then we didn’t provide the oversight that was necessary. In hindsight, we spent a lot more money in trying to recover than we ever would have spent if we tried to keep many of the key technologies closer to Boeing. The pendulum swung too far.

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But as the Times points out, hindsight wasn’t really the issue here. “As early as 2001, L.J. Hart-Smith, a Boeing senior technical fellow, produced a prescient analysis projecting that excessive outsourcing would raise Boeing’s costs and steer profits to its subcontractors,” the newspaper reports. In fact, Hart-Smith’s analysis predicted that subcontractors assumed almost no risk because Boeing could not afford to let them fail–the worst thing that could happen is that Boeing would buy them out. Which is exactly what happened to Vought Aircraft Industries. 

“On-the-job training for senior executives, it seems, can be very expensive,” comments the Times’ Michael Hiltzik. Krugman contents himself with noting that it’s a terrific illustration of Oliver Williamson’s “theory of the firm,” which undertakes to explain why an old-school Boeing would have ever existed, if outsourcing is always and everywhere such a bright idea. He is also careful to say that this isn’t a vindication of command-and-control in every situation, just that “there’s a tradeoff. But that’s the point–and it’s this tradeoff that determines how big firms should be.”