Offshoring and Its Effects on the Labour Market and Productivity: a Survey of Recent Literature

Offshoring and Its Effects on the Labour Market and Productivity: A Survey of Recent Literature Calista Cheung and James Rossiter, International Department, Yi Zheng, Research Department • Firms relocate production processes ver the past couple of decades, the lower- internationally (offshore) primarily to achieve ing of trade and investment barriers as well cost savings. As offshoring becomes an as technological progress in transportation O and communications have facilitated the increasingly prominent aspect of the globalization of production processes. Firms increas- globalization process, understanding its effects ingly take advantage of the cost savings and other on the economy is important for handling benefits that result from making or buying inputs the policy challenges that arise from structural where they can be produced more efficiently. This phenomenon of production relocation across national changes induced by globalization in general. boundaries is generally known as offshoring.1 Under- • In advanced economies, offshoring of materials standing the implications of offshoring in the current used in manufacturing has risen steadily over context is an important step towards handling the opportunities and challenges of globalization as it the past two decades. The scale of offshoring matures. This article contributes to such understand- in services is much smaller, but has grown ing by summarizing some key findings in the litera- faster than that of materials since the mid- ture on the impact of offshoring on employment, 1990s. The intensity of offshoring in Canada wages, and productivity in developed economies. Note that while offshoring of services is still in its has been higher than in many other advanced infancy, it merits as close a study as that of manufac- economies, probably because of our close turing offshoring, given its unique characteristics and economic relationship with the United States. greater potential for growth. • Offshoring has not exerted a noticeable impact While offshoring can help businesses improve their profitability, and host countries (i.e., providers of off- on overall employment and earnings growth shored goods and services) generally welcome the in advanced economies, but it has likely resulting creation of jobs, its macroeconomic effect on contributed to shifting the demand for home countries (i.e., importers of offshored inputs) labour towards higher-skilled jobs. remains a subject of debate. There has long been concern that labour markets in developed economies • There appear to be some positive effects of have faced adjustment challenges associated with offshoring on productivity consistent with theoretical expectations, but such effects 1. This broad definition holds regardless of whether the counterparty to the offshoring firm is an independent firm or a foreign affiliate. Outsourcing, on differ by country. the other hand, emphasizes the relocation of production processes across firm boundaries. BANK OF CANADA REVIEW • AUTUMN 2008 15 offshoring to low-wage countries, first in the manu- are used as intermediate inputs.2 For example, between facturing sector and then services. The concerns are 2000 and 2006, world exports of intermediate goods summarized as follows: “If you can describe a job grew at an annual rate of 14 per cent, compared with a precisely, or write rules for doing it, it's unlikely to 9 per cent rate for final goods (Chart 1).3 survive. Either we'll program a computer to do it, or Following common practice, we quantify the intensity we'll teach a foreigner to do it” (Wessel 2004). of offshoring by country and by industry using two The gains to the overall economy as a result of offshor- ratios: (a) imported intermediate inputs over gross ing, on the other hand, have received less publicity, output, and (b) imported intermediate inputs over partly because they usually do not occur immediately their total usage. Both are calculated from standard and thus are more difficult to associate directly with industry datasets maintained by national statistical offshoring. Nevertheless, research suggests that off- agencies and thus allow for international and cross- shoring may contribute to productivity gains, promote industry comparisons. While measures based on skills upgrading, enhance the purchasing power of import content are derived under some restrictive consumers via lower import prices, and reduce the assumptions and do not convey a complete picture of exposure of exporters to exchange rate fluctuations by providing a natural hedge. Chart 1 Offshoring has likely played an important role in World Exports of Intermediate and Final Goods and shifting the composition of industries in favour of Services those more aligned with the comparative advantages of the home economy. Furthermore, the widening of 2000 = 100 the global supply base as a result of offshoring tends 250 250 to raise competitive pressures and leads to changes in Intermediate relative prices, such as those of standardized manu- goods 200 200 factured goods versus metals and oil, or those of call centre services versus architectural design. Despite their still limited impact, such changes have the 150 150 potential to grow in prominence and thus warrant Intermediate Final goods services careful consideration, along with domestic circum- 100 100 stances, in conducting effective economic policies. For example, the productivity effect from offshoring could influence the growth potential of the economy, while 50 50 persistent relative price movements could affect infla- tion expectations—and both may lead to changes in 0 0 inflationary pressure that need to be taken into 2000 2001 2002 2003 2004 2005 2006 account by monetary policy-makers (Carney 2008). Note: Intermediate goods: agricultural raw material, fuel and The remainder of the article begins with some recent mining products, iron and steel, chemicals and other semi- finished goods developments in offshoring in both the international Final goods: all merchandise except intermediate goods and Canadian context. This leads to a discussion of Intermediate services: commercial services excluding travel and transportation what drives offshoring. A survey of the empirical evi- Source: World Trade Organization dence regarding the impact of offshoring on labour markets and productivity follows, highlighting find- 2. Throughout this article, the term intermediate inputs means goods (mate- ings for Canada. Finally, the article concludes with a rial inputs) and services (service inputs) that undergo further processing summary of the key results and a brief discussion of before being sold as final. For example, rolled steel and car engines are material inputs to motor vehicle manufacturing, while call centre services and the future of offshoring. accounting are typical examples of service inputs to many industries. 3. The globalization of production has also led to multiple border crossings of Recent Trends in Offshoring semi-finished goods with incremental value added at each production stage (Yi 2003), further boosting the share of intermediate goods in overall trade. Growth in offshoring on a global scale is evident in the Indeed, as of 2006, 40 per cent of world merchandise exports consisted of steady expansion of trade in goods and services that intermediate goods. 16 BANK OF CANADA REVIEW • AUTUMN 2008 the globalization of production (see Box), they are Chart 2 likely indicative of the general trends. G-7 Offshoring of Non-Energy Inputs According to the International Monetary Fund (IMF Per cent of gross output 2007), imports of material and service inputs in 2003 14 14 represented about 5 per cent of gross output in advanced economies belonging to the Organisation 12 Canada 12 for Economic Co-operation and Development 4 (OECD). Within the G-7, a wide dispersion of scale 10 United 10 exists, ranging from 2 to 3 per cent in the United Kingdom States and Japan, to more than 10 per cent in Can- 8 8 ada (Chart 2). In addition, starting in the 1990s, Can- Italy ada, Italy, and Germany saw a noticeable increase in 6 6 the degree of offshoring. Germany France 4 4 United States 2 2 Japan The manufacturing sector is most 0 0 affected by offshoring because of its 1980 1985 1990 1995 2000 Source: International Monetary Fund, World Economic Outlook greater openness to trade and high (April 2007) intermediate-input content. The manufacturing sector is most affected by offshoring because of its greater openness to trade and high intermediate-input content in the production process. In the advanced OECD economies, the weighted Chart 3 average share of imported material inputs in manu- Offshored Material Inputs in the Manufacturing facturing gross output rose from 6 per cent in 1981 to Sector 10 per cent in 2001 (Chart 3).5 The ratio in Canada is almost three times as high. Canadian manufacturers Per cent of manufactured gross output engage intensively in trade in intermediate inputs 30 30 with the United States, given the existence of a tightly knit cross-border supply chain arising from the geo- 25 25 graphical proximity of the two countries and the Canada signing of trade agreements that have fostered a large 20 20 volume of regional investment and trade flows.6, 7 A 15 15 4. Advanced OECD economies in IMF (2007) include Australia, Canada, Canada excluding motor France, Germany, Japan, the Netherlands, the United Kingdom, and the 10 vehicles and parts 10 United States. Advanced OECD economies 5. Shares are weighted using share of nominal gross domestic product 5 5 denominated in

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