Efficiency gains and income transfers in outsourcing : a trade-theoretic perspective John Quiggin Schools of Economics & Political Science University of Queensland Paper will be available at

Outsourcing, efficiency and transfer2 Outsourcing and competitive tendering  Growing importance in both public and private sectors  ‘Steeering not rowing’  ‘The virtual corporation’

Outsourcing, efficiency and transfer3 Efficiency gains and income transfers  Normally outsourcing will take place only if outside supplier has a cost advantage  This cost advantage may arise from  Greater efficiency  Implies net efficiency gain from outsourcing  Lower wages  Implies cost reduction is mainly an income transfer

Outsourcing, efficiency and transfer4 Economic significance  Industry Commission estimates gains from government CTC ranging from 0.3 to 1.7 per cent of GDP  Crucial issue is whether cost savings arise from efficiency improvements or wage reductions  Total benefit of mid-90s productivity surge (relative to trend) was 4.8 per cent of GDP  Data suggests outsourcing played a major role

Outsourcing, efficiency and transfer5 A trade-theory perspective  Shift from full vertical integration to outsourcing/competitive tendering is like shift from autarky to free trade  Efficiency gains and comparative advantage  Factor price equalisation

Outsourcing, efficiency and transfer6 Comparative advantage  With equal factor prices, comparative advantage coincides with absolute advantage  Benefits from specialisation  Firm/country-specific technology  Economies of scale vs economies of scope

Outsourcing, efficiency and transfer7 Factor price equalisation  Stolper-Samuelson theorem - relatively abundant factor gains from trade  In firms controlled by capital, but with effective shortage of labour due to unions or contracts, outsourcing will be attractive  In presence of distortions, need not be welfare-improving

Outsourcing, efficiency and transfer8 Welfare implications   General presumption of potential Pareto- improvement   Need not apply in the presence of pre- existing distortions   Net gains are second-order

Outsourcing, efficiency and transfer9 Applying trade theory models to outsourcing   Dixit-Norman dual approach   Krugman-Helpman on scale economies

Outsourcing, efficiency and transfer10 Formal modelling of outsourcing   Outsourcing defined as purchase of intermediate outputs   Profit functions   Convex case - relative and absolute advantage   Nonconvex case - specialisation

Outsourcing, efficiency and transfer11 Specialisation and diseconomies of scale   Consideration of outsourcing suggests an explanation in terms of agency theory   Unobservable contingencies in the production of intermediate goods increases severity of principal’s problem

Outsourcing, efficiency and transfer12 Transfers  Arise from trade between firms facing different factor prices or wage-employment bargains  Simplest case is that of high-wage firm outsourcing to low-wage suppliers

Outsourcing, efficiency and transfer13 Concluding comments   Income distribution is crucial   This fact has been   Long-recognised in debate about trade   Largely ignored in economic discussion of outsourcing