Outsourcing, Offshoring and Productivity: Measurement Issues

1
Outsourcing, Offshoring and Productivity
Measurement Issues

• Susan Houseman
• Upjohn Institute for Employment Research
• Presentation prepared for World Congress on
  National Accounts and Economic Performance
  Measures for Nations
• Session 3 May 16, 2009

2
Outline

• Distinguishing import price measurement issues
  related to product variety v. outsourcing
  offshoring
• Outsourcing and offshoring
• Definitions
• Causes
• Problems measuring input price changes with
  changes in sourcing
• Evidence on growth of outsourcing offshoring
• Why measurement issue important

3
Distinguishing from Import Prices and Gains from
Variety Literature

• Recent literature focuses on problems in
  measuring prices in trade models with product
  differentiation monopolistic competition
• Debate on whether growth in trade ? growth in
  variety of goods
• Feenstra (1994), Broda Weinstein (2006),
  Feenstra, Reinsdorf, Slaughter (2008),
  Arkolakis, et al. (2008)
• If growth imports ? increase variety, consumer
  surplus from variety not measured price index
  growth overstated, domestic output growth
  overstated, productivity overstated

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Distinguishing from Import Prices and Gains from
Variety Literature

• Models assume separability between domestic
  imported goods substitution between domestic
  and imported goods not explicitly considered
• Any bias to price index theoretically depends on
  low substitutability of new varieties
• when existing varieties are close substitutes to
  new or disappearing varieties, changes in variety
  will not have a large effect on exact price
  index. (Broda Weinstein 2008)
• Offshore outsourcing primarily concerns the
  substitution of relatively homongeneous foreign
  inputs for domestic inputs

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Outsourcing Offshoring

• Use broad definition
• Change in sourcing of inputs in the production of
  a good or service
• Types of outsourcing offshoring
• Switch from something produced internally in
  organization to domestic supplier (domestic
  outsourcing)
• Switch from producing internally to foreign
  supplier (offshore outsourcing) or to foreign
  affiliate (offshoring)
• Switch from domestic to foreign supplier
  (offshore outsourcing)

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Outsourcing Offshoring

• Examples
• Manufacturer outsources labor services to
  staffing agencies
• Manufacturer offshores first stage of production
  of good, keeps final finishing of product in U.S.
  
• Bank offshores back office functions
• Retailer shifts from domestic to imported goods
  or manufacturer switching from domestic to
  imported inputs
• Driving force of outsourcing offshoring
• Factor price arbitrage substitution of lower
  priced input for internally or domestically
  produced good or service
• Reducing production costs for any given good or
  service, not increase in product variety

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Offshore Outsourcing Offshoring

• Trade models of comparative advantage appropriate
  for offshoring phenomenon
• Product cycle theory of international trade
  (Vernon 1966)
• Complicated by fact that much of trade occurs
  within financially related parties production
  of single product or service may become divided
  among countries
• Growth of offshoring outsourcing offshoring
  driven by confluence of factors
• Reduction tariffs (Feenstra, Reinsdorf,
  Slaughter 2008)
• Reduction transportation communication costs
• Economic political reforms major parts of the
  world China, Eastern Europe
• Rapid economic development many countries

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Problems measuring input price changes with
changes in sourcing

• Price measurement system assumes stable sourcing
  patterns
• Important set of cases in which input price drop
  associated with outsourcing offshoring not
  measured even when goods services homogeneous
  
• Real value of outsourced or offshored input
  understated price index growth overstated,
• Real domestic output and/or sector value-added
  growth overstated,
• Aggregate and/or sectoral productivity overstated

9
Problems measuring input price changes with
changes in sourcing (cont.)

• Certain tasks outsourced or offshored labor
  input now becomes purchased services or materials
  inputno price drop measured across input
  categories (Houseman 2006, 2007)
• Wage cut effected via wage reduction to employees
  no first order effect on measured productivity
• Wage cut effected by firing employees,
  outsourcing or offshoring task to lower paid
  workers ? drop in input price not measured,
  productivity overstated
• Shift from domestic, internal production to
  domestic contractor or offshore
• slicing the value chain (Krugman 1996),
  intra-mediate trade (Antweiler Trefler),
  disintegration (Yuskavage et al. 2008)

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Problems measuring input price changes with
changes in sourcing (cont.)

• Shift from domestic, internal production to
  domestic contractor or offshore Affects
  measurement for goods services
• Services Mann (2004) emphasizes lack of prices
  for services need to develop with growth
  services offshoring
• Goods example First stage of production of good
  sent overseas final finishing kept in U.S. ?
  new imported good not previously observed ? price
  drop not measured
• Shift from domestic supplier to foreign supplier
• No link between domestic price series import
  price series ? input price drop not captured
• Business Week furniture example (Mandel 2007)
• Shift from one foreign supplier to another
• Price drop captured only if importer the same

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Size of any bias to output productivity measures

• Dont know But body of evidence suggests
  growing importance of outsourcing especially
  offshore outsourcing/offshoring
• Rapid increase in imports relative to GDP
• Growth of imports dominated by growth of imports
  from developing countries especially China
• Studies indicate rapid shifts in sourcing of
  intermediate inputs

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Growing Importance of Imports from Developing
Countries

• Imports as percent GDP grew from 10.8 in 1989 to
  17.0 in 2007
• Developing countriesgrowth non-oil imports
• 56 1989-2000
• 70 growth 2000-2007
• Growth imports from China especially dramatic
• 13 growth non-oil imports 1989-2000
• 39 growth 2000-2007

• Imports and Exports as Percent of GDP, 1989-2007

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Evidence of growth of outsourced and imported
intermediate inputs

• Domestic providers of outsourcing services
  significant growth in share of GDP 1982-2006 7
  to 12
• Domestic outsourcing esp. strong durable
  manufacturing
• Substantial substitution imported inputs for
  domestic inputs in production of goods services
  1997-2005
• Growth imported intermediates esp. strong
  manufacturing accelerated 1997-2005
• Yuskavage, Strassner, Medeiros (2008) Kurz
  Lengermann (2008)

• Manufacturing Real Output and Employment
  1989-2007
• (Indexes, 1992100)

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Why Measurement Issues Important

• Potential bias to sector and aggregate output
  productivity measures real value of outsourced
  offshored goods services understated
• Data measurement issues preclude answering key
  questions about offshoring What impact does
  substitution of lower-cost imports for
  domestically produced goods services have on
• Employment, esp. manufacturing employment?
• Wages and wage inequality?
• Consumer prices?
• Data not suited for answering these questions
• Structure of sourcing assumed stable
• Price drops associated with outsourcing
  offshoring not adequately measured
• Studies biased against finding impacts

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Other measurement issues related to growth of
globalization

• Reclassification of manufacturers to wholesalers
• Timeliness of BEA benchmark I-O tables and
  validity of import comparability assumption
• Measurement of services offshoring among
  multinationals
• Intangible assets

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Data point from the furniture industry

• Manufacturer produced desk in Holland, Michigan
• Cost of production 3,750
• Sale price 5,000
• Profit 1,250
• Shifted production to the Philippines
• Cost of production 500
• Sale price 4,500
• Profit 4,000
• Example illustrates
• Cost savings/input price declines can be large
• Manufacturer becomes wholesaler
• Changes in CPI from domestic to imported good may
  not be good measure of input price change