Offshoring

OFFSHORING LEADS TO LOWER WAGES FOR LOW-SKILLED WORKERS

Offshoring of production and services to low-cost countries can harm the wages of workers with low skills back at home. That is the one of the findings of research by Daron Acemoglu, Gino Gancia and Fabrizio Zilibotti, presented at the Royal Economic Society’s 2013 annual conference.

Their study uses a theoretical model to show that when labour is sufficiently cheap abroad, firms have an incentive to offshore low-skill tasks and focus on jobs that require highly-skilled workers, that are less easy to offshore and that often involve working with advanced technologies (known as ‘skill-biased’ technologies). This process reduces the wages of unskilled workers in the country and drives up the wages of skilled workers.

Over time, however, offshoring raises foreign wages, reducing the incentive to offshore. As a result, offshoring can eventually lead to higher wages for everybody and lower income inequality.

But the researchers show that this is likely to be a long way off. Looking at wages and employment in the US and China between 2000 and 2008, they find that offshoring probably increased the wage premium for skilled workers by 10% and slightly lowered the inflation-adjusted wages of unskilled workers in the US.

Despite this, the authors stress the benefits of offshoring, pointing to the example of Apple’s iPod. Though most production jobs are offshored, a significant number of high-skill engineering jobs and lower-skill retail jobs are created in the US, and more than 50% of the value added is captured by domestic companies. The authors comment:

‘With more limited offshoring, some of the production jobs may have stayed in the US. But the variety of iPods may not have been profitable to develop due to the higher labour costs.

‘More importantly, iPods and other products may have been designed differently in the face of different labour costs’.

More…

The rapid rise of offshoring has been one of the most visible trends in the US labour market over the last three decades. Despite its prevalence, the implications for wages and skill premia are still debated.

The production structure of Apple’s iPod illustrates the potential effects. Though most production jobs are offshored, a significant number of high-skill engineering jobs and lower-skill retail jobs are created in the US, and more than 50% of the value added is captured by domestic companies.

With more limited offshoring, some of the production jobs may have stayed in the US. But the variety of iPods may not have been profitable to develop due to the higher labour costs. More importantly, iPods and other products may have been designed differently in the face of different labour costs.

This research studies the impact of offshoring on the wages of high- and low-skill workers through its effect on technological progress. To do so, the researchers build a model where an advanced country invests in innovation to boost the productivity of either skilled or unskilled workers, and can relocate part of production to a low-wage country.

Price and market size effects

The effect of offshoring on innovation works through price and market size effects. By lowering the cost of tasks performed by unskilled workers, offshoring increases the relative price of skill-intensive products. This ‘price effect’ tends to spur innovation in the skill-intensive sector. Counteracting this, however, offshoring expands the market for technologies used by unskilled labour. This ‘market size’ effect tends to induce innovations in less skill-intensive sectors.

Which force dominates depends on the level of offshoring: for low levels, the price effect dominates, so that greater offshoring opportunities initially induce skill-biased technological change. If the level of offshoring is already high, however, the opposite pattern obtains. Thus, the unequalising effect of offshoring is greatest at the beginning.

The reason for this switch in the direction of technological progress is that offshoring increases the demand for labour abroad and thus foreign wages. In turn, the closing of the wage gap between countries mutes the price effect.

But which scenario is more plausible? To address this question, the researchers calibrate the model to match wages and offshoring in the US and China. The results of their simulations suggest that, during the period 2000-08, offshoring may have increased the skill premium by 10% and marginally eroded the real wage of unskilled workers in the US.

Conclusion

The finding that offshoring may have triggered skill-biased technical change, thereby raising wage disparities, accord well with available evidence. It is consistent both with recent findings that imports from China encouraged investments in information technology and reduced employment.

According to the theory, however, the implications of offshoring are very different once its volume reaches a critical level. If wages in China keep rising at current rates, further offshoring may soon induce innovation in less skill-intensive sectors. Thus, the future distributional effects of offshoring could be quite different than its past impact.

ENDS


Notes for editors:

‘Offshoring and Directed Technical Change’ by Daron Acemoglu (MIT), Gino Gancia (CREI) and Fabrizio Zilibotti (University of Zurich)

Contact:

Gino Gancia, +34 93 542 2732 (ggancia@crei.cat)
Daron Acemoglu: daron@mit.edu
Fabrizio Zilibotti: fabrizio.zilibotti@econ.uzh.ch

RES media consultant Romesh Vaitilingam:
+44 (0) 7768 661095
romesh@vaitilingam.com
@econromesh

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