The Economics of O ¤ shoring

This paper examines the various economic issues on o¤shoring (international outsourcing). It begins with a discussion of the factors that determine a rms decision to o¤shore and illustrates, with simple models, the cost saving of o¤shoring certain stages of production and the advantages of specializing in some input production and engaging in other input trade. The paper then examines the recent trend in o¤shoring with emphasis on the rise of IT o¤shoring and also the characteristics of rms in relation to o¤shoring and exporting. The e¤ect of o¤shoring and national welfare is then discussed in light of numerous results in recent empirical studies. After examining the current U.S. programs to help the displaced workers, the paper concludes with the various short-run and long-run policy proposals to solve the growing public concern and vexation on o¤shoring. JEL Classi cation: A10, D21, D22, D63 , F16, J28. Keywords: o¤shoring, outsourcing, fragmentation, gains from o¤shoring, input trade and specialization, IT o¤shoring, economic welfare, U.S. policies and reform proposals Paper to be presented to the Conference on Global Economy, sponsored by APEA, KIET and RCIE, March 1718, 2012, Seattle, WA. yDepartment of Economics, SUNY at Bu¤alo, Bu¤alo, NY 14260. E-mail: ecowwc@bu¤alo.edu; Tel: 1-716-645-8671; Fax: 1-716-645-2127. I am grateful to James ODay, Nicole Hunter, Hongxiu Li, Takashi Mita, Han Eol Ryu and Mei Ling Toh for helpful comments. 1 Outsourcing and O¤shoring The term "o¤shore outsourcing" or "o¤shoring" can be de ned in various ways. It can refer to U.S. multinational rms shifting production away to an overseas subsidiary, U.S. rms importing services or intermediate goods from foreign companies, or U.S. rms making overseas investments. Other than the last category, economists regard o¤shoring as a form of trade in goods or services. In this paper, we shall follow Garners (2004) de nition of o¤shoring which is the relocation of jobs and production to a foreign country. This relocation can occur through a separate company located abroad or through the foreign o¢ ce of the same rm. Conversely, the term "outsourcing" does not necessarily imply that jobs and production are being relocated to another country. Over the years, economists have utilized many di¤erent terms when referring to outsourcing and o¤shoring.1 According to Grossman and Rossie-Hansberg (2006; p.1), they prefer "using the term o¤shoring to the more popular outsourcing,because the latter suggests that tasks formerly performed in-house are now being purchased at arms-length, whereas the former implies that tasks formerly undertaken in one country are now being performed abroad. In other words, o¤shoring includes not only foreign sourcing from unrelated suppliers, but also the migration abroad of some of the activities conducted by a multinational rm. " Thus, o¤shoring can take place within the boundaries of a rm through foreign direct investment (FDI), or at arms length, with independent foreign suppliers or partners. It can be classi ed into captive o¤shoring and non-captive o¤shoring the former outsources the business to a foreign a¢ liate, while the latter to a foreign, non-a¢ liated rm. Instead of using domestic factor resources, o¤shoring results in the importation of goods or services produced in foreign countries, or equivalently, importation of embodied foreign factor contents. It is often regarded as driven by comparative advantage. In theory, service o¤shoring is just a form of o¤shoring that should yield the usual gains from trade and entail the necessity of resource adjustment. From a global point of view, o¤shoring increases the e¢ ciency of resource allocation in the world economy and will raise the average living standard worldwide. However, there is a distributional consequence from o¤shoring. A rm that o¤shores can cut costs and increase pro t, but the factors that are laid o¤ will likely su¤er as they must seek employment elsewhere. This has created a heated debate about the costs and bene ts of o¤shoring. For example, the inuential Lou Dobbs has used CNN programs to express his strong personal view against 1For example, "kaleidoscope comparative advantage" by Bhagwati and Dehejia (1994) to describe rms changing their production locations; "fragmentation" by Jones and Keirzkowski (1990) favored by Deardor¤ (2001) to emphasize the splitting of an integrated production system into separated production processes connected by service links; "slicing up the value chain" by Krugman (1994); "intra-mediate trade" by Antweiler and Treer (1997, 2002); "intra-product specialization" by Arndt (1997 and 1998); "delocalization" by Leamer (1998); and "vertical specialization" by Hanson (1996) and Hummels, et al. (1998).