Employment Research Newsletter

Volume 23 Number 1 Article 2

1-1-2016

Domestic Outsourcing Reduces Wages and Contributes to Rising Inequality

Johannes Schmieder Boston University

Deborah Goldschmidt Boston University

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Citation Schmieder, Johannes, and Deborah Goldschmidt. 2016. "Domestic Outsourcing Reduces Wages and Contributes to Rising Inequality." Employment Research 23(1): 4-6. https://doi.org/10.17848/ 1075-8445.23(1)-2

This title is brought to you by the Upjohn Institute. For more information, please contact [email protected]. Employment Research JANUARY 2016 growth is weak, labor force participation Johannes Schmieder and Deborah Goldschmidt is historically low, and deep concerns remain, particularly about the low-wage workforce. Temporary help agencies, Domestic Outsourcing which hire a disproportionate share of low-wage workers, are often touted as providing a pathway to permanent, Reduces Wages and better jobs for these workers, yet we see strikingly low hire rates in our data, even Contributes to Rising among those in temp-to-hire contracts. Low conversion rates to permanent jobs with clients refl ect the fact that employers Inequality are highly selective in making job offers to temporary help workers, but they also This article highlights fi ndings from “The Rise of rather than offshoring, as it refers to a refl ect skills defi cits among the workers. Domestic Outsourcing and the Evolution of the Ger- form of outsourcing where the service Performance problems or quits prior to man Wage Structure,” Upjohn Institute Working provider is located in the same country. assignment completion drive a signifi cant Paper No. 15-244. To read the paper, please visit We document for the fi rst time in detail research.upjohn.org/up_workingpapers/244/. share of temporary help assignment the increase in outsourced labor services terminations, with “soft skill” problems over the last three decades in Germany, such as tardiness and unexcused absences The last three decades have seen a focusing in particular on cleaning, notably high among the lower-paid thorough transformation of the nature security, logistics, and food services. temporary workers. In sum, our data of the labor market, with large fi rms Figure 1 shows the share of all full- indicate that the pathway to better jobs increasingly relying on nontraditional time workers in business service fi rms via temporary help employment currently employment arrangements such as that provide cleaning, security, and is limited for low-wage workers. outsourcing, temporary or contingent logistics services, as well as temporary work, offshoring, and subcontracting. help agencies. In 1975 only 2 percent References Across a wide range of industries, of the German labor force worked for fi rms have been focusing on their such companies, but that number almost Cappelli, Peter. 2012. Why Good People “core competencies” and hiring outside quadrupled by 2008 to around 7 percent. Can’t Get Jobs: The Skills Gap and What companies to provide services that were A substantial share of this rise is due to Companies Can Do About It. Philadelphia: once performed by their own employees, the growth in both temp agency work and Wharton Digital Press. such as cleaning, security, logistics, human business service fi rms. Since employment resources, or information technology. in cleaning, security, and logistics Eisenberg, Daniel. 1999. “Rise of the Outsourcing to business service occupations has remained relatively Permatemp.” Time, July 12. http://content.time providers potentially allows for reductions constant, this suggests that a much larger .com/time/magazine/article/0,9171,27707,00. in wages for the contracted-out jobs. The html (accessed March 12, 2015). share of these occupations are now outsourcing fi rms are often traditional working for contractors. Houseman, Susan N., Arne L. Kalleberg, lead companies in sectors such as In order to obtain credible effects of and George A. Erickcek. 2003. “The Role manufacturing or fi nance, and they outsourcing on wages, we develop a new of Temporary Agency Employment in Tight typically offer the most attractive jobs, method of identifying a particular type Labor Markets.” Industrial and Labor with higher wages, increased job security, of outsourcing—on-site outsourcing— Relations Review 57(1): 105–127. strong worker representation, and union which refers to situations where a large coverage. Large employers may thus employer spins out a group of workers International Monetary Fund. 2012. fi nd it benefi cial to reduce the number providing a particular service, such as “World Economic Outlook: IMF Sees of direct employees who benefi t from cafeteria workers, to a legally separate Heightened Risks Sapping Slower Global such wage premia by outsourcing jobs to business unit, such as a subsidiary or an Recovery.” IMF Survey Magazine: IMF subcontractors. These business service Research, October 9. Washington, DC: existing business service provider. In these fi rms compete fi ercely with each other for International Monetary Fund. http://www situations the outsourced workers still .imf.org/external/pubs/ft/survey/so/2012/ service contracts from large companies work together and do essentially the same res100812a.htm (accessed March 16, 2015). on price, and since labor costs are a large job at the same physical location but for share of business service fi rms’ total costs, a different employer. Such outsourcing Susan Houseman is a senior economist at the this creates intense pressure to lower events can be identifi ed in administrative Upjohn Institute. Carolyn Heinrich is professor of wages and reduce benefi ts. data sets using worker fl ows between public policy and education at the Peabody College We analyze domestic labor service and professor of economics in the College of Arts establishments. and Sciences at Vanderbilt University. outsourcing in Germany using detailed The basic intuition is that if a group administrative data on workers and fi rms. of workers is contracted out at the same We use the term domestic outsourcing time, this can be observed by following 4 Employment Research JANUARY 2016 the establishment identifi ers as well Figure 1 Fraction of Full-Time Workers in Germany in Cleaning, Security, or as occupation and industry codes. For Logistics Business Service Firms or Temp Agencies, by Year example, if a group of workers splits off from a large bank in year t − 1 and forms a 0.08 new establishment identifi er in year t with Cleaning, security, or logistics business service firms or temp agencies Temp agencies an industry code of “cafeteria,” this likely 0.07 indicates that the bank is outsourcing its cafeteria staff. We compare workers who 0.06 are outsourced in these on-site outsourcing events to workers in the same occupation and industry who are not outsourced and 0.05 estimate how their wages change over time. 0.04 Figure 2 shows the main estimates of outsourcing’s effect on wages. While 0.03 wages of both groups of workers move in parallel up to the year of outsourcing (year 0 in the fi gure), they drop for the 0.02 outsourced workers as soon as outsourcing occurs by about 2.5 percent. The wage 0.01 differential then keeps growing until it reaches about 10 percent, approximately 0 5–10 years after outsourcing. This 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 suggests large and long-lasting wage differentials between outsourced and SOURCE: Authors’ calculations. in-house jobs. Since these differences also imply that outsourcing may lead to substantial cost savings to employers, we Figure 2 The Effect of Outsourcing on Log Wages of Outsourced Workers in Germany investigate whether fi rms that pay higher wages relative to the market have a higher 0.02 likelihood of outsourcing any of their labor services, and we do indeed fi nd that 0.00 fi rms are signifi cantly more likely to do 0.02 so the more they pay above market-level í wages. í0.04 Finally, we consider the relationship between the documented impacts of í0.06 outsourcing in Germany and the broad changes in the country’s wage structure í0.08 over the last three decades. Dustmann et al. (2014) document a dramatic decline of í0.10 real wages at the lower end of the wage distribution since the early 2000s. After a í0.12 decade of stagnation from 1990 to 2000, real wages at the 15th percentile fell by í0.14 around 10 percent between 2000 and 2008. í0.16 Furthermore, Card, Heining, and Kline (2013) observe that low-skill í0.18 workers are increasingly working 0510 at low-paying establishments and Years relative to outsourcing are increasingly concentrated in NOTE: The blue lines represent 95 percent confi dence intervals. The fi gure shows the evolution of establishments with homogenous wages for outsourced workers in food, cleaning, security, and logistics occupations relative to the workforces where most workers have wages of workers in the same occupations and industries who are not outsourced. Year 0 is the similar occupations. Outsourcing provides fi rst year of outsourcing. The y-axis is measured in fraction of relative wage losses to obtain the a natural explanation for this, since it wage loss in percent multiply by 100. typically involves outsourcing low-skill SOURCE: Authors’ calculations.

5 Employment Research JANUARY 2016 workers to very competitive low-paying for by the increase in outsourcing of service fi rms makes it diffi cult for establishments. In addition, outsourcing just these four occupations. Since many outsourced workers to bargain for a share provides a natural explanation for the other tasks experienced an increase in of the fi rm rents at the lead company. In increase in occupational sorting: since outsourcing, this should be viewed as a this article, we provide careful estimates business service fi rms are much more lower bound with the overall contribution of how this translates into lower wages homogenous (for example, in the typical of all forms of outsourcing to wage for outsourced workers, and we fi nd cleaning fi rm, about 60 percent of the inequality possibly being much larger. that across a wide range of measures, employees are cleaners), moving workers The labor market has seen a fundamental outsourcing reduces wages by around from heterogeneous lead employers to restructuring in recent decades, with lead 10 percent. Our method implies that this business service fi rms that employ largely employers increasingly contracting out is not due to selection of different types the same occupations as the outsourced parts of their noncore labor force. of workers in outsourced employment worker will increase the overall This reorganization of the production relationships or to differences in the occupational assortativeness. structure changes the employment types of jobs that outsourced workers We quantify the contribution of relationship for a large share of the do. Instead, it appears that outsourced outsourcing to the rise in wage inequality workforce. As more workers become workers receive lower pay because they in Germany using a reweighting employed by specialized business service are excluded from fi rm rents that are being method, which allows us to calculate fi rms, they fi nd themselves working for paid to workers at the lead companies. a counterfactual distribution of wages companies that provide narrow products It is diffi cult to know why fi rms decide in Germany under the scenario that and compete fi ercely with similar fi rms to outsource parts of their workforces, outsourcing did not increase since the for contracts with lead companies. This but our evidence indicates that fi rms that 1980s. Figure 3 shows the evolution creates pressure to reduce costs and lower pay wage premia to their workers are of different percentiles of the wage wages, which likely makes up a large more likely to outsource. This suggests distribution relative to 1985. Especially share of input costs among these types of that saving on labor costs is part of the for low wages, outsourcing contributed business service providers. motivation, but other reasons include substantially to the increase in inequality. This restructuring also drastically comparative advantage of business service Overall we show that about 9 percent of changes the bargaining environment, as fi rms in their specialty, cost savings the increase in inequality can be accounted the price competition among business through economies of scale, and gains in effi ciency through market pressures in the competitive environment of bidding Figure 3 The Contribution of Oursourcing of Cleaning, Security, and Logistics for service contracts. It is even more Occupations to the Rise in Wage Inequality in Germany diffi cult to know what is driving the long- term increase in outsourcing. Changes 0.30 15th actual 15th reweighted in management philosophy (e.g., a move 50th actual 50th reweighted toward emphasis on shareholder value in 0.25 85th actual 85th reweighted the 1980s and 1990s) may be of similar importance as the development of new 0.20 technologies makes it easier to rely on contractors. Understanding this is beyond 0.15 the scope of this project but a fruitful area for future research.

0.10 References

0.05 Card, David, Jörg Heining, and Patrick Kline. 2013. “Workplace Heterogeneity and the Rise of West German Wage Inequality.” 0.00 Quarterly Journal of Economics 128(3): 967–1015. í0.05 Dustmann, Christian, Bernd Fitzenberger, Uta Schönberg, and Alexandra Spitz-Oener. í0.10 2014. “From Sick Man of Europe to Economic 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 Superstar: Germany’s Resurgent Economy.” Journal of Economic Perspectives 28(1): NOTE: The fi gure shows the percentage change in wages relative to 1985 at the 15th, 50th, and 85th 167–188. percentiles of the wage distribution for full-time men. The blue lines show the evolution of the actual wage distribution, while the red lines show how the wage distribution would have evolved Johannes Schmieder is an assistant professor if outsourcing for cleaning, security, and logistics workers had not increased relative to 1985. and Deborah Goldschmidt is a PhD candidate, both SOURCE: Authors’ calculations. at Boston University. 6