WWWDAGLIANUNIMIIT CENTR STUDI LUCA D AGLIAN DEVELPMENT STUDIES WRKING PAPERS N 245 Aprl 2008 ffshorng and Immgrant Employment: Frm-level Theory and Evdence Gorgo Barba Navarett * Guseppe Bertola ** Alessandro Sembenell ** * Unversty of Mlan and Centro Stud Luca d Aglano ** Unversty of Turn
ffshorng and Immgrant Employment: Frm-level theory and evdence Gorgo Barba Navarett () Guseppe Bertola () Alessandro Sembenell () February 2008 Abstract: We propose and solve a smple model of frm-level decsons to offshore producton stages of lower skll ntensty than that of actvtes that reman n the domestc locaton In theory, offshorng s optmal only for the more productve among heterogeneous frms f t entals a fxed cost In a large sample of Italan frms, offshorng - especally of ntermedate producton stages - s ndeed more prevalent among frms that are larger and more productve, and s predcted by arguably relevant frm-level characterstcs We also document that offshorng decreases the share of unsklled employment n domestc producton facltes as well as frms propensty to employ mmgrant workers, and we dscuss the possble determnants and polcy mplcaton of the latter fndng JEL: F2; J61 () Unverstà d Mlano and Centro Stud Luca d Aglano () Unverstà d Torno We gratefully acknowledge useful comments receved on prevous drafts at ISIT (Stockholm), Erwt (Venna), ECARE (Brussels), Unverstat de Grona, World Bank, Georgetown Unversty, New York Unversty We are also grateful to Lorenza Mola for helpful suggestons, to Captala for provdng the data, to SUSDIV project and to Fondazone CRT - Progetto Alfer for fnancal support, n the framework of the Centro Stud Luca d Aglano research project on Mgraton and Frms Moblty
1 Introducton ffshorng of producton to low-wage countres s often blamed for job destructon and mmgrant nflows also appear to threaten the employment opportuntes of unsklled workers n rch countres The causes of these phenomena and the polcy reactons motvated by employment and wage concerns are tghtly related (as dscussed n eg Jones, 2005) Lberalzaton of trade n goods trggers relocaton of producton from advanced to less developed countres f foregn labor costs are low But the extent to whch foregn wages fall short of domestc ones also affects mgraton ncentves, and reflects obstacles to mgraton flows If mmgraton affects domestc wages and employment (as dscussed n Borjas 2003, ttavano and Per 2005 and 2006 and n Per and Sparber 2007), t also nfluences the attractveness of offshorng optons, and the vablty of manufacturng producton n developed countres Ths paper takes emprcal and theoretcal steps towards a better understandng of frmlevel lnks wthn ths ntrcate set of nteractons A survey of Italan manufacturng frms makes t possble to assess frm-level relatonshps between the sze and skll ntensty of employment, sze and productvty, the share of foregn born workers and offshorng decsons The descrptve statstcs we examne n Secton 2 ndcate that only some frms offshore producton, that these frms are larger and more effcent, and that they employ a larger share of whte-collar workers and relatvely fewer foregn-born workers Whle mmgrant employment and offshorng tend to correlate postvely across Italan provnces, clusterng n those where manufacturng actvty s strong, the frm-level negatve relatonshp between the two ndcators and dscreteness and heterogenety of ndvdual choces observed n the data suggest a modelng perspectve focused on frms Wthn ths perspectve t s possble to analyze how frm-specfc sources of compettveness determne choces between confguratons characterzed by dfferent margnal and fxed costs, lke domestc and foregn producton In Secton 3 we specfy a model of frm-level decsons to offshore portons of the producton process We adapt to the purpose nsghts drawn from the recent lterature focused on the role of unobserved compettveness n shapng heterogeneous frms nternatonal actvtes ur model adopts many ngredents of key contrbutons to ths lterature, brefly revewed below, and extends t to characterze the skll composton of employment as well as of the sze dstrbuton of frms n terms of sales and of employment Snce offshorng entals a fxed cost, t 2
s optmal only for hghly productve (hence larger) frms And to the extent that offshorng s meant to take advantage of dfferent wage structures n domestc and foregn locatons, t should be assocated wth dfferences n the skll ntensty of domestc employment Secton 4 confronts these theoretcal mplcatons wth the data Controlled regressons confrm that frms that do offshore some of ther producton actvtes have a larger share of sklled personnel n ther remanng home actvtes The data also ndcate that such frms employ relatvely few mmgrant workers ur modelng perspectve can explan such evdence f the share of unsklled workers s larger among mmgrants than among natves, as s realstc n Italy (see Murat and Paba, 2004) We fnd that offshorng s emprcally related to employment of mmgrants even after controllng for frm-level employment s skll composton Ths could be so because the sklls of mgrants dffer from the sklls of local workers along more detaled dmensons than that of the rough ndcators (whte and blue collars) avalable n standard data Indeed, recent works on the US show that even among low sklled workers, specfc tasks requre dfferent sets of sklls and that mmgrant workers tend to specalze n manual tasks rather than n nteractve and language ntensve ones (Per and Sparber, 2007) Secton 5 concludes revewng how our frm-level results bear on more general nteractons between offshorng and mmgraton Evdence of a negatve relatonshp between hrng of mgrant workers and offshorng at the frm level has potentally mportant mplcatons for the nteracton between polces rulng mgraton flows and affectng frms compettveness and the ncentve to offshore Restrctons to the nflow of unsklled mgrants not only ncrease ncentves to offshore, but also jeopardze the proftablty of frms that are unwllng to pursue the offshorng opton and requre unsklled workers at home Symmetrcally, recent calls n Europe and n the US for measures penalzng frms that offshore producton may deprve domestc ndustres frms of an mportant strategc opton, slow down the pace of transton of manufacturng towards hgh value added actvtes, and ncrease the demand for unsklled mgrant workers 12 Related lterature Much has been wrtten on the mpact of offshorng and other forms of nternatonalzaton on the relatve demand for sklls In a representatve-frm Hecksher-hln framework, Helpman (1984), 3
Helpman and Krugman (1985), Feenstra and Hanson (1996) show that fragmentaton leads to an ncrease n the relatve demand for sklls and n wage dfferentals n the North Many emprcal studes have tred to estmate these effects on data where the wage gap between sklled and unsklled workers n advanced countres grows n parallel wth flows of mports of manufactured products from developng countres Ths lterature generally measures offshorng ether on the bass of nput-output tables or of trade data (by lookng at ntrandustry trade) or by combnng the two Some consder the aggregate of all mported nputs; others dstngush between nputs orgnatng from developng countres and from ndustralzed countres Usually, a translog cost functon specfcaton s estmated, addng measures of offshorng and of techncal change or R&D nvestment to control for the effect of sklled based techncal change on the sklled-labor cost share Feenstra and Hanson (1996a, 1996b and 1999) and many follow-up studes on US data fnd evdence of a role for offshorng that s szable, f not as mportant as that of techncal change, n determnng ncreases n the wage share of sklled workers 1 We buld on a recent hghly nfluental strand of lterature, revewed n Helpman (2006), whch studes the role of heterogeneous frm-level compettveness n shapng nternatonal actvtes Meltz (2003) and Helpman, Meltz, and Yeaple (2004) focus on the choce of the output market (home vs foregn) and of how to serve t (exports vs FDI); Antras and Helpman (2004) on the choce of where to source nputs (nshorng vs offshorng) and how (nsourcng vs outsourcng); Grossman, Helpman and Szedl (2006) explore the jont choce of both nternatonalzaton patterns In the equlbrum of these and other models, only the more productve frms fnd t optmal to engage n nternatonal actvtes entalng a fxed cost 2 ur man focus s on the choce to offshore part of the producton process to a foregn country We model the choce n terms of a tradeoff between lower producton costs n the foregn locaton and the cost of coordnatng fragmented producton (see Helpman and Krugman, 1985; Jones and Kerzkovsk, 1990; Jones, 2005 for dscussons of the structure of such costs) 1 Slaughter (2000) s also on the US; Ekholm and Hakkala (2005) on Sweden; Egger and Egger (2003) on Austra; Anderton and Brenton (1998) and Hjen, Gorg and Hne (2005) on the UK; Helg and Tajol (2005), on Italy and Germany; Falk and Koebel (2002) also on Germany and Strauss-Khan (2003) on France Amt and We (2005a,b) on the US and the UK look at the effects on total labor demand and productvty of servce offshorng; Egger and Egger (2006) examne the effects on the productvty of low skll workers 2 In other models heterogenety n the access nto the export market s not drven by fxed costs Bernard, Eaton Jensen and Kortum (2002) obtan heterogenety n the decson to export by assumng a model of Bertrand competton and Meltz and ttavano (2005) by usng lnear demand systems across a contnuum of varetes 4
We dsregard organzatonal choces and assume a sngle ntegrated output market, n order to focus on the mpact of offshorng on the level and skll composton of employment n domestc plants 3 Yeaple (2005) smlarly ams at characterzng the nteracton between nternatonal actvtes and domestc employment, n the presence of frm and/or worker heterogenety We focus on mperfect substtutablty across dfferent type of labor, however, whle Yeaple models worker heterogenety n terms of effcency unts and shows that frms engaged n nternatonal actvtes endogenously employ more sophstcated technologes and more productve workers ur emprcal analyss focuses on relatonshps between offshorng and the demand for sklls at the frm level, rather than at the ndustry level Few earler papers explot frm or plant specfc evdence and, to the best of our knowledge, none specfcally relates a broad measure of offshorng to the structure of the work force Gorg and Hanley (2004) examne the effect on total labor demand for a sample of Irsh plants by estmatng a dynamc employment equaton where offshorng (measured by mported ntermedates) s ntroduced as a demand shfter They fnd that offshorng has a negatve effect on short term plant-level labor demand Head and Res (2002) and Hansson (2005) consder more drectly the effects on the skll composton of the labor force, for Japan and Sweden respectvely But these studes are based on the actvtes of multnatonal frms Measurng offshorng as the sze of the foregn actvtes and estmatng short run labor demand derved from translog cost functons, both studes fnd that the skll ntensty of home actvtes ncreases wth the share of foregn actvtes carred out n labor ntensve countres The focus of ths paper on skll ntensty also makes t possble to characterze the lnk between offshorng and employment of mgrant workers, nsofar as t s related to the skll structure of the frm The relevant lterature has mostly focused on whether mgrant flows and FDI are substtute or complements for a gven locaton (country, provnce, regon etc) or par of locatons and has not looked at ths lnk wthn frms Some among these studes are Murat and Paba (2004) on Italy, Buch et al (2005) on Germany, Krkegard (2005) on outsourcng of 3 ther theoretcal contrbutons analyze the lnk between offshorng and the demand for sklls n representatve-frm settngs See Jones and Kerzkowsky (1990) and Jones (2005) Egger and Egger (2003) also examne whether the effect s dfferent under a compettve or a unonzed labour market for unsklled workers Markusen (2006) also studes how standard theores of nternatonal trade and FDI can explan the effects of the off-shorng of hgh sklled servces 5
servces and mmgraton n the US, Aroca and Maloney (2005) on Mexco Emprcally, the nflow of mgrants n a gven locaton s typcally found to be related to a reducton of outward nvestment or even an ncrease n nward nvestment Such substtutablty may be explaned by factor cost effects wthn a standard Hecksher hln model wth compettve markets and no frctons, or bran dran factors drven by the complementarty between human captal and nvestment, or networkng effects as mgrants attract nvestment to ther country of resdence from ther country of orgn (although Kugler and Rapoport (2005) and Docquer and Lodgan (2006) show that networkng effects may also work n the opposte drecton) Alternatvely t could smply be drven by other varables lke the sze of markets and cultural and geographcal proxmty, whch are factors of attracton for both FDI and mgraton flows 2 Data and descrptve statstcs We analyze the Captala survey of 4289 Italan manufacturng frms, carred out n 2004 wth current and retrospectve yearly nformaton for 2001-2003 4 Lke the earler waves of a longrunnng seres of smlar surveys, the dataset ncludes all Italan frms wth more than 500 employees as well as a representatve sample of smaller frms, stratfed on geographcal area, ndustry, and sze Besdes standard frm specfc varables, ncludng balance sheet entres, the data also report detaled nformaton on nternatonal actvtes As regards the relatonshp between nternatonalzaton and frm characterstcs, the data appear to conform to smlar datasets from other countres Benfratello and Razzoln (2007), for example, fnd that larger and more productve frms are more lkely to export some of ther producton and to produce abroad n order to serve foregn markets Crucally for our purposes, the survey features addtonal detal as to the sze and purpose of each frm s foregn operatons, ncludng nformaton as to whether foregn operatons are meant to supply ntermedate parts, and data on the composton of domestc employment nclude the percentage of foregn workers 4 In the emprcal analyss we excluded form the sample frms wth ncomplete nformaton or wth extreme observatons for the varables of nterest The Data Appendx outlnes the sample selecton procedure n detal 6
Table 1 reports descrptve statstcs for the man varables used n the emprcal analyss The dstrbutons of sales, valued added, and employment s heavly skewed, and the ratos of sales and value added to total employment are very heterogeneous across frms Skll levels are also hghly heterogeneous across frms: the nterquartle range of whte-collar employees as a rato of total employment s n the order of 20 percentage ponts 5 Fnally, and very mportantly for our purposes, we see, stll n Table 1, that foregn workers are a rather small fracton of total employment (38% on average) but are hghly dspersed across frms Whle more than 50% of surveyed frms report no foregn employees, we see that 25% of the observatons report at least 43% foregn employment (and 10% of the frms report a share hgher than 10 percent) We wll be nterested n explorng the relatonshp of these dmensons of heterogenety to each other, and to frm-specfc ndcators of actvty offshorng and labor force composton Roughly 75% of the frms report that some of the producton ncluded n sales occurs n other countres; among these, 38% state that offshored producton accounts for less than 10% of sales, 43% that t accounts for between 10 and 50%, and 19% that t accounts for over half of sales Not all offshorng s alke Usng nput-output nformaton, Daver and Jona-Lasno (2007) detect szable dfferences n the assocaton wth productvty of offshorng of ntermedates rather than servces The survey we analyze elcts nformaton as to the motvaton and destnaton of nternatonal producton actvtes Among frms that do offshore some actvtes, 72% state that lower labor costs as one of the two man reasons for dong so, and another 35% cte the need to avod beng prced out of the output market; only 22% vew offshorng as a way to reduce costs of foregn market penetraton Romana s the destnaton country for 31% of the offshorng frms, Chna s the next most frequent at 215%, and vrtually all countres mentoned n the survey as offshorng destnatons are at much lower levels of development than Italy We defne a dummy takng the value one when some offshorng actvty s observed, and refer to such observatons as offshorng frms Among such frms, we sngle out those that ndcate both that the porton of ther sales that s produced abroad ncludes ntermedates (thus 5 Another survey queston refers to the number of specalzed (plant managers and techncans) blue-collar employees These are rather often reported to be absent or to concde wth total blue-collar workers, whch may spurously reflect survey respondents nablty or unwllngness to provde more precse nformaton, Indcators based on ths varable proved unnformatve when used alongsde or n place of the standard whte/blue collar dstncton n regressons such as those reported below 7
excludng those that offshore only producton of fnshed products, and may be motvated by market proxmty consderatons rather than by producton cost savngs) and that some of ther offshorng actvtes are re-mported We refer to these as the restrcted sample of offshorng frms As we shall see, these are slghtly more dfferent from non-offshorng frms n ways consstent wth the modelng perspectve we propose below Table 2 dsplays the man descrptve statstcs separately for non-offshorng frms and for offshorng frms n average, relatve to other frms, offshorng frms are about three tmes larger n terms of sales and less than three tmes larger n terms of employment Sales per employee are some 15% hgher Ths s to a large extent an obvous reflecton of the fact that sales nclude producton performed by the employees of foregn plants, on whch we have no nformaton More nterestngly, the value added per employee of offshorng frms s some 2% hgher than that of non-offshorng frms, and the former employ a much larger share of whte collar workers 6 ffshorng frms also employ fewer extra-eu workers All such dfferences are larger f the comparson focuses on a restrcted sample of frms that offshore only a porton of ther manufacturng process and therefore perform n ther domestc plants at least some varable-cost producton actvtes Avalablty of both mmgrant employment and offshorng nformaton offers a rare opportunty to assess emprcally the relatonshp between the two phenomena ur analyss wll be focused on frm-level nformaton, but wll need to account and control for market-level nteractons To document the mportance of those nteractons, Table 3 reports the results of descrptve regressons of the offshorng dummy and of frm-level foregn employment share on a provnce-specfc ndcator of ndustral compettveness : the share of manufacturng employment on total employment That ndcator, the ncdence of offshorng, and employment of mmgrants are postvely and very sgnfcantly correlated, suggestng that provnce-level factors play an mportant role n shapng labor cost consderatons and mmgraton ncentves 7 6 The skll composton of the domestc labor force of offshorng frms may well be a reason why offshorng of manufacturng actvtes s assocated wth hgher productvty of (not qualty adjusted) labor, and why ths s not the case when offshorng of servces can be sngled out (Daver and Jona-Lasno, 2007): servces are lkely performed by hgh value-added whte-collar workers wthn manufacturng frms, and measured productvty wll tend to be lower when such actvtes are performed elsewhere 7 Regonal and frm level outcomes can be reconcled n ntutve terms If effcency trggers the choce of offshorng, n regons wth a strong concentraton of hghly compettve frms there wll be a larger share of them producng abroad At the same tme average wages wll be hgher and attract more mgrants However, for gven 8
3 Producton offshorng by heterogeneous frms Whle the regonal patterns documented n Table 3 ndcate that stronger manufacturng ndustres are assocated wth more ntense offshorng and mmgraton, frm-level evdence, ndcate the potental relevance of exogenously heterogeneous compettveness n determnng both frm-level and market-level outcomes The descrptve evdence of Table 2 s consstent wth a data-generatng mechansm that assocates hgher effcency and stronger skll ntensty to frm-level offshorng decson We proceed to formulate a model of frm-level decsons that delvers the two mplcatons on the bass of economcally sensble assumptons Frst, we show that sortng of hghly productve frms nto offshorng can be explaned f the reorganzaton of producton needed to take advantage of lower margnal costs n foregn locatons entals fxed costs Second, we show that dfferent skll ntenstes across the domestc actvtes of offshorng and nonoffshorng frms are a natural consequence of foregn locatons comparatve advantage n lowskll actvtes In the next secton we dscuss how ths may bear on the evdence, especally as regards employment of mmgrant workers 31 Frm level heterogenety and offshorng As ponted out by Meltz (2003), a frm s ntrnsc effcency bears on ts choce across producton and sales modes wth dfferent fxed and margnal cost and benefts In Meltz s orgnal contrbuton, more effcent frms are better able to take advantage of market access, and more nclned to bear the fxed cost of equppng themselves to export In ths paper s context offshorng s more attractve for stronger frms f, at the same tme as t makes t possble to tap nto cheaper labor pool and decrease margnal costs, t entals hgher fxed costs Substantal fxed costs may n fact be entaled not only by foregn drect nvestment n wholly owned plants, but also by the negotatons and know-how requred by arms-length outsourcng relatonshps Ths mples that, among heterogeneous frms wthn an ndustry, the more productve ones wll select themselves nto offshorng We suppose that offshorng costs are the same for all frms, local condtons, only hghly productve frms wll offshore and these wll employ relatvely more sklled workers and mplctly less mgrants 9
and dsregard the dstncton between nsourcng or outsourcng arrangements for producton relocaton To focus on nternatonal factor cost dfferences as the drvng force of the offshorng decsons we wsh to characterze, we suppose that a frm s nverse demand functon s 1 σ p ( y) = ay, where σ > 1, a s an ndex of demand strength, and y denotes the frm s total producton ndependently of where ts plants are located Ths means that offshorng decsons are not based on product market consderatons, such as foregn market penetraton The demand-strength parameter a, to whch we wll occasonally refer as compettveness for brevty, may depend on the stage of the frm s product s cycle or other frm-specfc marketposton phenomena For a gven frm, however, t s ndependent of the producton process and locaton, because output s sold on an ntegrated world market or s transported back to the frm s specfc natonal market Producton costs (net of transport costs) may nstead be affected by offshorng f factor prces are dfferent across locatons Postponng to the next subsecton an explct model of margnal cost determnaton, we suppose producton costs to be lnear n producton and proceed to characterze how proft-maxmzng frms wth revenue functon 1 1 σ yp ( y) = ay choose the locaton and level of producton f margnal and fxed costs depend on whether producton s wholly domestc or s partly offshored 8 Let margnal cost c(o ) be ndependent of scale, but take dfferent values dependng on whether frm offshores part of ts producton actvtes (ndcated by o =1) or performs all of t domestcally (o =0) And let the frm s fxed cost of producton f(o, m ) smlarly depend on the offshorng vs domestc producton choce, as well as on other frm-specfc factors ndexed by m Wthn each producton regme 1 y o, maxmzaton of profts 1 1 σ Π( y, o ) = a y [ f ( o, m ) + c( o, m ) y ] σ requres that prce, a, be equal to margnal cost c o ) tmes the mark up factor σ /( σ 1) ( 8 Ths functonal specfcaton represents monopolstcally compettve frms producng dfferentated goods, but can also be renterpreted n terms of decreasng returns to producton at the level of the frm 10
The correspondng output s * ( ) σ ( c( o ) a ) σ y / = σ σ 1 To decde whether to offshore, the frm compares maxmzed proft levels (1) Π( y *, o ) = a σ σ σ 1 1 σ 1 c( o ) σ 1 σ f ( o, m ) across the wholly domestc (o =0) and partly offshored (o =1) confguratons of ts producton process 9 ffshorng s optmal for a gven frm f the unt cost dfference mples a large enough operatng proft dfference to cover the fxed cost dfference, σ 1 σ 1 σ σ 1 σ ( a ) ( c(1) c(0) ) > ( σ 1) ( f (1, m ) f (0, m )) σ, e f a s so large that the addtonal profts from lower margnal cost at least cover the fxed cost dfference Hence, the model predcts that among frms wth smlar cost structures but heterogeneous compettveness offshorng s only observed by frms whose a exceed a crtcal level σ 1 σ 1 σ 1 σ [ ln( σ ( σ 1) ( f (1, m ) f (0, m ))) ln( c(1) ) (0) )]/ σ ] a = exp c, (2) whch depends ntutvely on offshorng s mpact on fxed and margnal costs We model next how technology and labor costs bear on these aspects of the frm s cost structure 32 ffshorng and the skll ntensty of producton To model the relatonshp between the frm s offshorng choces and costs, we suppose that producton nvolves two dstnct stages, dubbed components and assembly n what follows We make the smple defntonal assumpton that producton of a unt of fnal output requres components and assembly actvtes n fxed proportons But we allow each of the two stages of producton to use sklled and unsklled labor n flexble proportons, and we allow wages of effectvely equvalent labor to dffer across locatons (because barrers to mgraton and trade prevent factor prce equalzaton) 9 If the strength ndcator a s so low as to mply that profts are negatve for both offshorng choces, then the frm should shut down 11
Adoptng Cobb-Douglas functonal forms, let x unts of sklled labor and z unts of unsklled labor produce the components of Gx γ 1 γ unts of output If a unt of sklled labor costs s and a unt of unsklled labor costs u, a cost-mnmzng frm therefore uses 1 1 γ γ s x = ( ) 1 1 γ s sklled workers and z = ( ) γ γ G γ u components of a unt of output, at total cost 1 γ γ 1 1 γ s 1 γ s 1 γ 1 ( ) s + ( ) u = ()() s u, γ ~ G G z 1 unsklled workers to produce the 1 γ γ where ( ) G u G γ u 1 G 1 γ We smlarly suppose that the producton functon 1 1 s α x = ( ) 1 1 α s sklled workers and z = ( ) α α A α α u α A α γ u u Ax 1 ~ G γ γ ( γ ) 1 z α 1 α (3) mples employment of 1 unsklled workers to assemble a unt of output The margnal cost of assembly actvtes s therefore gven, as a functon of wages, by an expresson smlar to that of equaton (3), n terms of A and α rather than G and γ Wage rates, w pj, dffer not only across the skll levels (p=s or u, for sklled and unsklled) but also across the possble locatons (j=d or f, for domestc and foregn) of the workers engaged n producng the frm s output ur functonal form and wage structure assumptons mply that margnal cost can be expressed, as a functon c( wsd, wud, wsf, wuf, o ) of domestc and foregn sklled and unsklled wages, and of the offshorng ndcator o (equal to 1 f the frm offshores some of ts producton, to zero f t performs t all domestcally): 1 1 c( wsd, wud, wsf, wuf,0) = ~ sd ud ~ sd ud G A f all producton facltes are local, and as ( ) γ 1 ( ) γ ( ) α 1 w w + w ( w ) α 1 1 c ( wsd, wud, wsf, wuf,1) = ~ sd ud ~ sf uf G A ( ) γ 1 ( ) γ ( ) α 1 w w + w ( w ) α f assembly takes place offshore If offshorng entals hgher fxed costs, n order to be potentally optmal t must mply lower margnal cost Imposng that rankng on the margnal cost expressons requres that the wage of effectve labor abroad should be suffcently lower than domestc wages to satsfy the condton ( ) α 1 ( ) α ( ) α 1 w < w ( w ) α w (4) sf uf sd ud, 12
For a gven frm, the lower margnal cost of offshored producton ncreases the output level accordng to equaton (1) The effects of offshorng on output and employment are nterestngly dfferent For a gven frm, offshorng s assocated wth larger output nasmuch as t decreases margnal cost; t has ambguous mplcatons for domestc employment, however, because whle relocaton of assembly lowers the local labor nput requrement of each unt of fnal output, as more output s produced employment may ncrease n the components actvty that remans domestc The mplcatons for the composton of employment are however unambguous f, as s realstc, the assembly producton actvtes that may be performed offshore have lower skll ntensty ( α < γ ) We llustrate and elaborate on these results n the next subsecton 33 bservable mplcatons Fgure 1 llustrates frm-level relatonshps between compettveness, employment, and offshorng The plots report (as dashed and dotted lnes) theoretcal relatonshps condtonal on whether producton s offshored or not The crcles refer to a sample of frms drawn from a lognormal dstrbuton of compettveness a (measured on the horzontal axs of panels A and C n the fgure; to mprove legblty, a small amount of unrelated nose s added to the varables mpled by each draw of a) The frms that offshore producton are those whose a draw s larger than the threshold defned n equaton (2) Snce offshorng entals a fxed cost and the parameters satsfy condton (4), offshorng frms have lower margnal costs and, as shown n panel A of Fgure 1, are unambguously larger n terms of producton and sales: the selecton nto offshorng of exogenously more compettve frms renforces the postve assocaton between offshorng and producton levels nduced by the lower margnal cost of offshored producton Panel C llustrates the mplcatons of offshorng outcomes for frms domestc employment levels Snce the lower margnal cost of an offshorng frm ncreases producton at the same tme as t decreases ts domestc labor requrements, offshorng s n general ambguously related to domestc employment For the parameters used n plottng the Fgure, we see n panel C that at a gven level of exogenous compettveness a offshorng reduces the sze of frms n terms of employment: t ncreases ther sze n terms of sales n panel A, but not by enough to offset the lower domestc labor requrement of offshored producton But even after 13
the parameters have pnned down a negatve mpact of offshorng for a gven frm s sze, the model yelds an nterestngly ambguous cross-sectonal assocaton between employment levels and the actual, endogenous offshorng choces of heterogeneous frms Snce more compettve (and lkely larger) frms selected nto offshorng by fxed costs, n panel C the more compettve non-offshorng frms are larger n terms of employment than the least compettve offshorng frms As to the observable mplcatons of frm heterogenety and offshorng choces, we see n panel B of Fgure 1 that offshorng frms are larger n terms of sales, but not necessarly n terms of domestc employment, and qute ntutvely dsplay hgher sales/worker ratos In realty as n the model, only some of the frms that operate n a gven labor and product market offshore producton The model nterprets these outcomes n terms of heterogeneous frm-level effcency or compettveness, and predcts that frms that offshore a porton of ther producton actvtes should be larger n terms of output and sales but may or may not be larger n terms of local employment Fgure 2 s of partcular nterest to our purpose It llustrates the more detaled and nformatve mplcatons of our model for the relatonshp between offshorng, frm sze, and skll ntensty Its panel A agan llustrates the basc mechansm whereby the structure of fxed cost and margnal costs mples that offshorng frms produce and sell more than non-offshorng ones The other three panels of Fgure 2 llustrate the mplcatons of the model s explct treatment not only of the cost, but also of the skll structure of employment For the parameters used n plottng the fgures, the assembly actvtes canddates for offshorng are much more unsklled-labor ntensve than the components actvtes that are always performed n the frm s domestc plant Thus, n panel C the heterogeneous compettveness ndcator a s related to unsklled employment (crcles refer to frm specfc observatons of unsklled employment) n very dfferent ways across offshorng and non-offshorng frms: for gven a offshorng mples much lower unsklled employment, but t actually mples a hgher level of sklled employment (plus sgns refer to frm specfc observatons of sklled employment), because component producton s suffcently skll ntensve wth respect to assembly that offshorng ncreases a frm s sales (n panel A) so as to more than offset the loss of domestc sklled labor entaled by delocaton of assembly Panels B and D of Fgure 2 relate the level of sales (on ther and panel A s vertcal axs) 14
to sklled and unsklled employment levels, respectvely In panel D, the rato of (hgher) sales to (lower) unsklled employment levels s much larger for offshorng frms In panel C, sales per sklled domestc worker are actually smaller when producton s offshored, and are not nearly as dfferent across offshorng and non-offshorng frms: as both of these perform domestcally the actvtes that employ most of ther sklled workers, the relatonshp between sales and sklled employment s very smlar regardless of whether less skll-ntensve actvtes are performed domestcally or abroad 10 4 Emprcal evdence The structure of our theoretcal offshorng model s nspred by the descrptve statstcs of Secton 2, as well as by recent advances n modelng of related phenomena, and s therefore by constructon compatble wth some key emprcal features In the data, offshorng frms are larger, have larger sales/employment and value added/employment ratos, and employ a larger share of sklled workers n ther domestc operatons, especally when offshored producton ncludes ntermedate products to be re-mported and assembled, rather than fnshed products only In the model lad out n Secton 3, offshorng s motvated by cost savngs rather than output market proxmty and, snce a porton of varable producton actvtes remans domestc, offshorng frms may be larger n terms of overall domestc employment, and should employ more sklled and less unsklled workers than non-offshorng frms To assess the emprcal ft of the model along less obvous dmensons, we frst revst the emprcal relatonshp between sales and employment (of dfferent skll levels) n a graphcal format smlar to that we have used to llustrate theoretcal nsghts Fgure 3 dsplays descrptve regressons amed at assessng the ft between our data and theoretcal perspectve As shown n Fgures 1B, 2B, and 2D, frm sales and employment should be lnearly related when the varaton across observatons s drven only by the frms compettveness ndcator, a In realty, the relatonshp s of course affected by other unobservable heterogenety, and a log-lnear relatonshp fts the data much better The plots of actual and predcted sales as functons of employment n Fgure 3 are qualtatvely consstent wth ther theoretcal counterparts n Fgures 10 Ths paper s model focuses on margnal labor costs and dsregards the labor content of fxed costs, whch s lkely to consst predomnantly of relatvely sklled workers The mplcatons of offshorng for the composton of domestc headquarters employment would be qualtatvely smlar to those we analyze explctly 15
1 and 2 ffshorng frms (marked by crcles) vsbly tend to be larger n terms of sales than nonoffshorng frms (marked by dots) There s much more overlap across the dstrbutons along the (horzontal) employment dmenson The effect of offshorng on the slope of the sales/employment relatonshp s postve, and much more pronounced for blue collars than for whte collars: regressng sales on whte collar employment and ts nteracton wth the offshorng dummy ndcates that, as suggested by Fgure 2B, the sales/sklled labor relatonshp s not very sgnfcantly affected by whether the frm offshored (unsklled-ntensve) producton actvtes The model of Secton 3 explans n terms of fxed costs relevance Secton 2 s descrptve evdence of offshorng choce dscreteness and of (employment, sales, and value added) sze dfferentals across offshorng and non-offshorng frms, that n the model reflect the role of frm-level compettveness n determnng how easly margnal cost savngs may offset the fxed cost of organzng foregn producton The model also features a novel role for dfferent skll ntensty of the actvtes that may or may not be offshored, and can explan dfferences across the two groups of frms n terms of employment composton In what follows, we assess the statstcal sgnfcance of these patterns, and attempt to provde more structural evdence of the model's ft, by specfyng and estmatng formal models that, unlke graphcal llustratons, make t possble to controllng for observable heterogenety across sectors an geographcal locaton To characterze the relatonshp between offshorng and mgraton, we estmate a system of two equatons The frst one relates the (endogenous) offshorng outcome to other observable frmlevel characterstcs, and the second relates (nstrumented) offshorng nformaton to the structure of frms employment 41 Determnants of offshorng decsons The ft between theory and evdence s qualtatvely ntrgung but, of course, far from perfect In Fgures 1 and 2 the dstrbuton of ntrnsc effcency was assumed to be lognormal and only a modest amount of uncorrelated nose was added to artfcal data The dstrbuton of sales and employment n the real data n Fgure 3 s much more strongly skewed and, unsurprsngly, much noser than the model llustratons ur theoretcal framework tself suggests reasons why ths s the case, and ways n whch nose may be reduced by controlled regresson technques 16
In the theoretcal model, the chef determnant of a frm s decson to offshore s ts ntrnsc compettveness, ndexed by the frm-specfc varable n the model As Fgures 1 and 2 make clear, ths varable jontly determnes the volume of sales, the sze and composton of employment, and offshorng decsons In practce, compettveness s not drectly observable It mght n prncple be estmated by standard producton functon methods, whch however would be partcularly problematc from a theoretcal perspectve where the factor ntensty of producton n domestc plants s naturally dfferent across offshorng and nonoffshorng frms In fact, smple descrptve regressons that control for captal and ntermedate nputs confrm the broad message of the regressons dsplayed n Fgure 3, as regards the relatonshp between offshorng and the elastctes to blue and whte collar employment To account for producton functon heterogenety across offshorng and non-offshorng frms, observable varables relevant to that choce could be used to endogenze selecton of frms nto dfferent technologes, and mprove estmaton of producton functon parameters and TFP resduals Estmatng structural producton functons would reman problematc on crosssectonal data, however, snce smultanety and unobserved heterogenety would stll be worrsome sources of bas for the resultng productvty ndcators In lght of these problems, we choose to report results based on an admttedly smple mnded approach to TFP estmaton, controllng only for captal ntensty on all data pooled n cross-secton For our man purpose of detectng lnkages between nternatonalzaton of producton and domestc employment, we adopt the sem-structural approach of nstrumentng the offshorng dummy wth varables that plausbly drve offshorng but, for gven offshorng, do not drectly nfluence the composton of employment In realty sales, employment, and offshorng depend on many more frm characterstcs than just ntrnsc effcency Whle the theoretcal llustratons n Fgures 1 and 2 kept those constant across frms, they are lkely to vary across sectors and local labor markets n the data To some extent ths heterogenety may be controlled by ndustry and geographcal dummes Moreover, t s possble to use the survey s nformaton to try and control for addtonal dmensons heterogenety that may select frms nto the offshorng mode of operaton At the frm level, for gven compettveness and gven market condtons, the choce between offshored and domestc mmgrant-ntensve producton may be drven by heterogenety of the fxed costs of offshorng (as ndexed by m n the model of Secton 3) Some of the a 17
relevant varaton may be observable, at least n prncple: frms located near arports, or frms whose managers prevous career ncludes overseas postngs, mght well fnd t easer to set up and control offshore producton facltes These and other organzatonal features, however, can hardly be vewed as completely exogenous, snce a frm that fnds the offshorng opton attractve for unobservable reasons mght well choose ts locaton or managers so as to make that convenent Moreover, our data do not nclude locaton nformaton beyond the provncal dummes that we nclude n our specfcatons to control for a myrad of phenomena, nor do the data offer nformaton about the prevous career or lngustc sklls of managers The data do nclude survey questons meant to sngle out famly frms: we know whether members of the owner s famly are senor managers, and whether frms employ managers who are not members of the famly Ths nformaton can arguably provde nstruments for the purpose of detectng the mplcatons offshorng decsons It s hard to see how explotng nternatonal producton opportuntes could have causal effects on the aspects of manager selecton that reflect famly hstores and demographc developments (n our data, non-famly managers are sgnfcantly and ncreasngly lkely to be employed by older frms) But the presence of famly and non-famly managers arguably can affect a frm s propensty to offshore producton, because less dversfed famly owners may well be more reluctant to rsk and nnovate than the managers of publc frms, 11 and wll affect offshorng costs f external managers are more lkely than the entrepreneurs offsprng to have relevant sklls Formally, let the offshorng S = 1 outcome be observed f a latent varable S 0, whle S = 0 otherwse We consder specfcatons for the latent varable n the form S ( ) = α g X + ε, (5) where g( X ) s a sutable functon of a set of frm-level varables The frst and thrd columns of Table 4 report the results of the estmaton of reduced form probt models for offshorng outcomes that specfy g ( Y ) as a lnear functon of the TFP proxy for productvty, computed as the resdual from the cross-sectonal estmaton of a two-factor Cobb-Douglas accountng for captal ntensty and augmented wth provnce and (2-dgt NACE) ndustry dummes, to control for producton-functon and wage-drven relatonshps between 11 Tucc, Barba Navarett and Fan (2006) dscuss how rsk averson n famly frms may ncrease the perceved cost of carryng out rsky foregn operatons 18
frms producton and sales Lke the less formal evdence reported n Table 2 above, these regressons ndcate that offshorng s rather tghtly related to productvty proxes n our data The other two columns of Table 4 specfy g( X as a lnear functon of the arguably relevant determnants of offshorng decsons ntroduced above, namely the presence of famly members and of others n the frms top management The explanatory power of these organzatonal ndcators s also very hgh: the sgnfcantly negatve coeffcent of the FF dummy ndcates that the presence of a famly member reduces the management s propensty to offshore producton, whle the presence of external managers has the opposte effect The two ndcators are mperfectly correlated n our data: about a ffth of frms report employment of a sngle manager (and about one out of eght reports zero managers), but whle the number and the share of external managers s postvely related to the sze of the frm, frms of all szes may or may not employ non-famly managers: among the frms that employ a sngle manager, for example, about a ffth report that the person s not a member of the owner s famly (or the owner herself) ) 42 ffshorng, skll ntensty, and mmgrant employment Ths evdence reported n the prevous subsecton s consstent wth our theoretcal model s focus on offshorng decsons drven (at a gven market wage) by frm-level compettveness and/or by determnants of offshorng costs In the model, offshorng n turn affects the skll composton of employment, n that the actvtes whch reman n the domestc country have hgher skll requrements than those that may be performed abroad To assess the realsm of ths mplcaton we run regresson n the form L j L = β S + v (6) where the dependent varable may be the rato of sklled to total employees, or the rato of foregn employees to total employment, n the domestc operatons of surveyed frms n the rght hand sde, the coeffcent β 1 measures the relevance of offshorng n those respects If a sngle exogenous compettveness characterstc determned all aspects of frm heterogenety, the offshorng ndcator S 1 would be unquely determned by frm-level effcency As mentoned, however, more than one dmenson of relevant heterogenety 19
determnes offshorng and employment n realty The parameter of nterest β 1 can be estmated consstently by LS only f the unobservable determnants relegated to the error terms of (5) and (6) are not correlated, E ε ν ) = 0 Ths however rules out the plausble possblty that ( unobserved frm characterstcs may jontly affect the skll structure and natonalty of the workforce and management s nclnaton to offshore If, for example, entrepreneurs who dscrmnate aganst mmgrant workers also lke to nternatonalze ther actvtes, then E ( ε ) < 0 and the LS estmates of β 1 wll be based downwards More generally, the v bas wll depend on the correlaton between the unobservables n (5) and (6) To try and dsentangle structural mechansms from such spurous relatonshps, we estmate (6) by nstrumental varables (IV), usng the predcted propensty to offshore * S from the reduced-form relatonshp (5) to nstrument the observed offshorng outcome 12 Table 5 reports the results of LS and IV regressons of the share of whte collar employees on observed offshorng (LS) and on nstrumented offshorng (IV), usng provnce and ndustry dummes to control for the effects of technologcal dfferences n the skll ntensty of producton actvtes and of locally determned wages 13 The postve sgn of the coeffcents s consstent wth our theoretcal perspectve: f wthn each sector and provnce the producton stages that may be offshored are low-skll ntensve, frms that do offshore for the reasons we model should employ a larger share of hghskll workers Ths s the case n all specfcatons, and the effect s stronger when estmated on the restrcted sample of frms that we expect to conform more closely to our theoretcal perspectve The coeffcents are larger when estmated by IV, ndcatng that unobservable reasons why a specfc frm decdes to offshore may ndeed be related to the skll composton of ts employment n ways that bas the LS estmates towards zero The TFP-based IV estmates are mplausbly large and rather mprecsely estmated Ths may ndcate that accountng captal stock nformaton s too mprecse to allow estmaton of producton functons on cross-sectonal data The a pror more relable dentfcaton strategy 12 Whle the data do not deny the relevance of our productvty-based explanaton to ndvdual frms offshorng decsons, t s of course mpossble to rule out uncontrolled endogenety bas Egger and Egger (2003) use a formally smlar approach to ndustry-level data, and model heterogenety n terms of offshorng costs and ncentves proxed by varables excluded from the determnants of employment s skll ntensty 13 We report results of lnear regressons Specfcatons that account for the lmted range of the dependent varable yeld essentally dentcal results 20
based on frm-specfc organzatonal characterstcs ndeed yelds smaller (f stll qute large and hghly sgnfcant) estmates for the response to offshorng decsons of the whte collar component of employment 14 Recall that the descrptve statstcs of Secton 2 found mmgrant employment to be negatvely related to offshorng actvty The theoretcal model of Secton 3 only dstngushed workers accordng to ther skll, not to ther natonal orgn If, at a gven level of skll, mmgrants are perfect substtutes for natve workers, frms should be ndfferent between hrng ether, at a gven market wage Ths does not however deny that a relatonshp may be observed between offshorng and mmgrant employment at the frm level, because wthn each frm s hrng pool the proporton of unsklled workers may dffer across the mmgrant and domestc components: f an unsklled worker s more lkely to be mmgrant than a sklled worker, the hgher skll requrements of offshorng frms mples that mmgrants should be a smaller fracton of ther domestc employment In what follows we run regressons, controllng for (rough) frm-level skll ndcators, meant to assess whether ths smple statstcal mechansm or more structural relatonshps underle the observed correlaton Table 6 reports estmates of regressons n the form (6) wth the share of mmgrants as the dependent varable If the reason why offshorng s related to mmgrant employment s that unsklled workers are more lkely than sklled workers to be mmgrant, we expect a negatve sgn Ths s the case n both LS and IV estmates, agan more strongly when the sample s restrcted to frms that are more lkely motvated by our theoretcal model s mechansms All the IV coeffcents are larger n absolute value, and smlar across the dfferent sets of nstrumental varables Evdence of downward bas n LS coeffcents agan ndcates that the unobservable (and unrelated to TFP and organzatonal nstruments) component of what determnes decsons to offshorng choces s negatvely related, at the frm level, to the unpredctable nclnaton to hre mmgrants (n smple words, entrepreneurs who for some reason prefer to outsource ther actvtes abroad also, for equally unexplanable reasons, prefer 14 ther productvty proxes, wth addtonal controls or wthout attemptng to account for captal, yeld qualtatvely smlar results When usng as IVs frm-level nvestments n telecommuncaton (TLC) equpment, we have obtaned reasonably plausble results (a pont estmate around 02 for the offshorng dummy), whch are however not easy to nterpret Whle effcent communcatons are arguably related to offshorng decsons, and TLC nvestments are less lkely than more general technologcal nvestments (such as PCs) to drectly affect the skll structure of the frm s domestc operatons, they are lkely to be jontly endogenous to producton offshorng decsons 21