Vysoká škola ekonomická v Praze Fakulta národohospodá ř ská
Hlavní specializace: Hospodá ř ská politika
OFFSHORING OF BUSINESS,
PROFESSIONAL, AND TECHNICAL SERVICES:
THE CASE OF THE USA
diplomová práce
Autorka: Martina Burjanová
Vedoucí práce: RNDr. Miron Tegze, CSc.
Rok: 2007
Prohlašuji na svou č est, že jsem diplomovou práci vypracovala samostatn ě a s použitím uvedené literatury.
Martina Burjanová
V Praze, dne 2. 5. 2007
Anotace
Tématem mé práce je offshoring v sektoru služeb ve Spojených státech amerických. Offshoring je proces, při kterém jsou rozděleny jednolivé části produkce a některé z nich jsou pak přesunuty do zahraničí. Většinou je motivací k offshoringu snižování nákladů. Offshoring může být spojen s outsourcingem, tj. zajištěním služby nebo výrobku externím dodavatelem. Ve své práci prezentuji teoretické přístupy k offshoringu a outsourcingu a platnost jejich závěrů zkoumám na datech ze sektoru služeb Spojených států amerických. Zaměřila jsem se na služby z kategorie informačních a komunikačních technologií, administrativních služeb poskytovaných firmám a výzkumu a vývoje. Analyzuji zejména data o produkci, produktivitě, zaměstnanosti a mezinárodním obchodě. Poslední část mé práce je analýzou americké vládní politiky zaměřené na negativní dopady offshoringu v sektoru zpracovatelského průmyslu. Zkoumám, je-li účelné takovou politiku zavádět také pro sektor služeb.
The aim of my master thesis is to analyze whether the empirical data support the assumption that offshoring causes job shortage which is sometimes presented in the media and which is often negatively perceived by public. Offshoring is a process of separation of phases of production and the shift of some of these phases abroad.
Offshoring may be connected with outsourcing that stands for securing goods or services from external provider. I analyzed theoretical approaches explaining the nature of offshoring and outsourcing. I focused on the U.S. sector of services (information and communication technologies, business process services and research and development) where offshoring appeared with the development of cheaper and more efficient information and communication technologies. I examined the theoretical conclusions on the U.S. data on output, productivity, employment and international trade. Finally I analyzed the American policy in the sector of manufacturing aimed at negative impacts of offshoring and I examined whether this policy should be a pattern for the American policy in the sector of services.
Outline
INTRODUCTION 3
1 METHODOLOGY 5
2 TERMINOLOGY EXPLANATION 6
3 OFFSHORING, OUTSOURCING, ECONOMIC GROWTH 8 3.1FIRMS´DECISIONS ON OFFSHORING AND OUTSOURCING 9 3.2THEORETICAL APPROACHES TO OFFSHORING AND OUTSOURCING 11 3.2.1MARKUSEN´S OFFSHORING-OUTSOURCING MODEL 14 3.2.2OUTSOURCING:TRANSACTION COSTS VS.MANAGEMENT BURDEN 16 3.2.3CHANNELS OF THE IMPACT OF OFFSHORING ON PRODUCTIVITY 17 3.2DOES OFFSHORING RESULT IN SHORTAGE OF JOBS? 18 3.2.1WHICH JOBS MAY BE OFFSHORED?WHICH JOBS ARE SAFE? 21
3.2.2WHO LOOSES DUE TO OFFSHORING? 22
4 OFFSHORING OF R&&&&D 25 4.1TYPES OF OFFSHORE R&&&D& DEPARTMENTS 25 4.2COSTS AND BENEFITS FOR HOME COUNTRIES 26
5 ICT SECTOR 28
6 MEASUREMENT OF OFFSHORING 30
6.1EXTENT OF OFFSHORE OUTSOURCING IN R&D 33
7 ANALYSIS OF THE DATA ON BPT 34
7.1ANALYSIS OF THE OUTPUT AND PRODUCTIVITY 34
7.2PRICE ANALYSIS OF BPT 38
7.3ANALYSIS OF LABOUR MARKET DATA 39
7.4ANALYSIS OF INTENATIONAL TRADE 45
8 ANALYSIS OF U.S. OFFSHORING POLICY 60
8.1SOCIAL POLICY 60
8.1.1DEVELOPMENT AND FUNCTIONING OF THE PROGRAMMES 61 8.1.2DO THE PROGRAMMES SERVE THEIR PURPOSES? 63
8.2OBJECTIONS 64
8.3BENEFITS OF THE PROGRAMMES 67
8.4POLICY OF SMOOTHING ADJUSTMENT TO STRUCTURAL CHANGES 68
8.5POLICY CONCLUSION 69
CONCLUSIONS 70
SOURCES 73
INTERNET SOURCES 75
Introduction
My paper reviews impacts of offshoring on high-income developed economies.
Offshoring is a certain kind of separation of phases of production process. A firm offshores when it moves parts of production from one country to another. At the beginning the firm moves the parts of production process from the country where the central office of the firm is. Consequently, the firm may further replace it to a country with preferable conditions. Offshorin is very frequently mistaken for outsourcing.
Outsourcing is the process of purchasing services or goods from external provider.
Offshore outsourcing stands for purchasing services or goods from the provider from abroad.
Offshoring is not a new phenomenon. The firms have been moving the plants to low-income countries for decades. The public attention is now attracted by offshoring of services or white-collar jobs in general. The factors that raised the extent of offshoring were technological progress, competitive pressure and liberalisation of international trade. (Olsen 2006: 5)
Firms offshore mostly in order to save costs, namely on wages. This is the reason why only firms from countries with higher living standard offshore. Since more and more jobs requiring higher qualification have been offshored, inhabitants of high- income countries may not find their jobs safe any more and offshoring became one of the most discussed issue in public. Lobby of trade unions or special interest groups try to persuade the governmental agencies to protect the economy from assumed negative consequences of offshoring.
The fact that firms do not offshore only to low-income countries stays beyond public interest. For instance the American technological clusters attract firms whose managers wish to be in touch with the most recent rsearch. Offshoring is a bidirectional process.
In my paper I am going to study the most discussed negative impacts of offshoring such as shortage of jobs or decrease of living standard and I am also going to examine the theoretically assumed positive effects of offshoring such as rising productivity and output, increasing salaries, and higher employment. My study is
focused on the U.S. sector of Business, professional and technical services (BPT) which are most likely to be offshored. The sectors of Information and Communication Technologies (ICT) and Research and Development (R&&&&D) belong to BPT and I am going to focus on them in particular since these sectors employ very qualified people and I am going to examine whether the people of very high gain or loose from offshoring.
My paper is basically dividend into two parts. Firstly it is the theoretical part (chapters 2, 3, 4) where I clarify the terminology and I present theoretical approaches to offshoring (namely issues of productivity growth) and impact of offshoring on labour market (for instance assumed shortage of jobs). It deals with the sector of R&D particularly since it is the most recent trend in offshoring.
Secondly it is the empirical-analytical part (chapters 5, 6, 7, 8) which involves the analysis of U.S. data on product and labour market of in the sector of Business, professional, and technical services.
1 Methodology
I am going to review theoretical sources in order to find appropriate aproaches to offshoring. I am presenting features that contributed to the rise of ICT offshoring in past decade and factors that enabled offshoring of R&D.
We may pose a lot of relevant questions:
• What are possible benefits and costs of offshoring (impact on productivity, growth, employment)?
• What types of jobs are jeopardized by offshoring?
• What ratio of American economy/sector of sevices compete with offshoring locations?
• What is the contribution of offshored services to GDP in terms of international trade?
• How can be offshoring measured?
• To what extent does ofshoring occur?
• Is there shortage of jobs in the American economy due to offshoring?
I am going to discuss these questions theoretically and then examine their conclusions on the American data. I am going to collect relevant data, present them and decide about the gains and the losses of offshoring from the point of view of high- income economies. My analysis consists of study of the data on value-added growth, productivity, employment, wages and international trade.
The final part of my paper is focused on U.S. offsoring policy. I am going to search for the policy aimed at alleviating negative effects of offshoring and analyze whether this policy is effective in reaching its goals. Them I am going to ask what policy could be recommended to smooth the adjustment to offshoring.
2 Terminology explanation
In this section I am going to clarify the terminology. Offshoring is the transfer of parts of production abroad. If managers of a firm decide to offshore, they may choose whether the firm runs an own affiliate abroad (this is called offshore insourcing) or the firm hires another company to provide the requested goods or services (this is called offshore outsourcing). Outsourcing is in general purchasing of goods or services from external provider. Nearshoring is offshoring to a country in the short distance. We may also meet terms cross-border or international or global outsourcing which are equivalent to offshore outsourcing. Table 1 presents the matrix of terms.
Table 1: Terminology explanation
Home country Abroad
Own affiliate Inshore Insourcing Offshore insourcing Not affiliated Inshore outsourcing Offshore outsourcing Provider
Country of the provider
I focused on Business, Professional and Technical Services (BPT) that belong to the sector of Private services1 but BPT services are much more likely to be offshored than the rest of private services which include for instance transportation, educational, telecommunication and financial services.
Statistical category "Private services" involves „Transportation“, „Royalties and licence fees“ and „Other private services“. Other private services my be further divided into „Financial services“ and „Business, professional and technical services“ (BPT).
BPT includes (I underline those categories which are important from the point of view of my paper) „Computer and information services“, „Management and consulting services“, „Research and development and testing services“, „Operational leasing“ and
„Other business, prodessional and technical services“.
1 According to the U.S. statistical classification.
Outsourcing of Information and Communication Technologies2 (ICT) and Research and Development3 (R&&&&D) has much in common. The firms outsource very sophisticated products or services. They outsource for instance computer systems or testing of new pharmaceutical or cosmetic products.
Why do the firms outsource these tasks? They are not willing to keep and pay the whole ICT or R&D department in the firm. Moreover small intra-firm departments may not be up to absorb the ongoing technological progress in these two branches. The extent of specialization nowadays requires high level of human and technical capital which the firm can not secure or the firm is not willing to pay their costs. The crucial task for the firms which outsource is to find appropriate outsourcing providers because ICT and R&D outsourcing handle with very confidental data or know-how of the firm.
Statistical categories „Management and consulting services“ and „Other business, professional and technical services“ involve also business proceedings.
„Other business, professional and technical services“ include for instance accounting, auditing, advertising, trade-related services, training services and legal services. Firms outsource the business proceedings which need to be done but managers do not want to waste costs (time, effort) on securing the processes that someone else can do cheaper or even better for lower price. We may call them Business process services (BPS). The best known example is offshore outsourcing of US call centers to India or Canada, other example is business consulting service for firm that move offshore.
The fact that offshoring goes in both directions (from and into the economy) can not be neglected. The best known examlpe is probably offshoring to technological clusters to Silicon Valley in the USA. The firms which offshore there do not aim at decreasing costs but they do not want to stay aside the latest technological progress.
The offshoring balance may reach surplus or deficit and I am going to analyze the data on international trade in the chapter 7.4 and to present the offshoring balance.
2 That is represented by statistical category „Computer and information services“
3 That is represented by statistical category „Research and development and testing services“
3 Offshoring, Outsourcing, Economic Growth
Outsourcing is nowadays presented as a modern solution for proceedings of tasks in the sectors of ICT, human resources, accounting, logistics, cleaning services, security, marketing, public relations, call centers etc. It is obvious that not all of these tasks may be offshored. Outsoucing appered in the seventies. In the eighties it was implemented for instance in companies such as Kodak, Xerox or General Motors.
Offshoring of services appeared in the late eighties. The development of information and communication technologies was the crucial factor which contributed to the raise of offshoring. It not only reduced transaction costs but it transformed completely the nature of procedures and the services previously seen as non-tradable in the international markets were offshored. (Olsen 2006: 5) Global liberalisation and standardization of services belong to other relevant causes of rising extent of offshoring of services. (OECD 2005c: 65)
Outsourcing of ICT may be defined as „delegation of one or more IT-intensive business processes to an external provider that, in turn, owns, administrates and manages the selected process based on defined and measurable performance metrics“.
(OECD 2005c: 64) Downturn in the sector of ICT in 2001 was one of the most important factors which made firms look for ways how to cut costs.
Actually, outsourcing may be seen just as posh name for trade in goods and services between producers. Does outsourcing depict to something different than trade between producers as it has been observed for decades in manufacturing?
Outsourcing stands for purchasing of the final product or the complete service.
Outsourcing may be seen as a new feature which may differentiate outsourcing from trade between firms in semi-finished products. It is the risig extent of specialization which has been changing the nature of trade between the firms from trade in semi- finished products to final products or complete services. Outsourcing is often presented as a solution for process which are not core substances of the firm´s business. However this is not the case of R&D services secured by the outsourcing provider because R&D shift the production possibilities frontier of a firm and thus it is a core substance of the firm´s business in for instance pharmaceutical or semiconductor producing branches.
The same may be the case of manufacturing. We can imagine for instance a car producer ordering highly sophisticated electronic devices for its cars. In this case the car producer orders the final product or the complete service. My conclusion is that outsourcing is just a term depicting to a more sophisticated trade in inputs between firms.
Outsourcing provider bears the responsibility of securing the proceedings and their development. Outsourcing client and outsourcing provider need to cooperate very closely since the services secured by the povider should suit the client the best and since they wish to keep their know-how confident.
3.1 Firms´ Decisions on Offshoring and Outsourcing
Although the usage and meaning of the terms offshoring and outsourcing is usually very confusing firms´ decisions about outsourcing and offshoring are not based on the same reasoning. The arguments in favor of outsourcing may be at the same time discouraging for offshoring (and then the firm for instance chooses to export production from the home country instead of movement of parts of the firm). There is not a single criterion which would assess whether a firm should offshore or not. The process of evaluating possibilities to offshore is always very costly. It is firstly the collecting of information about possible locations, searching for appropriate partners, examining whether there are potential employees, translation services, travelling costs etc. These expenditures present sunk investments before any decision can be made.
When a firm collected the relevant information what factors finally decide about offshoring? Markusen (2005: 20) gives a review of factors which support the decision to outsource but reject offshoring:
• restriction on foreign investment
• restriction on the right of establishment
• restriction on immigration (temporary) of foreign personnel
The third factor emerges with the fact that when a firm sets up an affliliate abroad it needs employees from the home country for certain period of time. The three
factors raise the transaction costs of setting up an affiliate. If they are found too high the firm will hire an outsourcing firm in the home country.
There are other two factors that come with know-how that the firm brings while it builds physical capital and it trains employees. These factors raise the transaction costs too. The other factors are:
• lack of intellectual property protection
• lack of contract enforcement
The firm will be less willing to outsource the key issues of its business because it may loose its know-how. (Olsen 2006: 8)
The relationship between outsourcing provider and the firm that orders outsourcing can be described as typical principal-agent relationship. The outsourcing provider follows its interest which is mainly high profit and it may artificially raise the price for its services after certain period of existence of partnership when the sunk investments are too high too be wasted.4 The risk of principal-agent problems my be decreased when the outsourcing provider is connected to the profit of the firms that order outsourcing. The outsourcing provide will be the most willing to provide the services in the best quality and for the lowest costs if it has only one client. In this case the economic existence of outsourcing provider will be firmly connected to economic performance of its client. The two concrete examples of solving the problem of conflicting goals emerging in the case of outsourcing are presented in the following paragraphs.
There is a risk that the trained personnel would establish their own business that might compete with the offshored plant. Markusen (2005: 21) presents two views on this issue. First is called „labour-learning model“ and it claims that when a firm can not bind an employee to the firm by contract or/and the firm can not enforce this contract,
4 Imagine for instance a complicated transfer of the ICT system of the firm into a new one. The employees have been working on it and the firm paid them. During the phase of implementation there appeared some problems and the outsourcing provider will ask for extra payments. Will the firm search for a new outsourcing provider? It would be better if these cases were already included in the contratcs.
Then there is just an effective conract enforcement needed.
then the firm has to „share rents with local employees“ in order to discourage them to set up the competitive company (Markusen 2005: 21).
Markusen (2005: 21) calls the second model „hold-up model“ and it claims that both sides of offshore contract ( the first is the firm which offshores and the second is local agent who might be a manager of an affiliate or an owner of unaffiliated company providing outsourcing) make kind of sunk investments (physical capital, investments in training of personnel in the case of offshoring firm). Then the model suggests that the ownership should belong to the party with higher sunk investments to prevent higher losses in the case of a conflict when no negotiation is succesful. This approach recommends to share rents with locals as does the previous model.
3.2 Theoretical Approaches to Offshoring and Outsourcing
There is a number of theories of international trade. In accordance with Markusen (2005: 3-6) There are 6 groups of theories which are potentially applicable to offshoring:
(1) „Comparative advantages theories“: firstly Ricardian theories that that are based on the assumption that countries differ from each other in technologies.
Secondly Heckscher-Ohlin model predicting that a country exports the goods whose production requires the country´s abundant factor and it imports the goods produced due to country´s scarce factors. The firms make use of cheap (abundant) labour when they move the plants offshore and use the advanced capital stock from high-income countries.
(2) „Non-comparative-advantages theories of trade“: new-trade theory or industrial- organization approach (for instance Melitz 2003, Helpman, Melitz and Yeaple 2004). Their proponents question the decreasing returns of scale and state protection of developing industries. In their point of view the world economy would benefit from the huge sizes of multinational companies. Offshoring is a process that mostly large companies establish and this way they gain advantages over the firms that do not take use of offshoring.
(3) „Trade in factors“: this approach stresses the study of trade in factor instead of the study of trade in goods or services. It claims that trade in factors and trade in goods are complements (the comparative advantages theory claimed the opposite). I am going to present an example for better understanding of this issue. Imagine that a high-income counry allows the liberalizatio of its market.
Then there might rise the import from the low-income countries. The comparative advantage theory makes the conclusion that the imigration from the low-income countries decrease with the rise of its export to high-income countries. According to the „trade in factor“ theories the migration increases with the increased export from low-income country. (Schiff 2000: 1) The negative impacts of higher migration from low-income countries (Migration of mainly unskilled labour force who can not speak the language of the new country result for instance in higher costs on social policy) may weaken the government´s willingness to liberalize the market. See for instance Mundell (1957) or Markusen (1983)
(4) „Theories of foreign direct investment and arm´s lenght trade in firm-specific assets“: These theories do not regard movements of foreign direct investments as the ordinary part of capital movements. The stress that most of flows of FDI are among high-income countries. There are basically two major directions of these heories. First is a kind of upgrade of comparative advantage models that claims that phases of production differs in requirements for factor intensities and the countries differ from each other in abundance of the factors. The second group of theories stresses that the firms follow specific policies at particular markets, so called horizontal approach. The firms do not invest abroad (since there are economies of scale in the home countries) and keep exporting as long as there are no cost of trade. If there are trade costs the firms will offshore the parts of production and the extent of offshoring will be as high as the economies of scale equals the trade costs. (Foldvari 2006:
81) The number of explaining theories of outsourcing belong to the fourth group of theories. They claim that the most important factors for the firms´
decision of offshoring are „moral hazzard, adverse selection, contract
enforcement and intellectual property protction“ (Markusen 2006: 5). These theories are evolved for instance in Helpman (2004) or Brainard (1997) or Markusen (1984).
(5) „Trade in business services“: traditionally the services were considered to be non-tradable but this is not the case any more. A relevant theory from this group is called „theory of multinational“ and it claims basically that the firms export the services of „knowledge based assests“ from home countries of the firm to a countries of affiliates. Markusen (2006: 6)
(6) „Trade expansion at extensive margin“: These theories raise the importance of traditional liberalisation approach which viewed the trade liberalisation as a mean of extension of volume of traded goods. There is a new contribution claiming that thank to fall of prices (caused by international trade competition) may make tradable also the goods and services previously seen as non-tradable. This is a conclusion presented in Dornbusch, Fischer and Samuelson (1977).
3.2.1 Markusen´s offshoring-outsourcing model
I chose to present Markusen´s model (2005: 16-23) because it encompases closest the nature of offshoring. Imagine that there are two types of companies: (1) multinational companies that do not outsource, they use their foreign affiliates, (2) other firms that enter into agreements of both offshore insourcing and offshore outsourcing.
He supposes that there are:
(1) three factors of production: skilled and unskilled labour and know-how (imagine for instance high-tec physical capital such as telecommunications devices or organisation, managerial and marketing knowledge)
(2) two products (X, Y), three production activities (a, b, c): product Y (a - unskilled-labour intensive production), product X (b - skilled-labour and know-how intensive production), c - production of X can be divided into high- tech manufacturing (M) and services (S). M is more skilled-labour intensive than production of X. S is skilled-labour and know-how intensive.
(3) skilled labour and know-how are complements in the production of S (which means that there is a very limited option of substitution between skilled labour and know-how in producing S)
(4) two competetive, constant return economies: North (high-skilled and know- how abundant), South (low-skilled abundant, very know-how scarce)
Let´s make an assumption that at the beginning skilled labour and high-tech physical capital can not move between countries. Product X is made in the North since it has plently of skilled labour and know-how and export X to the South. Although there might be also skilled labour force in the South, there are no appropriate jobs created for people with higher qualification and under such conditions potential employees would accept lower wages if there were appropriate jobs so the high- qualified labour is cheap.
When trade in high-tech physical capital is allowed the capital moves to the South and it replaces relative demand for skilled-labour to the South. It results not only in the decreased demand for skilled labour in the North but also in the end of monopoly
of the production of product X in the North. If the North is a large country the scarcity of skilled labour in the South is relatively higher and in this case the firms from the North would save less than in the case if the North is not large. Unskilled labour is real-income loser in the North and on the other hand it is real-income gainer in the South. Number of traded goods increases.
The most important conclusion from the point of view of my paper is that this model admits the value of the the idea of losses for high-income countries due to offshoring of white-collar services. However he did not take into account that there might be a fall in prices because of lower production costs, further investments and new jobs for people previously working at offshored workplaces. Offshoring is not necessarily loss to qualified workforce. According to Farell (2006: 3) each $1 of costs of services that was sent offshore brings at least $1,14 to the US economy from which the firm that offshored gets at least $0,58. This amount of money may create new investments at home country.
Markusen made some adjustments to the previous model. There are only two production factors – skilled and unskilled labour (not know-how any more). Other change is that high-tech manufacturing capital can be produced only in the North. He supposes that there are two types of firms – national (which produce X while using integrated M and S in the North and export X to the South) and multinational companies (producing M in the North and exporting M to the South where S is produced, or vice versa). S might have low marginal costs but high fixed costs (imagine for instance a call center) but Markusen claims that this has no real effect on the results of the model. The conclusion of this model is that both countries gain since the firms compete, scale of firms growth and markups are lower. Markusen finds this to be the most important conclusion: theoretically (all) countries gain due to liberalization of international trade. (Markusen 2005: 17) Skilled labour in both countries gains particularly. Unskilled labour gains in the South and it loses in the North.
The analytical part (chapter 7) will provide analysis of US data to decide on the effects hat are presented in the model.
3.2.2 Outsourcing: Transaction Costs vs. Management Burden
Outsourcing is a phenomenon of specialization. How works the impact of outsourcing on productivity? Well-known view is based on transaction costs. A firm compares transaction costs and management burden. The firm secures internally those proceedings whose management burden does not exceed transaction costs of purchasing the required product or service externally. The rising extent of outsourcing means that the relationship between transaction costs and management burden has been changing. It may reflect the increasing management burden or/and decreasing transaction costs. I claim that both features are the case simultaneously. The management tasks are getting more complex because the economic surrounding and technologies change very fast and the managers have to decide faster on the basis of the overflow of information. At the same time the computers enabled outsourcing providers to work on the great distance, travelling gets cheaper and the governments often pursue reforms in order to decrease the costs of contract enforcement in order to attract investments. Moreover opportunity costs arise when managers devote their time to less productive activiies.
I can not decide whether the decreasing transaction costs resulted in deepening specialization or the increasing extent of specialization decreased the transaction costs.
Imagine that for instance the law was passed which cuts the maximum length of the trial, the firms will be more willing to outsource because they can sew a cheating business partner cheaper. On the other hand the complexity of for instance software programs gets that far that the firms are founded just to provide the consultation service. The higher supply decreases the transaction costs because it creates the market and the customers can find a partner easier and cheaper.
The specialization on these parts of production where the firm can use its comprative advantage is just another expression for higher productivity. If the firm focuses on a particular issue, it takes advantages of detailed and concentrated study of it and it probably finds better solutions than those firms which are not specialized and the specialized firm is more productive. A firm can focus on its comparative advantage or it
can gain a comparative advantage due to specialization (so called learning by doing approach).
Amiti and Wei (2006: 4) mention the question of endogeneity of outsourcing. It is assumed that there can be a bias against (offshore) outsourcing. Are the higher- productive firms more likely incorporated in outsourcing? Or do the lower-productivity firms get engaged in the global production strategies in order to raise their productivity?
In my point of view if there was the option to raise the productivity by engaging in the global production strategies both lower- and higher-productive firms would enter in the global solutions and naturally the higher-productive firms would gain more and they would further force out the lower-productive firms from the market.
The rise in productivity is a source of economic growth. The extent of outsourcing is thus a kind of indicator. The more firms outsource the higher productivity in the branch or in the economy is. If there are outsourcing providers present in the branch it means that opportunity costs in the branch or in the economy are too high to be wasted. This indicates higher productivity compared to the branches or economies that do not use the service outsourcing provider. Outsourcing is then connected to rise in productivity and to economic growth.
3.2.3 Channels of the Impact of Offshoring on Productivity
Acording to Amiti and Wei (2006) the major benefit of offshoring concerns productivity. What are the channels through which offshoring may affect productivity?
• First, when firms move less productive parts of production to a country where it can be produced cheaper the productivity of the remaining workers relatively raises.
• Second, offshoring may allow firms to invest more in technologies which push out the technological frontier. According to Amiti and Wei (2006: 7) this is more likely to appear on the basis of outsourcing of information and communication technologies rather than material inputs.
• Third, learning externalities may arise from the usage of more advanced imported services.
• Fourth, firms may use the greater variety of inputs (Amiti and Wei 2006: 8)
Offshore outsourcing may cause a productivity gap between (multinational) companies which are able to gain from this type of cooperation and between the other firms. There is also an advantage for companies commucating in global languages.
Companies comunicating in English benefit the most and to lesser extent also firms communicating in French (they outsource from Morocco and Tunisia. (OECD 2005c:
68)
3.2 Does Offshoring result in shortage of jobs?
What is the public image of outsourcing? Imagine that some one has been working in the particular position for years and suddenly he or she is made redundant because the task previously done by him or her is now supplied by an outsourcing provider. He or she may find a job at the outsourcing provider, he or she may find a job in a different branch or stay unemployed. I believe that inshore outsourcing is not perceived negatively because people think that the workplaces stay in their country and they can still find jobs of this type. On the other hand offshore outsourcing is perceived very negatively, probably because people think that the jobs just disappear and there will be lack of jobs.
In my point of view there are some types of jobs which will not be to find in high-income countries any more. If a firm can offshore a particular type of job, the other firms will do the same or the production technology in the high-income countries has to be more efficient compared to the productive capital in the offshore countries (due to higher wages). All types of potentially offshored jobs in the high-income economies will require employees to raise their level of knowledge of technology in order to compete successfully with the lower-wage countries. Learning is an inevitable presumption of economic growth. If there are branches where the comparable cost efficiency between high- and low-income countries can not be achieved, the branches will be offshored completely.
People slightly got used to offshoring of jobs with low value added in the sector of manufacturing. The services were previously seen as non-tradable and thus non- offshorable. However, the development of cheaper and more efficient information and
communication technologies caused that still greater extent of services are being offshored as well. The clear difference between BPS (Business Process services) and ICT is that ICT is still considered to be the branch which employed people who achieved very high level of education. Offshoring was considered to be connected to low-qualified workforce which can be easily found in countries with lower living standard. Suddenly the Indian programmers substitute the those American and there emerges the impression that the education is not a way to prevent some one´s job from offshoring either. The most recent type of offshoring that appeared in the sector of R&D supports this impression. Offshoring of white-collar jobs became one of the most discussed topic in the public.
There is a great numbe of lobby groups that are interested in drawing public attention to offshoring. Firstly there are trade unions that are willing to raise the number of their members and their financial sources. They may profit from exaggerating the negative effects of offshoring because if people find their workplaces vulnerable to offshoring they may be more willing to become members and pay contributions. The rising number of members further provides importance to the opinions of union leaders etc. We should be aware of the potential bias while listening to the speeches of the union laders on the radio or on TV as well as reading the interviews with them in the newspaper.
One of the proposed solution of offshoring is the trade protectionism. The firms in the economy may (in the short run) gain from protectionism and the managers may be willing to exaggerate the negative impacts of offshoring too. Another lobby group that is concerned with creating negative image of offshoring are employees of state offices and consultation companies that use threats to offshoring as advertisement their services. The U.S. policy owards offshoring will be discussed in the chapter 8.
The objections against the negative impacts of offshoring are based on economic theory. It claims that when some jobs „disappear“ offshore, the new jobs emerge in home country. Why? There is an example based on the theory of comparative advantage. There are two ladies, Ms. C is great at planting cucumbers but she can plant mushrooms less efficient than Ms. M, who is the mistress of planting mushrooms but she is not that good at planting cucumbers. When they do not exchange
their production they consume less cucumbers and mushrooms than they could in the case of exchange. When they trade, they both focus on products which they can produce more efficient and both consume more. This conclusion is valid even for the case that one of the ladies is more efficient in planting of both products, the most efficient lady focuses in this case on the production at which she is relatively more efficient.
We can present this example in larger scale. Imagine that there are two groups of states. The states of one group have higher level of technological knowledge and produce more efficient than the states of the second group. The states of the first group focus on the products they can produce relatively most efficient and exchange the goods with the states of the second group. They both consume more. The technical progress goes faster in the first group of states (in reality there is no catch-up in technical level between rich and poor economies) and the specialization shift still goes on because the businessmen and businesswomen relocate sources to the branches with higher productivity. The workplaces in some sectors disappear (offshore) and the other workplaces appear elsewhere. It is the shift of jobs and not the shortage that is observed. I stress that the shift to the branches with higher level of productivity (and thus higher consumption due to the increasing wages) is caused by market and no state intervention is needed. I am going to test these theoretical assumptions on the U.S. data, see the result in the analytical part (chapter 8 ).
The examples also illustrated the fact that ofshoring is not a one-direction process. The USA are one of the world´s biggest supplier of ICT services. While the USA offshore the less productive proceedings the American firms supply the market with sofisticated poducts and technologies and make profit on it. Foreign scholars who come to study at US universities may leave the USA afterwards and set up a competing firm in India but they may participate in the research in the American firm which shifts forward technology frontier.
3.2.1 Which jobs may be offshored? Which jobs are safe?
What types of jobs are typically offshored? They require little contact with customers and costs of their set-up are low. They provide mostly information service. It is a kind of work which can be performed via remote communication. Firms focus on cutting costs and thus the jobs with high wage diferentials are offshored with preference. (Rowe 2004) Farell (2006: 2) reports that currently 11% of overall jobs in the US sector of sevices may be offshored.
The least vulnerable jobs to offshoring are those which require personal contact with customers. To this category belong for instance non-tradable services. Part of ICT jobs may be offshored as well. However, the design phase of a software project, when customers specify their needs and a vendor offers possible solutions, may be hardly offshored. On the other hand the programming and testing software jobs can be offshored easily. Moreover, personal contact is not required during the design of products and thus it can be easily offshored as well. The further development of ICT can cause that still greater extent of services will be offshored. The same is applicable to BPS, for instance call centers, accounting, human resources departments etc.
What can be recommended to employees if they do not want to become redundant? They should steadily raise their qualification and they should avoid being on the entry-level positions in the firm. Specialization is helpful. They should improve their communication skills in order to be able to perform jobs in management. The employees should find a job with broad range of responsibilities and they should not focus on the narrow scope of work activity. Table 2 presents overview of job categories which are safe from offshoring.
Table 2: Jobs safe from offshoring according to Thomas Friedman5
Type Description Examples
Special
Highly paid individuals who cater to a gobal market.
Michael Jordan, The Rolling Stones
Specialized
Individuals with highly specialized, cutting-edge skills that are not easily
digitized and transferred.
Brain surgeons, specialized workers
Anchored
Individuals whose work must be performed in a specific location.
Their work cannot easily digitized, although certain aspects may be, such as radiologists in India who read CAT scans performed in
America. Barbers, nurses
Really adaptable
Individuals who constantly acquire new skills, knowledge, and expertise
in oder to continually create value.
Applicable to many fields
Source: Murphy (2007: 6)
Ofshoring is not only question of the type of the job. The smaller firms may not be willing to offshore due to the size of the departments. They may be too small and the costs of whole offshore procedure would exceed the saved costs. (Farell 2006: 2)
3.2.2 Who Looses Due to Offshoring?
The politicians in high-income countries are approving rules to stop offshoring because they think that no more job opportunities will come instead. The issue of economic policy towards offshoring will be discussed in chapter 9. Offshore outsourcing (which embodies specialization and technological process) goes on continually. People who are able to perform jobs requiring higher qualification benefit
5 Friedman, Thomas L. (2005), The World is Flat: a Brief History of the Twenty-first Century. New York: Farrar, Strauss and Giroux.
from offshoring. The firms that are able to compete under these conditions and the states whose administrative does do not blockade offshoring benefit as well.
The era of offshoring requires a lot of flexibility. It demands continuous learning and one should be always ready to change the field of qualification. The schools should not teach the scholars the curriculum of facts but the teachers should mediate the skill of learning and the knowledge applicable in the whole range of potential jobs (PC skills, communication a presentation skils etc.).
People who can not participate in the economy which uses computers and other brand new technical stuff (such as people of low qualification and elderly), they are the losers. Mothers who stay at home with their children for a long time without keeping in touch with their profession are threated as well. I would recommend to people who are not willing or able to react on this pressure to find a job in personal services which can not be offshored or in the craft. However the jobs currently seen as non-offshorable may in few years move offshore as well.
The economic policy (social state benefits) should motivate people to do their best to participate in the labour market. Even the economies with rather flexible labour markets implement new schemes of unemployment benefits. USA, South Korea, Japan or France pay extra benefits when a job seeker finds a job within certain period of time. US government also pays elderly people when they accept lower paid job than they had before. The amount is equal to difference between previous and new salary.
These policies support fast re-employment. (OECD 2005c: 83) Another type of policies facilitating adjustment concerns consulting and training services. (OECD 2005c: 67) Mobility of labour force should be supported. One of the potential barriers is high tax on property transactions. (OECD 2005c: 87)
The states that aim at stopping offshoring will not benefit from the world market to the maximum potential extent. OECD analysts definitely reject trade protectionism.
According to them international competition itself is a powerful instrument for restructuring. (OECD 2005c: 90) The firms which do not offshore while the others in the branch do will go bankrupt.
In my point of view discrimination of women and people of ethnic minorities hampers the economic growth because this way the economy looses their talent. More
should be done particularly in the case of women to make it easier for them to joint childcare and work if they like. The men can start at themselves and help the women in households to give the women more time to gain new knowledge and participate in the labour market. The state may provide extra childcare benefits in order to help parents to pay a baby sitter if they need one. The minorities often face the undervaluation when they apply for a job. The state administrative of high-income countries should work more properly on reducing discrimination of people who do not come from the Euroatlantic region6 who suffer from the worst discrimination at the labour market
Nature suffers a lot thank to offshoring because it requires a lot of transportation and thus it causes pollution. The countries should adopt such taxation systems which gives preferential treatment to environment-friendly transportation technologies. The additional policy option is to aim at fulfilling the assumptions of the Coase theorem to decrease the transaction costs of reaching the agreements in the case of natural demages.
6 Western Europe and Noth America.
4 Offshoring of R& & & &D
Offshoring in research and development presents the most recent trend. The paragraphs in this section focus on changes which enabled offshoring of this kind and specific types of cooperation in the sector of R&D.
It was common that a firm ran its R&D department close to its headquarters.
Recently firms started to move the R&D departements offshore. Fims from high- income countries locate R&D centers in both high- and low-income economies. What factors do firms take into account when they decide to move or not to move R&D?
On one hand there are internal factors. Centralisation secures proximity and coordination with the headquarters. On the other hand it may worse cooperation with the parts of production located elsewhere and loose advantages from setting-up the research center in a technological cluster. Decreasing communication costs and new management proceedings reduce transaction costs. Decentralisation is also supported by higher standardization and codification of R&D work. Availability of skilled and cheaper workforce belong to external factors. (UNCTAD 2005: 158) In general, „costs rise with geographical, economic, cultural and linguistic distance“. (UNCTAD 2005:
157) The firms would not locate R&D center in weak intellectual property rights regimes (where firms might not save their R&D achievements).
Once a firm decides to offshore R&D center, it may also outsource it. High minimum starting investment needed to run a firm´s R&D department increaseses willingness to outsource R&D.
4.1 Types of Offshore R& & & &D Departments
The most common type of R&D offshoring is adaptive R&D which secures adjustment of products to local specifications. (UNCTAD 205: 158) R&D centers of this type take a place when a market abroad is very different and large enough for export. Technology sourcing and monitoring is the second most important type of R&D
investment. It aims at monitoring of the latest technological innovations. That is the reason why many firms located their branches in Silicon Valley in the USA.
R&D centers may be divided into three levels according to the extent of independence within the firm. Satellite laboratories adapt existing products on local conditions. Contract R&D centers deal with the implementation of global projects.
Equal partnership allows R&D centers to full knowledge-exchange within firms and have regional or global product mandate. (UNCTAD 2005: 166) It is assumed that the satellite-type laboratories prevail in low-income economies (for instance in China) while the equal partnership laboratories are settled mostly in low-incom economies.
(UNCTAD 2005: 167)
India is an exceptional case among low-income countries. Satellite laboratories have been settled there since the seventies. Nature of the R&D investment have been changing since the eighties and global firms such as Microsoft, Pfizer, Motorola, Daimler-Benz came in the nineties and developed advanced laboratories. (UNCTAD 2005: 167)
4.2 Costs and Benefits for Home Countries
Higher efficiency of R&D within a firm is the very first benefit. While the research gets more complex, a single firm may have not the sufficient capacity. The second benefit arises from technological exchange, the reverse flow of knowledge to home countries and spill-overs within home economy. Third, adaptive R&D centers facilitate market expansion abroad.
There is a debate over replacement of domestic researchers. According to UNCTAD (2005: 195-197) the domestic firms usually do not close home R&D departments when they offshore R&D because it may lead to loss of domestic capacity to cope with innovations. These firms may not expand at home and some employees may become redundant. For better imagination of cost differential see table 3 which presents salary of chip designer in the most important ICT-producing countries.
Table 3: Annual costs on a chip designer in selected countries7
Location Annual costs (USD) USA (Sillicon Valley) 300 000
Canada 150 000
Ireland 75 000
Republic of Korea 65 000
Taiwan 60 000
India 30 000
China (Shanghai) 28 000 China (Suzhou) 24 000
Source: UNCTAD 2005: 174.
Fro table 3 we see that the annual costs of a place of a chip designer are ten times higher than in India.
7 Annual costs include salary, benefits, equipment, office space and other infrastructure.
5 ICT Sector
ICT sector in general includes manufacturing of computer and telecommunication related products and computer as well as non-material production such as research and software design or telecommunication-related services. Before I start with analysis of the productivity and labour market data, I am going to make a general overview of offshoring of ICT.
U.S. ICT manufacturing has been offshored since the sixties, particularly to Taiwan, Malaysia and Hong-kong. Offshoring of that period included labour-intensive and capital-intensive parts of semiconductor industry such as assembly operations, packaging and testing. The firms aimed at saving costs, using cheap unskilled labour force and penetration of new markets thank to adaption of goods and services to local market.
According to the GAO8 report wafer fabrication (production of devices involving integrated circuits) has been offshored from Taiwan to some Asian countries (the most important countries for this purose were China, Malaysia and Philippines) since the eighties and Taiwan became the most important offshoring location of US semiconductor manufacturing (devices for data processing) already with some share of fabrication phase of ICT production which requires employees with higher level of education. China gained the top position of offshoring country when it started opening its market. GAO puts the beginning of programming jobs offshoring to the late nineties when it was necessary to suit software to the Y2K issue. The firms not only saved costs, they observed availability of skilled labour and started offshoring more sofisticated parts of production such as jobs of programmers in particular to India and Ireland. Since then offshoring of ICT divides into two branches: Firstly it is offshoring of semiconductor production (mainly to Taiwan and China) and secondly offshoring of software services (mostly to India). US semiconductor production amounts 24% of
8 United States Government Accountability Office
value of general U.S. computers and electronic manufacturing. Software services represent 48% of general U.S. services in broader ICT sector9. (GAO Report 2006: 6)
GAO report concludes that despite the rapidly growing extent of offshoring the USA are still the leader of the ICT branch and GAO proves it among others on the fact that foreign firms started their offices in the U.S. to be in touch with the most advanced technologies. The report says that the ICT branch recovered after recession of 2001, the employment rises in the sector of software and the employment in the semiconductor industry stays on. There is a trade surplus within the two ICT industries. GAO report depicts to educational and research systems and to competetive business environment as the main factors which support the US position as a global leader. (GAO Report 2006: 2-3, 10)
9 publishing industries (which includes software), information and data processing services, computer sysems design and related services)
6 Measurement of Offshoring
Measurement of offshoring in general is according to many sources difficult. I chose to present the measurement of offshore outsourcing provided by Amiti and Wei (2006: 10) based on an analogous measurement of Feenstra and Hanson (1996a, 1999) for the sector of manufacturing. They define outsourcing intensity of services ossi,t as follows:
− +
∗
=
∑
t time at j orts j
imports j
production
t time at j service of
imports
t time at i industry by
used inputs energy non
total
t time at i industry by
j service of
purchases input
oss
j t i
* exp
,
The calculation of the first bracket is based on input/output tables. The categories from input/outout tables are aggregated to match he categories from the IMF Balance of Payments Statistics Yearbook.
The calculation of the second bracket (the cullom called import of services in table 1) requires data on international trade. While counting the extent of offshoring one has to take into acount trade between affiliated and unaffiliated subjects. Amtiti and Wei used the data from IMF Balance of Payments Statistics Yearbook and did take into acount both channels of international exchange of services and goods. (Amiti and Wei 2006: 3) Due to the lack of detailed data Amiti and Wei assumed that the ratio of imported inputs of particular service in a branch was the same as the average ratio for the aggregated economy. For instance the ratio of imported business services in 2000 was 2,2%, then they supposed that each branch of economy imported 2,2% of business service in 2000. Offshoring intensity is then counted: 0,12*0,022 = 0,3 (stressed in table 5). (Amiti and Wei 2006: 10-11)
Table 4 presents time flow of offshoring intensity of material and service inputs in the period from 1992 to 2000.
Table 4: Offshoring intensity of material and service inputs
% % change % % change
1992 11,72 0,18
1993 12,68 5,25 0,18 4,88
1994 13,41 5,06 0,20 6,39
1995 14,18 4,65 0,20 4,10
1996 14,32 1,75 0,21 6,64
1997 14,55 1,75 0,23 6,97
1998 14,94 2,97 0,24 6,57
1999 15,55 3,49 0,29 16,73
2000 17,33 10,12 0,29 -2,23
1992-2000 4,38 6,26
Share of imported material inputs Share of imported service inputs
Source: Amiti and Wei (2006: 29)
The data in table 4 confirm the rising extent of offshoring. Import of material inputs exceeds the ratio of usage of imported services. This fact is connected to the earlier start of offshoring in the sector of manufacturing. The extent of imported inputs rose on average 4,38% in manufacturing and 6,26% in the sector of services annually.
Table 5 shows ratio of import of services and share of services needed for production of the sectors of the American economy.
Table 5: Offshoring of Services, by type, 1992 and 2000 Type of services Import of services /%/
1992 Mean Maximum Minimum Std. deviation
Communication 2,47 1,16 4,82 0,25 0,79
Finance 0,25 1,91 4,72 0,93 0,63
Insurance 1,82 0,43 1,39 0,16 0,18
Other business services 1,47 9,69 37,93 1,87 7,16
Computer and information 0,16 0,55 2,53 0,02 0,44
2000
Communication 1,18 1,27 5,45 0,28 0,94
Finance 0,51 2,37 5,28 0,71 0,86
Insurance 2,84 0,47 1,36 0,10 0,22
Other business services 2,23 12,02 44,99 1,89 8,55
Computer and information 0,62 0,38 2,01 0,01 0,31
Share of service /%/
Source: Amiti and Wei (2006: 29)
As we see from table 5 there is considerable increase in import of services between 1992 and 2000, the only exception is the sector of communication. The share of services needed for the production also rose. The explanation of increasing share of services may be connected to rising extent of offshoring due to its benefits such as lower prices and greater choice of inputs. Amiti and Wei (2006: 11) depict to the great variety in purchase of service inputs between particular industries, or instance the use of business services in the industry „household audio and video equipment“ was 2%
and in comprarison the usage of business sevices in the industry „greeting cards“ was 45%.
Amiti and Wei (2006: 12) mentioned the potential problems of offshoring measurement. There might be underestimation of offshoring due to the lower costs of services purchased from abroad. They would prefer to work with the data on quantity of import categories which are not available for the USA. The other problem is the assupmtion that all the idustries use the same ratio of offshoring material of service inputs. It would be interesing to see what industries use offshoring the most and what level offshoring reaches in those industries.
Amiti and Wei (2006) used time series of offshoring intensity for egresion analysis. The results will be discussed in the following chapters.
6.1 Extent of Offshore Outsourcing in R&D
The measurement of the extent of offshoring in R&D is problematic. Firtsly due to the lack of appropriate data on international trade. Secondly thank to the fact that the firms may not be willing to reveal the data on their firms or they manipulate with them (and this can be done easily when they operate on markets in the several countries).
UNCTAD report (2005: 294) presents statistics on the expenditures on R&D by US affiliates abroad (thus we measure offshoring and we neglect offshore outsourcing, results possibly underestimates the importance of India) and the report estimate the extent of offshoring this way. 21 billions of U.S. dollars were spent in 2002. Canada received more than 10% of this amount, japan 6,8%. On the other hand low-income countries got only 13%, the rest flows to high-income economies. China received 3,1%, Singapur 2,8%, Brazil 1,4%, Mexico 1,3%, South Korea 0,8% and India 0,8% The highest ratio of expenditures went to the sectors of transportation equipment (5,9 billions), computer and electronic products (5,3 billions) and chemicals (4,8 billions).
The expenditures in other categories did not exceed 1,5 billion.
Data on U.S. R&D offshoring are missing or they are ot detailed enough to provide the relevant information. That is the reason why I focused my data analysis on the sectors of ICT and BPS.
7 Analysis of the data on BPT
What conclusion can be made from the data? Does offshoring contribute to the higher rise of productivity? Does the productivity rise faster than in other branches of the economy? Does it have impact on price of services? Does offshoring result in shortage of jobs? Do the salaries in the branches where offshoring occur decrease? This chapter should prove the theoretical assumptions on concrete U.S. data.
7.1 Analysis of the output and productivity
How does evolve the production of the branches that use offshoring? How do they contribute to the US GDP growth? Table 6 presents comparison of change in real value added in the relevant sectors.
Table 6: Percent Changes in Real Value Added by Industry Group
2002 2003 2004 2005
GDP 1,6 2,5 3,9 3,2
Private industries 1,4 2,7 4,2 3,3
Private goods-producing industries 1,3 0,6 4,8 2,1
Private services-producing industries 1,5 3,3 4,1 3,7
ICT-producing industries* 2,0 7,2 13,7 13,3
Information 2,1 3,0 11,4 9,0
Professional and business services (of which:) -0,2 4,4 5,2 5,6 Professional, scientific, and technical services -1,5 4,0 7,8 6,8 Administrative and waste management services 1,2 6,4 0,8 5,3
Source: Bureau of Economic Research.10
Note: *Consists of computer and electronic products within durable-goods manufacturing; publishing industries (includes software) and information and data processing services within information; and computer systems design and related services within professional, scientific, and technical services.
In table 6 we see that there is difference in real value added between private industries producing services and industries producing goods. The first grew faster.
ICT-producing industries are summary category for both ICT sectors of production of
10 http://www.bea.gov/newsreleases/industry/gdpindustry/2006/gdpind05_rev.htm
