But the fallacy of your argument is that the government is outsourcing services. There are services that the government used to provide that are now outsourced to private organisations (Blackwater springs readily to mind). The "free" stuff like healthcare, internet, cell phones, are paid for by the government yet there are no government workers providing these services.

I'd say your friend and you are both right - but you need to look at the whole equation, not just your popular side of it.
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I used to think it was terrible that life was unfair. Then I thought what if life were fair and all of the terrible things that happen came because we really deserved them? Now I take comfort in the general unfairness and hostility of the universe.