Outsourcing, Productivity, and Input Composition at the Plant Level

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Outsourcing, Productivity, and Input Composition
at the Plant Level

• Catherine J. Morrison Paul and Mahmut Yasar

World Congress, Washington D.C., May 2008
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Make-or-Buy

• It is the maxim of every prudent master of a
  family, never to attempt to make at home what it
  will cost him more to make than to buy. Smith
  (1776, pp.485-486)
• quite apart from the question of diminishing
  returns the costs of organizing certain
  transactions within the firm may be greater than
  the costs of carrying out the exchange
  transactions in the open market. Coase (1937,
  pp. 7-8)

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Productivity drivers

• Firms productivity depends on their potential to
  minimize production costs by substituting among a
  variety of inputs
• Studies used to focus on value added capital
  and labor inputs but now recognize substitution
  of processed (materials) for processing (capital
  and labor) inputs
• More generally, input choices include purchasing
  rather than producing goods and services (implies
  outsourcing or subcontracting)
• Affects the productivity competitiveness of
  outsourcing firms

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Outsourcing drivers

• Firms would be expected to use their own inputs
  for activities they have a comparative advantage
  for and outsource others
• Roodhooft and Warlop (1999)
• A firms comparative advantage depends on trade,
  price, and technical conditions
• E.g., import competition from lower wage
  countries encourages foreign outsourcing,
  reducing the wages of less skilled laborers
• Feenstra and Hanson (1999, 2003), Hanson et al.
  (2005)
• In reverse, lower wage countries may subcontract
  output
• Both specialized tasks and lower
  productivity/skill processes may be outsourced to
  other domestic or foreign firms

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Our goal

• We explore how outsourcing or subcontracting is
  related to plant productivity and input
  composition/substitution
• from the perspective of a developing country
• We consider the productivity effects of
• domestic outsourcing, through the share of inputs
  that are subcontracted
• receiving contracts, through the share of output
  that is subcontracted
• foreign outsourcing, through the share of
  imported intermediate inputs
• represented as production frontier shifts and
  twists
• from diff shares of subcontracted inputs/outputs
  or imported materials
• and find this aspect of input choice important to
  recognize

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Literature

• Outsourcing/subcontracting has not been a focus
  of the production literature
• But some studies suggest (domestic or foreign)
  outsourcing results if producing inputs or
  services in-house is at least as costly as
  subcontracting them
• Involves two types of costs
• production costs labor costs, scale economies,
  clustering of special skills or expertise, or
  production smoothing
• transactions costs negotiating, monitoring, and
  enforcing contracts, or searching for outside
  suppliers
• Also may be benefits from foreign technology
  transfer through outsourcing
• importing RD embodied in materials/capital
  imports and learning from their use (input
  subcontracting through input imports)
• FDI/exports increased demand for exports from
  host country suppliers (output subcontracting)

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Data output and inputs

• Plant data collected by the State of Statistics
  in Turkey for the Annual Surveys of Manufacturing
  Industries
• International Standard Industrial Classification,
  Apparel Textiles
• Output (Y) total value of shipments plus changes
  in inventories of finished goods and
  work-in-progress
• Material (M) expenditures, allowing for changes
  in stocks
• Energy (E) value of fuelelectricity
• Y,M and E nominal values are divided by
  corresponding price deflators to get constant
  value quantities at 1987 prices
• Labor input (LT and LN) technical and
  administrative workers, production workers
• Capital (K) perpetual inventory method using
  gross investment data
• Seven regions distinguished

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Data outsourcing and technology transfer

• Our domestic outsourcing variables are
• subcontracted input (the share of a plants
  inputs subcontracted to supplier plants, in total
  inputs)
• subcontracted output (the share of output
  subcontracted by other plants, in total output)
• Klicaslan and Taymaz (2005)
• Our foreign outsourcing variable is
• the share of imported materials in total
  materials use
• Our foreign technology transfer variables
  include
• the share of exports in total sales
• the share of foreign firm ownership (FDI)

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Empirical framework

• First look at premia/correlations
• for Pit performance indicators (ttime and
  iplant)
• labor productivity (LProd), wage, employment,
  skilled labor, and capital intensity
• O/Sjit (jSUBI, SUBO, IMPM)
• Dregional (r) and time (t) dummies and EMPsize
• Estimate

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Econometric Framework

• We assume that the plant production function Y
  f(X,r,t) can be represented by a translog
  approximation
• where Xj ( j K,LT,LN,E,M) is the jth input, the
  rm include the O/S, technology transfer,
  characteristics and dummy variables
  distinguishing the plants, and ? is a error term
• Use Olley and Pakes (OP) method to estimate

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SUBI Results

• ßSUBI is positive and significant (at 10)
• positive first order productivity effect of SUBI
• ßLT,SUBI is positive and significant (at 1)
• a strong positive LT bias
• a higher share of subcontracted inputs implies
  greater administrative and technical (skilled)
  labor intensity
• ßLN,SUBI is significantly negative (at 5)
• more SUBI is associated with less use of
  unskilled labor
• SUBI substantively affects only the labor shares
• all other cross-effects are insignificant
• The positive SUBI output elasticity is driven
  entirely by the positive first-order and LT
  effects

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Interpretation

• SUBI-LT complementarity and SUBI-LN
  substitutability
• implies that subcontracting inputs reduces
  in-house production of lower-productivity and
  -skill activities or processes or services
• e.g., those provided by unskilled production line
  workers or janitorial workers
• rather than services of skilled workers
• e.g., legal or accounting services
• Perhaps because input subcontracting requires
  administrative and technical expertise due to
  greater required supervision or support of
  contractors.

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SUBO Results

• By contrast, more SUBO implies significantly less
  reliance on skilled labor (LT)
• implies subcontract-receiving plants are more
  low-tech
• SUBO is also associated with lower M levels
• suggests more use of lower value primary rather
  than processed materials
• but a greater energy share
• perhaps required for the additional processing
• The lower M and LT levels for subcontract-receivin
  g plants underlie the negative SUBO output
  elasticity.

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IMPM Results

• More IMPM also implies lower (but not sig)
  domestic materials and skilled labor use
• The only sig IMPM bias is a positive E effect
• The dominant effect of IMPM is therefore from the
  first order coefficient bIMPM
• imports have little effect on input composition
• the primarily negative input biases are too small
  to counteract the strong positive overall effect

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Tech Trans Results,

• Linkages of trade factors with O/S vary by
  mechanism
• no significant productive relationships between
  SUBI and EXP, FDI, IMPM
• but effects between SUBO and trade variables are
  sig
• with EXP is negative, and with FDI and IMPM
  positive
• IMP or FDI firms do not have as low productivity
  as other SUBO plants, but EXP firms actually have
  worse productivity
• conversely, the productive contributions of trade
  factors are smaller for EXP and larger for IMP or
  FDI plants with SUBO
• a higher EXP share is associated with a lower LN
  share
• supports that internationally best practice
  production requires more skilled and less
  unskilled workers