Offshoring and Productivity: A Micro-data Analysis Jianmin Tang and Henrique do Livramento Presentation to The 2008 World Congress on National Accounts and Economic Performance Measures for Nations May 12–17, 2008

2 Outline Introduction Objective Data Offshoring and its Associated Factors Offshoring and Productivity Conclusion

3 What is offshoring? Domestic Outsourcing International Outsourcing Domestic SupplyInternational Insourcing Within countries Between countries Between Firms Within Firms OFFSHORING This paper covers Material offshoring (both international outsourcing and insourcing) R&D service offshoring (only international outsourcing)

4 Introduction Firms are heterogeneous even in the same industry Not all firms will participate in offshoring Participants may pursue different offshoring models They offshore to different geographical locations They may obtain different productivity dividends from offshoring Geographical locations of offshoring may matter for productivity  Better to use micro data with information on geographical location

5 Introduction (continued) Offshoring may depend on many factors Transaction costs –relationship-specific investment, –contractual incompleteness, –search efforts, –transportation costs, and –coordination and communication costs Market conditions of foreign suppliers –trade liberalization, –reduction in FDI restrictions, –the availability of cheap skilled labour, and –the ability to produce and supply high quality products and services Firm-specific factors –productivity level, –the skill level of workers and managers, and –size  Offshoring is not for every firm and every foreign location

6 Introduction (continued) Different offshoring business models Simply replacing expensive domestic suppliers by cheap foreign suppliers Offshoring low productive and low value added components, Employing foreign expertise (e.g. R&D services) and using high-tech components abroad for designing quality products, or Offshoring due to adopting foreign technologies (e.g., investing in foreign M&E)  Offshoring is associated with different business models or organization, which leads to different geographical locations

7 Introduction (continued) Possible productivity dividends from offshoring The composition effect -Moving up the value chain  Focusing on high value added component  Introducing high quality products -Specializing and obtaining economy of scale  Focusing on competency The innovation effect -Facing intense international competition -Exposing to the world technology frontier and best management practices The effects may depend on offshoring business models and geographical locations  Geographical location of offshoring may matter for productivity dividend

8 Objectives What factors are associated with material or R&D offshoring? Is material or R&D offshoring associated with plants’ productivity? Does the geographical location of offshoring matter for the association?

9 Data The Statistics Canada’s 2005 Survey of Innovation (SI) 6,143 plants in logging and manufacturing industries with at least 20 employees and $250,000 in revenue The response rate is 72% One-time cross-sectional, covering the year of 2004 (for the purpose of this study) Outward-oriented business activities with geographical locations Percentage of total expenditures on raw materials and components from overseas (material offshoring) Percentage of R&D services contracted out to independent foreign firms (R&D offshoring) Other plants and operations in the firm (multinationals) Percentage of investment on foreign M&E Percentage of revenue from exporting Other important variables Percentage of workers with university education Plant size

10 Data (continued) The SI was linked to 2002 and 2004 Annual Survey of Manufacturers (ASM) 6,109 in-sample manufacturing plants, representing a subpopulation of17,367 manufacturing plants. Production data

11 Offshoring and Its Associated Factors

12 Hypothesis 1 Offshoring is associated with: outward-oriented business activities -being multinationals (establishing foreign affiliates through FDI) -adoption of foreign technology (investment in foreign M&E) -exporting plant-specific factors -productivity level -skill level of workers and managers -plant size

13 outward-oriented business strategies Being a multinational intra-firm trade accounted for significant part of imports (47% in U.S. in 2005). most of the intra-firm transaction is associated with intermediate inputs Adopting foreign technologies requiring specific materials or accessories from the foreign manufacturers requiring the manufacturers’ expertise (R&D services) Exporting (indirectly influencing) forcing the firm to improve its cost-competitiveness by exposing a firm to international competition better understanding local markets lower offshoring transaction costs due to established networks

14 Plant-specific factors Productivity level offshoring is often considered to be endogenous to productivity (Amiti and Wei (2006). high-productivity firms more likely engage in offshoring activities than low-productivity firms (Antràs and Helpman 2004) Skill level knowledge and skills are required to coordinate the complexity involved in offshoring skilled workers are required to specify R&D projects for offshoring and to develop absorptive capacity to benefit from R&D offshoring. Plant size Large firms are perceived to be more likely to engage in offshoring than small firms.  the cost of financing offshoring projects is lower  larger benefit from economies of scale  lower risk of offshoring due to its large scope

15 Regression model 1

16 Estimation results: material offshoring and the associated factors Note: t-statistics are in parenthesis. “*”, “**”, and “***” denote significance at 10%, 5% and 1%, respectively.

17 Estimation results: R&D offshoring and the associated factors Note: t-statistics are in parenthesis. “*”, “**”, and “***” denote significance at 10%, 5% and 1%, respectively.

18 Productivity and Offshoring

19 Hypothesis 2 Productivity (MFP) is associated with offshoring and the association differs across geographical locations -The composition effect  Moving-up the value chain  Specializing and obtaining economy of scale -The innovation effect  Increased competition  Exposure to advanced technologies and business practices -These effects may differ across geographical locations

20 Regression model 2

21 Control variables Fuel and power consumption per worker, as a proxy for capital intensity working capital stock is highly correlated with fuel and power consumption industry differences in energy intensity are accounted for by industry dummies. Being multinationals multinationals are more productive than non-multinationals (Baldwin and Gellatly, 2007) scale, scope, diversified markets, unique technology, and superior business organizations Skills important for technology adoption and innovation Forming and managing business organizations Size, operating location and industry dummies introduced to capture specific effects from differences in local business environment, financial and technological opportunities across different size groups, operating locations and industries.

22 Estimation results: offshoring and productivity

23 Concluding remarks Material offshoring was highly associated with firms’ outward-oriented business activities including foreign operation, investing in foreign M&E, and exporting, after controlling for offshoring and operating locations advantages, and industry- specific effects. For R&D offshoring (international outsourcing only), it is found that it was mainly associated with investment in foreign M&E. Material offshoring is positively associated with productivity and the association is significantly larger for material offshoring to non-U.S. countries than for material offshoring to the U.S. after controlling for other effects including being multinationals, the education level of workers, and plant size.

24 Concluding remarks (continued) The results should be interpreted with the understanding: The results are only about association not about causal relationship No delayed effects The result that material offshoring to non-U.S. countries tends to be associated with higher productivity than material offshoring to the U.S may be justified by higher transaction cost associated with material offshoring to non-U.S. countries.