As economists explore the causes of the current worldwide recession, they are expressing a growing recognition that free markets are not always as efficient as many assumed them to be. In particular, free markets do not appear able to properly price systemic risk: the second- and third-order effects of decisions by a number of financial players, each apparently operating rationally, which can combine to cause a complex interrelated financial system to collapse.

These forces can also impel manufacturing companies—each independently making apparently rational decisions to outsource certain segments of their operations—to ravage their industrial commons: the infrastructure of suppliers and skills that underpins their business. The savings these firms expect to generate from outsourcing are based on costs that often do not properly reflect the damage caused by such activities.

A related situation occurs when financial players choose to buy or sell an asset (e.g., a stock bond, collateralized debt obligation or credit default swap) with the implicit assumption that they can either insure against possible losses from such decisions or reverse them at some later date. But insurers, deluged by an unforeseen surge in claims and faced with the possibility of losses, may not be able to honor their contracts. And, as shown by the role CDOs played in the recent economic collapse, once-reversible financial decisions may turn out not to be so.

Choosing to outsource assets to a foreign company is fraught with the same risks. Outsourcing can decimate both the skills and capabilities that are key to a company’s competitiveness. It can also undermine the competitiveness of the network of backup suppliers counted on to step in if a major supplier fails to meet its commitments.

A company’s competitive advantage is rooted in things it can do that its competitors cannot do as well, if at all. As the number of these core capabilities decreases, the company’s competitive vulnerability increases. US manufacturing companies’ preoccupation with outsourcing has had the effect of teaching an armada of hungry competitors first how to master their own capabilities, and then surpass those of the outsourcing firms. All the while the lower costs these companies have achieved have deluded them into thinking they’re improving their profitability. In actuality, they’re simply cashing out their intellectual assets. An ideological belief in the supposed transparency and efficiency of free markets has led these firms to the brink of disaster.

Robert H. Hayes is a professor of business administration emeritus at Harvard Business School.