The main principle of trade policy is make or buy.
“Economics” comes from the Greek word oikonomia, deriving from oikos, meaning “house” or “household,” and nomos, meaning “law” or “rule”. Thus, oikonomia originally meant “prudent household management,” including labor, finances, and property, to ensure stability and self-sufficiency for the family. Over time, the term expanded in scope and came to describe broader systems of resource management, eventually evolving into the modern concept of “economy.” Philosophers like Xenophon and Aristotle explored oikonomia in contrast to chrematistics, or wealth acquisition for its own sake.
The farmer/poet Hesiod tells of how his father was obliged by poverty to move from Boeotia to Cyme:
One day, he came to this place right here, having crossed a great stretch of ocean. He left behind him the Aeolic [city of] Kyme, sailing on a dark-colored ship, fleeing not wealth, not riches, not material bliss. No, he was fleeing wretched kakē, which Zeus gives to men. And he settled down near Helikon, in a settlement afflicted with human woes, Ascra by name. It is a place that is kakē in the wintertime, difficult in the summertime. It is a place that is never really good. (Hesiod, Works and Days, 640)
The Greek word kakē has no single English equivalent; it can variously mean poor, bad, or malignantly evil. In this case, Hesiod intends it to mean “scarcity,” a crushing want of sufficient resources that keep people in poverty. Hesiod thinks that kakē is the usual state of humans, because poor people have to make everything for themselves. This is exhausting, so if it is possible to buy something cheaper than we can make it ourselves, prudence dictates that we do it.
It is exactly this problem, the management of the resources of a household in the face of crushing scarcity, that led the famed chair of the London School of Economics, Lionel Robbins, to offer this definition: ”Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses.”
The point of this long introduction is that scarcity effectively increases the cost of waste, and of misused assets and effort. In times of plenty, or for the wealthy, squandering valuable resources may go unnoticed. But in times of scarcity, when things are bad in the wintertime, difficult in the summertime, and never really good, it is important to make the best use of every resource we possess.
It is precisely that problem of “making the best use” that brings the “make or buy” decision to the fore. In many households, someone does the shopping and then cooks meals. In other households, meals are usually takeout deliveries or things that can simply be served straight from the cupboard. Some people mend clothes themselves, some send the clothes out to a tailor. Generally, if the cost of making something at home is less than the cost of obtaining it in the market, then economics would suggest the household is better making the item. In times of scarcity, people may be forced to act “as if” they were economists, because otherwise they will be even poorer.
Ronald Coase famously pointed out that firms face exactly the same decision calculus: firms make things that they can sell for more than the costs of production. But the inputs to those manufactured items can be made by the firm, or can be purchased on the open market. It might seem like the firm is “losing money” if it buys inputs, but the problem of scarcity is raised again: spending the capital, and the labor time that the firm has contracted for, on items that could be purchased at a lower cost, is a loss of profits. A firm might make its own electric motors for a product, but it is unlikely to mine and smelt the copper that goes into those motors. And it almost certainly does not grow and mill the flour that goes into the bread in the employee cafeteria; in fact, the firm likely buys the bread, and maybe even the sandwiches, from a contractor.
This principle is very general, and once you start to think in “make or buy” terms it will change the way you think about the world. The pressure the choice puts on firms, and the opportunity given to households by the option to buy rather than to be self-sufficient, are both central to why commercial society is so successful.
Oliver Williamson, the Nobel-prize winning economist, said “I originally thought of ‘make-or-buy’ as a stand-alone problem. But now I think of it as being an exemplar. If you understand make-or-buy, which is a simple case, you can understand more complex cases.”
At the outset, I said something more. I said that the make or buy decision is the key to understanding trade policy. As far as I know, the first thinker to make this argument explicitly was Adam Smith, in The Wealth of Nations. Smith discussed how households decide what to make for themselves, and what to buy in the marketplace. The paradox is that it can cost much more to make something yourself, if someone else can make it more cheaply.
You may have had this experience yourself. To “save money,” I decided to grow tomatoes. I spent a lot of money and time preparing the ground and cultivating the plants, and then spraying bugs and trying to prevent rot when it rained too much. My wife calculated the total costs, including my time, and to this day laughingly refers to my “$100 tomatoes.” I didn’t save money at all; in fact, by making the thing instead of buying it, I lost both the expense of the making, and the value of whatever I could have been doing instead.
Smith recognized that the principle is very general, and extends beyond the household. As Smith put it:
What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage. Adam Smith, Book IV, Chapter 2.
It is very tempting to believe that a nation should try to be self-sufficient, in all things. After all, that way “we keep the money and the jobs here at home.” But as I have argued before, those are spoon jobs, not jobs that pay well or produce wealth or prosperity. As Adam Smith recognized, and as we should remember, trying to make everything and buy nothing makes you poorer, not richer. Those $100 tomatoes were quite tasty, but they weren’t worth what I saved by not buying them.