Intermediate good sourcing,wages and inequality: From theory to evidence

This paper examines the consequences of offshoring and outsourcing on domestic wages and wage inequality. I highlight the role of labor market frictions in impacting firms’ outsourcing and offshoring decisions; specifically, how differential costs of matching with workers affect the location of production (onshore or offshore) and how differential costs of assessing worker quality affect the ownership of intermediate production (intra‐firm or inter‐firm). I demonstrate how firm sourcing decisions can depend crucially on the industry skill intensity, which reflects the importance of worker–firm match quality, and as a result, the effect of offshoring on domestic labor depends on occupation and industry characteristics, as well as the ownership regime of trade. Bringing the theory to the data I rely on plausibly exogenous variation in the cost of inter‐ and intra‐firm offshoring to identify the effects of a change in each type of offshoring on domestic wages. I find strong evidence that the effect of offshoring on domestic wages—both on the average and on the wage distribution—is governed by the type of offshoring (inter‐ vs. intra‐firm), the skill intensity of the industry, and the offshorability of the occupation.     

Offshoring and Trade Balance in Developed and Emerging Economies

This paper analyzes the effects of off‐shore outsourcing for international trade, especially for the emerging and poor economies, in a two‐sector specific factor model, with a nontraded good being one of the sectors. The phenomenon of offshoring is modeled by incorporating the reduced use of domestic labor in the production function. This is regarded as a characteristic feature of offshoring in the literature. We find that increased offshoring leads to an increase in the relative price of the nontraded good. Given that this relative price can be interpreted as the real exchange rate, increased offshoring leads to exchange rate appreciation. This suggests that offshoring actually makes the goods and services from the emerging economies more competitive in the world market, and thus can be a contributory factor in the positive trade balance experienced by many emerging economies since early 2000s.     

Offshoring and jobs: The myriad channels of influence

Offshoring reallocates jobs inside firms, between firms, and across sectors, affecting the economy-wide unemployment rate. We study these channels in a model with labor market frictions and two sectors—a differentiated-good sector comprising heterogeneous firms that can offshore, and a homogeneous-good sector. A decline in offshoring costs affects intrafirm and intrasectoral reallocation of jobs in the differentiated-good sector through a selection effect, a productivity effect, and a job-relocation effect. The key parameters determining the impact of offshoring on jobs at various margins, as well as on the economy-wide unemployment rate, are the elasticity of substitution between inputs, the elasticity of substitution between varieties of differentiated goods, and the elasticity of demand for differentiated goods as a whole. Changes in search frictions affect unemployment both directly and through their interaction with offshoring.     

Relaxing CAFE: Foreign direct investment,NAFTA and domestic product standards

This paper studies the effects of domestic product standards on the offshoring behaviour of automotive firms. In particular, we examine an important non‐tariff barrier to trade within US fuel economy policy—the Corporate Average Fuel Economy (CAFE) “two‐fleet rule.” By leveraging the removal of the two‐fleet rule upon implementation of NAFTA and exploiting a policy discontinuity based on vehicle characteristics, we present evidence that the costs of offshoring were reduced to a larger degree for varieties that were subject to US fuel economy rules. Specifically, we estimate that prices fell between 5% to 10% for varieties subject to the CAFE two‐fleet rule relative to varieties that were exempt from the rule. These effects are persistent, not present for manufacturers that did not offshore prior to NAFTA and are robust to variety‐specific trends. These effects also reconcile the post‐NAFTA differences in implied compliance costs between cars and trucks for our treatment manufacturer (Chrysler). Overall, the results highlight the potential costs of regional enforcement of otherwise location‐neutral product standards, which may act as a barrier to natural patterns of efficient specialization.     

Salvation by good works? Offshoring,corporate philanthropy,and public attitudes toward trade policy

American consumers are routinely reminded of the fact that the products sold by American companies are often manufactured abroad. We use a survey‐based priming experiment to explore whether and when those reminders depress Americans’ enthusiasm for free trade. We consider in particular that offshoring's effects on policy preferences may be linked to negative perceptions of the offshoring firm, such that portraying the offshoring firm in a positive light might mitigate that effect. We also consider that offshoring's effect may be exaggerated among individuals whose position in the labor market makes them especially sensitive to trade‐related labor market disruption. Our experiment suggests support for both propositions.     

Partisan Cycles in Offshore Outsourcing: Evidence from U.S. Imports

The wage and employment effects of offshoring roil politics in the United States and around the world. Firms that offshore either outsource their activities to unaffiliated businesses, or internalize production by establishing subsidiaries from which they import intrafirm. We argue that the political environment in trade partner countries influences U.S. offshoring patterns in ways that have been ignored in the extant literature. Drawing on the political business cycle literature, we expect higher production costs and lower profits for firms in capital (labor) intensive sectors when the Left (Right) is in power. These partisan cycles, in turn, shape the sectoral composition of exports from the partner to the United States, and the degree to which trade is conducted intrafirm. Under a Left‐ (Right‐) leaning government in a partner country, U.S. intrafirm imports of capital‐ (labor‐) goods increase relative to total imports in these industries. Examining highly disaggregated U.S. import data, we find strong support for our argument. Our results indicate that the effect of partisan governments on offshore outsourcing depends on factor intensities of production, which vary across industries. The degree of internalization in global sourcing is shaped in part by the distributional objectives of partisan governments, and not by economic factors alone.     

Offshoring,computerization, labor market polarization and top income inequality

This paper proposes a model of occupational choice with heterogeneous agents in terms of human capital to quantify the role of offshoring and computerization in labor market polarization and increased top income inequality. We find that both offshoring and computerization played a major role regarding labor market polarization in the US over the period 1975–2008. We further show that the last decades can be decomposed into two subperiods. Computerization is the main driver of labor market polarization from 1975 to the mid 1990s, after which globalization (through decreased costs of offshoring) explains more than 70% of job and wage polarization. Our model can also explain around 40% of the observed increase in top income inequality since 1975.     

The Impact of Differential Falls in Offshoring Costs on Welfare

We highlight the fact that offshoring firms and local firms that do not offshore coexist in the North. Adopting the O‐ring production function approach to offshoring, we demonstrate that a fall in offshoring costs in any sector makes the South better off and that if offshoring costs in a high‐technology sector fall at a faster rate, the North is worse off, and vice versa.     

Offshoring,wages, and employment: Theory and evidence

This paper investigates the wage and employment effects of offshoring. I use firm-level data and two events in Mexico as a natural experiment to identify the effects of a fall in the marginal cost of offshoring to Mexico. I find that domestic wages actually rise at US firms likely to take advantage of this new offshoring opportunity. At the same time, domestic wages fall at US firms unlikely to take advantage of this opportunity. Furthermore, I find no evidence of greater domestic job loss at the former compared to the latter firms. These findings are consistent with productivity effects from offshoring. To explain the mechanism, I develop a theoretical framework that combines heterogeneous firms with imperfect labor markets and rent-sharing. Firms likely to take advantage of new offshoring opportunities increase their productivity and profitability at the expense of their competitors. Through rent-sharing, this channel leads to higher domestic wages at the former firms relative to the latter. Further, there is no empirical evidence of greater domestic job loss at the firms likely to expand their offshoring compared to their competitors that are unlikely to increase their offshoring.     

IS THERE A CURSE OF RELOCATION? ANALYSING THE CAUSAL LINK BETWEEN OFFSHORING AND THE INNOVATION PERFORMANCE OF (SMALL) FIRMS

We analyse the empirical link between offshoring activities and different dimensions of innovation performance at the firm‐level. In order to identify causal effects running from offshoring to innovation, we use a quasi‐experimental comparison group approach by means of (conditional) difference‐in‐difference estimations applied to German establishment‐level data for firms that conducted offshoring activities in the period 2007–13. We find that the international relocation of business functions has a negative impact on the firms’ propensity to be innovative in terms of product and process innovations as well as product improvements. While for larger firms the reduction in process innovations is most striking, potentially due to a lack of resources, stagnation in expertise and a reduction in intra‐organizational learning‐by‐doing associated with the relocation of some business activities, for small and medium‐sized enterprises we particularly observe a reduction in product innovations after the offshoring activity has taken place. When interpreting this ‘pessimistic’ picture on the link between offshoring and the innovation performance of firms, the reader should note that our findings for German establishments have to be assessed through the lens of a global economy in economic recession after 2008, which may have intensified the negative impact of offshoring on the firms’ innovation performance.     

International Organization of Production with Heterogeneous Firms

This paper presents a North–South model with differentiated goods being produced in the North. Each differentiated final good requires both management and manufacturing services as inputs, and firms are heterogeneous with regard to their productivity levels in providing these inputs. Two scenarios of relocating manufacturing to the South, which are interpreted to correspond to vertical foreign direct investment (FDI) and offshoring, are investigated. In both cases there is a minimum level of management productivity required for firms to benefit from relocation of manufacturing to the South. In the case of offshoring, productivity and profit gains are relatively larger for firms with low initial manufacturing productivity. Firms with high initial productivity in both aspects choose not to offshore owing to the presence of fixed costs. The model is subsequently used to examine the implications of global economic integration on the type of firm that exits an industry, changes production location or keeps manufacturing domestically.     

Offshoring along the production chain

Abstract In this paper, we analyze the offshoring decision of firms whose production process is characterized by a particular sequence of steps. International cost differences vary non‐monotonically along the production chain, and moving unfinished goods across borders incurs transport costs. We show that, in such a setting, firms may refrain from offshoring even if relocating individual steps would be advantageous in terms of offshoring costs, or they may offshore (almost) the entire production chain to save transport costs. Small variations in model parameters may thus have a substantial impact on offshoring activities.     

TIME TO MARKET AND IMPATIENT CUSTOMERS

We analyse the decision of firms about when to launch their products on the market when they produce differentiated goods and compete on prices. We find two subgame perfect equilibria: one in which the high‐quality firm holds its leadership in quality, and another in which the low‐quality firm leapfrogs its rival. When the initial level of differentiation is high enough, the low‐quality firm always launches first. Finally, we extend this model to analyse commercial piracy. We obtain that pirates are highly unlikely to launch the illegal copy first because they would bear a higher penalty and a higher risk of being detected.     

Offshoring and Reshoring: The Roles of Incomplete Contracts and Relative Bargaining Power

This paper demonstrates that an increase in bargaining power of Northern firms relative to that of their Southern contractors can trigger reshoring if the North-South wage differential is moderate, such that only industries with a high share of unskilled labor find outsourcing profitable. However, such an increase in Northern bargaining power can increase offshoring if the wage differential is so high that even industries with a low share of unskilled labor also offshore.     

Subsidy competition and imperfect labor markets

This study presents a two‐country model of subsidy competition for manufacturing firms under labor market imperfections. Because subsidies affect the distribution of firms, subsidies influence unemployment rates and welfare in both countries. We show that when labor market frictions are high, subsidy competition is beneficial, although subsidies under subsidy competition are inefficiently high. In the coordinated equilibrium, the supranational authority provides a subsidy to firms that equal the expected total search costs, which increases the number of firms relative to laissez‐faire and improves welfare relative to laissez‐faire and subsidy competition. Finally, we find that a rise in a country's labor market frictions raises the equilibrium subsidy rate, affects unemployment rates, and lowers welfare.     

Can domestic unions gain from offshoring?

This paper considers a unionised monopolistic firm producing a final good with isoelastic demand by using two intermediate commodities, one of which can be either imported from a low-wage country or bought from domestic subcontractors. The paper shows that, notwithstanding wage moderation, the union is better off when the firm chooses offshoring rather than domestic sourcing. The firm is the less likely to choose offshoring the more wage-oriented is the union and the higher is the union bargaining power in the wage negotiation.     

A Model of Spillovers Through Labor Recruitment

This paper develops a model where spillovers can be generated through domestic firm recruitment of employees at a multinational corporation (MNC) where more advanced technologies are employed. It is shown that both spillover and no-spilover equilibria are possible in the model, depending on the marginal costs and benefits of recruitment. Spillover benefits depend on demand parameters and the technological capabilities of the domestic firm, and spillover costs are determined by the MNC's internal wage. Compared with the no-spillover equilibrium, spillovers lead to fewer technology transfers by the MNC and higher market prices. [031, F23]     

Offshoring and Firm Performance: Evidence from the Italian Manufacturing Industry

The fundamental question of whether offshoring is value enhancing and, more specifically, whether Italian manufacturing firms that undertake offshoring benefit from higher productivity and profitability is explored. Using data from the tenth wave of the “Survey on Manufacturing Firms” conducted by Unicredit‐Capitalia, it was found that, compared with domestic firms, firms relocating activities to a foreign country have different characteristics, and “better” firms might self‐select into offshoring decision. To disentangle the effect of offshoring on firms' performances from the effect of firm characteristics, several variants of propensity score matching are used. A mild and insignificant positive effect of offshoring on profitability was found and also evidence of a statistically significant positive effect of offshoring on productivity.     

Regulation and Coordination of International Environmental Externalities with Incomplete Information and Costly Public Funds

In this article, we study cross-border externalities in a game played by two principal-agent pairs with adverse selection. Each firm/agent is located in one country and generates pollution by producing complementary or substitute goods, sold on a common market. A fraction of pollution is transferred from one country to another. Each regulator/principal is imperfectly informed about the marginal cost of his domestic firm and accordingly uses secret incentive contracts with costly public funds. We show the necessity of cooperation between competing regulators to effectively internalize all the damages caused to the environment, while reaching the first best. If the level of uncertainty is sufficiently low, we obtain an infinity of noncooperative Bayesian differentiable equilibria, which may necessitate competing regulators to coordinate on an equilibrium. Such coordination constitutes an incentive for competing regulators to cooperate. Our major result states that under some circumstances asymmetric information relaxes the transborder externality problem. Indeed, we show that, when there is a major transfer of pollution and firms' marginal costs are sufficiently high, competing regulators are better off under uncertainty. Therefore, asymmetry of information can have the very consequence of generating regulation that is too strict from the domestic viewpoint but that improves social efficiency when the benefits to both countries are taken into account.     

Regional integration and innovation offshoring with occupational choice and endogenous growth

We study the effects of regional integration on patterns of production and offshoring in a two-region model of occupational choice and endogenous growth. The distribution of asset wealth and allocation of heterogenous workers into innovation and production determines relative market size. When trade costs and knowledge dispersion are high (low), the asset wealthy (poor) region has a larger market and greater shares of innovation and manufacturing. For low to intermediate levels of trade costs, innovation and manufacturing offshoring flows toward the larger region, but when trade costs and knowledge dispersion are high, offshoring flows from the larger asset wealthy region to the smaller asset poor region. Economic growth is unaffected by the shifts in innovation and production that coincide with changes in relative market size.