Extending Ronald Coase's Theory of the Firm to an Economy

 Ronald Coase's Theory of Firm stressed on the importance of the firm in a market driven economy. Not all production processes can be outsourced from the market. Many production functions will have to stay within the firm in the best interests of the firm. 

 For example a pharma company will have to conduct in house research to produce and patent new drugs. It may not be prudent to depend on external research or tie-ups for all its products.We can also find several examples of horizontal and vertical integration in many sectors. Exxon and Mobil which were in the same stage of the value chain, merged to form an integrated oil behemoth primarily to save on costs. Walt Disney and Pixar was a successful vertical merger in 2006. 

The success or failure of a merger is not the central idea of this article. The question that I would want to address here is 'which production processes should a firm outsource or in house and why?'

If a firm can outsource a product or a part of a product at a cost, cheaper than the cost incurred on producing in-house, then outsourcing is a better option. Consider Apple's I-Phone, probably the best selling gadget known to man. Its components are outsourced  from different locations including China, Taiwan, Thailand, South Korea, Malaysia, Singapore, the Philippines, and the Czech Republic from companies like Foxconn and Pegatron. But, I-Phone's value proposition lies in its design, quality and software.

Not all product components can be outsourced purely based on a cost perspective. Items which are 'commoditized' and which do not require further processing can be outsourced. Whereas those production processes or functions which require specialized or customized solutions will have to be in-housed.

The same argument can be extended to an economy. All those goods and services which do not require specialized processes should be outsourced at a cheaper cost, wherever possible. The value proposition lies in enhancing these basic products or services by excelling in design, quality and customer service.

But if an economy chooses to protect its low value added generic manufacturers by imposing import duties and taxes, then it would be a disservice to its people. This not only adds to production costs but may also fuel inflation. At least in the longer run an efficient economy must be able to move its productive resources from low valued added activities to high value added processes.Unless, the goods or services in question are of strategic importance, there is no point in retaining activities just to benefit specific interest groups. 

References: Economics, Samuelson and Nordhaus, Google Search.