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Some Good News for White Collar Workers (Offshoring Edition)

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Offhshoring, the practice of companies sending work overseas (whether to their own operations located in other countries or to foreign outsourcing companies) has become the new worry of the white collar class. The business media regularly reports on software development, legal research, and Wall Street grunt work being sent to India. And it seems that roughly half the customer support calls these days are similarly routed overseas. Worse, Princeton economist Alan Blinder has estimated that as many as 29% of US jobs are offshorable. Will the only safe havens be one like hairdressing, retail, hotel operations, and divorce counseling?

Two recent posts at VoxEU give some hope to the besieged office worker. The first, “Service offshoring: Same old trade with a new label?” by Keith Head, Thierry Mayer, and John Ries, finds that service offshoring isn’t as easy to execute as proponents imagine, and distance serves as a barrier. Some key findings:

How much should service-sector workers in rich nations fear offshoring competition from much lower paid workers in India? New research suggests that distance still provides signification protection, almost as much in services as it does in goods. Once again the death of distance has been greatly exaggerated.

Pundits regularly invoke the notion of a world economy that is either “shrinking” or becoming “flat.” Explanations of this alleged flattening include technological innovations in transportation and communication that have enabled goods and ideas to flow more freely. The offshoring of service jobs, particularly call centers and computer software in India, has grabbed recent media attention. In his bestseller The World is Flat, New York Times columnist Thomas Friedman (2005) wrote of how he had “interviewed Indian entrepreneurs who wanted to prepare my taxes from Bangalore, read my X-rays from Bangalore, trace my lost luggage from Bangalore and write my new software from Bangalore.”….

Most economists, cognizant of the gains from trade, do not view a “flat” world as an alarming prospect…

Just as mainstream trade theory identifies gains from trade, it also shows that real wages of some workers tend to fall as a consequence of freer trade…

Our research investigates whether geographic separation limits offshoring trade, thereby shielding domestic workers from direct competition with their foreign counterparts. We develop a model that envisions employers searching globally for the most suitable workers for any given task and posits that distance raises the costs of using foreign workers. These higher costs reflect travel, training, or translation time associated with using workers that reside far from where their services will be consumed. Firms choose workers that offer the lowest costs after adjusting wages for productivity and distance-based service delivery costs…..

Those results indicate that geographic barriers offer high-wage workers substantial insulation from low-wage competitors based in remote countries. Distance has long acted as a serious impediment to international transactions. Unfortunately, most of what we know about the effects of distance on international transactions is based on studies of trade in goods. A consensus appears to be forming that freight costs cannot explain the strength and functional form of the distance effect for goods.1 Instead, physical distance seems to be picking up some combination of the barriers imposed by cultural differences, the continued desire for face-to-face communication, and the geographically-biased structure of social and business networks. These factors apply to services as well as goods…

How much should high-wage workers fear competition from much lower paid workers in India and China? Our findings suggest that distance still provides signification protection. Since these estimates reflect averages across a range of services, there are surely services where competition is especially acute. Moreover, service delivery costs associated with distance appear to have fallen over the last decade to a level that is slightly below the level estimated for goods. Unfortunately, the data do not clearly indicate whether distance costs for services will continue their downward trend or level off. We suspect that persistent cultural differences, as well as locally-biased social networks, will maintain distance costs at a high enough level to forestall the small, flat world envisioned by some journalistic accounts.

A second post, using empirical data rather than a model, reaches similar conclusions. Indeed, this work is particularly powerful because the study used data from Italy, a country that had suffered declining productivity and therefore ought to show strong improvement from outsourcing. Yet the researchers, Francesco Daveri and Cecilia Jona-Lasinio, concluded in “Offshoring, not enough to beat Italy’s productivity slowdown,” that while sending work abroad boosted productivity for manufacturing, it occurred only for certain types of goods. Conversely, offshoring did not help service productivity; indeed, in some cases, it appeared to reduce it:

The public debate on offshoring has created more heat than light to date, but researchers are beginning to get a picture of its real economic impact. New evidence from Italy, based on firm-level data and a direct measure of offshoring, shows that offshoring of parts and components boosts domestic productivity while offshoring of services does not.

The offshoring of activities of manufacturing firms and industries often features at the centre-stage of the political arena for its allegedly negative effects on domestic employment. During the 2004 US presidential campaign, the concern that outsourcing had gone too far creating more hardships than necessary for American unskilled workers was one of the hot political issues. Not by chance academic research on this topic (Feenstra and Hanson, 1996 and 1999, being perhaps the most celebrated contributions in this area)1 has mostly focused on such effects.

Yet the fear of potentially adverse labour market outcomes of offshoring ended up obscuring in the public debate the very reason that pushes a company to delocalize its activities: the search for efficiency gains. Luckily, an array of McKinsey2 and other business consultancy studies have also found that offshoring has been a crucial ingredient to enable the American economy to take full advantage of the potential productivity gains brought about by the IT revolution. And consistent with this evidence, the statistical analysis for US firms and industries (see Amiti and Wei, 2006)3 has also indicated that the offshoring of services and, less strongly, of intermediates has been associated with productivity gains. The same correlation seems to hold in the French and German manufacturing sector and in the British and Irish business services.

In a recent paper,4 we provide empirical evidence on the relation between offshoring and productivity growth in the Italian manufacturing industries. In the last few years, Italy has been on a declining productivity path. Yet this occurred in parallel with an acceleration of the opening up of the economy, also implemented by delocalizing abroad the manufacturing activities previously carried out within the domestic borders. Hence our research question is whether manufacturing offshoring has counteracted or possibly added to the declining productivity trends lately experimented by the Italian economy.5…

Overall, our statistical evidence shows a remarkably consistent pattern of correlation between offshoring and labour productivity growth with various statistical techniques. First of all, it appears that not all types of offshoring positively correlate with productivity growth. The type of good being outsourced indeed matters: the offshoring of intermediates is positively related to productivity growth, while the international outsourcing of services is either not related or – at times – even negatively related to productivity growth….

Our analysis is based on an original data set inclusive of input-output tables recently released by the Italian statistical institute. Such tables, by splitting the imported and domestic content of the inter-industry transactions of goods and services in the economy, allow us to directly measure the extent of intermediate and services off-shoring on the part of manufacturing industries. This is different and – in our opinion – preferable to using the methodology previously employed by Feenstra and Hanson (and repeatedly used in the other studies in this area). Since their measure is unobserved, the extent of outsourcing has to be inferred from trade data assuming that any purchasing industry would import intermediates or services in the same proportion as any other industry in the economy.

Our calculations do not have to rely on such assumptions that are restrictive and which our data suggest are unwarranted. We provide a direct measure of offshoring not based on untested assumptions and then we econometrically test whether using our indicator or the Feenstra-Hanson indicator makes a big difference. It seems it does. We find a positive relation between intermediate offshoring and productivity growth when using our (direct) measure of offshoring. However, the correlation disappears altogether when the standard Feenstra-Hanson measures of external outsourcing are employed.

We find our results of general interest, over and above the discussion of the case of Italy and we intend to pursue this line of research further in the close future.

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