‘International outsourcing’ – in which multinational firms move parts of their
production processes offshore to countries where wages are lower – can be a
friend, rather than an enemy, to workers in the home country, according to
new research by Professor Wilhelm Kohler, published in the March 2004
issue of the Economic Journal. It may lead to an increase in domestic wages
for some workers and/or other jobs coming back home.
Firms in many high-wage countries are increasingly moving single tasks or
stages of complex production processes to foreign locations where wages are
lower. International outsourcing of this kind seems to increase vastly the
exposure of domestic labour to international competition. And it seems to hit a
raw nerve of policy, sometimes giving rise to protectionist sentiment and even
restrictive policy reactions.
The underlying intuition seems fairly straightforward: if production processes
get fragmented and particular jobs move offshore, then we should surely
expect employment opportunities for that particular kind of domestic labour to
be worsened, either in the form of lower wages or increased unemployment.
This intuition is difficult to dismiss outright. Yet, it ignores two important
effects:
· First, if particular stages of production are more cheaply produced
abroad, then this should enable domestic firms, through a cost-savings
effect, to pay higher rewards to some domestic factors.
· And second, domestic labour may meet additional demand from those
production stages that are still produced at home, and it may also find
alternative employment in other industries.
Kohler’s research provides a theoretical analysis of these two effects, looking
at a case where a multi-stage industry faces competitive pressure in the form
of a falling world price for its final output, and where the option of outsourcing
labour-intensive stages of production to some low-wage country is an integral
part of coping with this pressure.
If there is a second domestic industry using the same type of labour and
capital, and if that industry is more labour-intensive than the outsourcing
industry, the outcome under perfect competition runs counter to the above
intuition in either of two forms:
· A: Domestic wages may rise, even though adjustment does involve
more outsourcing.
· B: Adjustment may in fact involve ‘insourcing’ some of the stages that
have previously been produced offshore, again with an attendant
domestic wage increase.
Case A (B) arises if the production stage that is moved offshore (back home)
is less (more) labour-intensive than the other industry. If the other industry is
less labour-intensive than the outsourcing industry as a whole, then the
adjustment again involves ‘insourcing’, but with an attendant domestic wage
cut.
The analysis thus identifies several instances where outsourcing as such
turns out to be a ‘friend’, rather than an ‘enemy’, to domestic labour. Similar
adjustments can be observed if outsourcing happens, not as a result of
increased competitive pressure, but because of technological improvements,
say in transport and communication.
The results of this analysis certainly suggest a view on outsourcing that is
more favourable, or at least more cautious, than is commonly assumed in
policy debates that largely assume, a priori, detrimental domestic labour
market effects from offshore procurement of parts and services for domestic
production.
But the general warning that economists often express in connection with
‘gains-from-trade’ applies to outsourcing as well: such gains do not come
without pains. More specifically, pains may arise in the form of income
redistribution involving a real income loss for some factor owners.
The analysis shows that this holds true even for the case where outsourcing
as such is the result of easier transport and communication. While the
economy as a whole will gain, some of its households will suffer a loss.
ENDS
Notes for Editors: ‘International Outsourcing and Factor Prices with
Multistage Production’ by Wilhelm Kohler is published in the March 2004
issue of the Economic Journal.
Kohler is Professor of Economics at Johannes Kepler University Linz, Austria
For Further Information: contact Wilhelm Kohler on +43-732-2468-8239
(email: wilhelm.kohler@jku.at; website: http://www.econ.jku.at/kohler); or RES
Media Consultant Romesh Vaitilingam on 0117-983-9770 or 07768-661095
(email: romesh@compuserve.com).