1. Outsourcing, Offshoring and Adjustment in the Global Economy Outsourcing, Offshoring and Adjustment in the Global Economy Presentation prepared for Munich Economic Summit, 4 May 2006 John Whalley (University of Western Ontario, CESifo & NBER)

2. 4 May 2006 5th Munich Economic Summit Outsourcing Purchase of goods and services that were previously produced inside a company. Company producing the goods and services can be located in the same country (domestic outsourcing) or outside the country of the purchasing company (international outsourcing).

3. 4 May 2006 5th Munich Economic Summit Offshoring Purchase of goods and services previously produced while inside the purchasing company from companies in locations outside the country. Covers not only international outsourcing, but also international insourcing with foreign affiliates of domestic parent companies exporting to their parents.

4. 4 May 2006 5th Munich Economic Summit Outsourcing in Research Literature Grossman – Helpman (2002) Outsourcing implies more than purchase of raw materials and standardized intermediate inputs. It involves vertical disintegration of production with relationship-specific partners. Outsourcing... “means finding a partner with which a firm can establish a bilateral relationship and having the partner undertake relationship specific investments so that it becomes able to produce goods and services that fit the firm’s particular needs” Bhagwati, Panagariya, Srinivasan (2004) Outsourcing of services, including professional services. Outsourcing equated with long distance purchases of services by electronic media, such as phone and fax.

5. 4 May 2006 5th Munich Economic Summit Measuring Outsourcing Abraham & Taylor (1996) document increase in outsourcing of business services in 13 US industries. Camper and Goldberg (1997) measure outsourcing of intermediate inputs for various industries in Canada, Japan, the UK, the US and except Japan show a doubling in the share of imported inputs between 1975 and 1996. Feenstra (1998) measures all imported components used in production by US firms and computes various measures of outsourcing arguing all have increased since the 1970s. Tomiura (2005) reports relatively few Japanese firms outsource across national boundaries.

6. 4 May 2006 5th Munich Economic Summit Impacts of Outsourcing Direct wage effects / employment effects in OECD as production moves offshore. Indirect effects on bargaining power of unions in OECD from prospect of outsourcing. Feenstra / Hanson (1996, 1997) find outsourcing increases wage of skilled versus unskilled labour in both US & Mexico. Feenstra / Hanson (1999) find US outsourcing raises real wage of US non production workers by 0.16% / year and also real wage of US production workers (slightly) by 0.01% / year. Dreher and Gaston (2005) report results indicating various measures of globalization are negatively correlated with both union bargaining power and union membership Amiti / Wei (2006) find between 1992 and 2000 service outsourcing (technical support, medical claims processing, software development) account for around 11% of US manufacturing productivity growth, compared to a 3-6% gain from imported material inputs.

7. 4 May 2006 5th Munich Economic Summit Outsourcing to China, Channels of Economic Integration, and Adjustment Pressures Adjustment pressures stem not only from component sales, but also final stage transactions involving OECD retailers. A variety of channels for such transactions exist. Resourcing of component and final stage suppliers across national borders. Insourcing – Chinese companies buying OECD firms; keeping distribution system in OECD & moving production back to China. Throughsourcing – Trade related transactions orchestrated and conducted via middlemen in Hong Kong (plus Korea, Taiwan) Roundaboutsourcing – preferential tax and other policies towards foreign invested enterprises generate outflows from China to be returned to trade oriented enterprises.

8. 4 May 2006 5th Munich Economic Summit OECD adjustments and Outsourcing Current adjustments and potential future adjustments. Size of low wage labour pool in China / India / Indonesia FIEs in China now account for 60% of exports but only 3% of employment. China’s exports growing at 35-40% / year Cumulative OECD FDI into China ≈US$500 bill. In OECD GDP ≈ $25 trillion. If K/Y ratio is 3, OECD capital stock ≈ $75 trillion. Adjustments in OECD from outsourcing may be only in their infancy?