Offshoring and middle-income workers

By Paul Walker 17/10/2012

A point about the wage distribution noted by labour economists has been about a relative decline in wages at the middle of the income distribution relative to wages at the top and bottom, or a ‘polarisation’ of the labour market. In the 1980s and 1990s the trend was a more straightforward increase in income inequality between high- and low-wage workers, with wages over time increasing more or less monotonically with a worker’s position in the income distribution. Yet sometime around the start of the new millennium that pattern shifted, with relative wage gains concentrated at both the top and the bottom of the distribution and relative losses in the middle.

In an article at Lindsay Oldenski offers new evidence on the relationship between this polarisation of the labour markets and offshoring. Oldenski writes about a new working paper (Oldenski 2012),

The results show that when the share of offshoring increases in a given industry, there is a significant increase in the gap between wages earned by workers in the highest-paid occupations relative to workers in the median-wage occupation in that industry. At the same time, the gap narrows between wages earned by the lowest-paid workers and workers in the middle of the distribution.

The relationship between offshoring and polarisation is driven by two important forces. The first, which has been mentioned in earlier work on polarisation, is the relative ease with which different types of occupational tasks can be fragmented across borders. The second, which has been neglected in the labour literature, is comparative advantage.

First, fragmenting the production process in a way that moves certain intermediate inputs or processes to another country is easier for some types of tasks than for others. For example, activities that involve direct interaction with consumers, such as haircuts or food service, are extremely difficult to offshore while those that are not location specific, such as data entry, can be performed anywhere. In addition, firms are more likely to offshore routine tasks and keep non-routine tasks in their headquarters. Routine tasks can easily be broken down into a clear set of steps, which can then be communicated to someone located in another country. Non-routine tasks involve decision making, problem solving, or creativity. These non-routine tasks are both more difficult to communicate to overseas contractors or foreign affiliates and more crucial to a firm’s core mission or strategy, and thus they are more likely to be performed in a company’s US headquarters rather than offshored.

But, argues Oldenski, if you focus just on the ease with which a given task can be traded you do not get the whole story. She continues,

Many extremely high-skilled tasks, such as engineering and research, are becoming increasingly tradable as well. Yet US workers in professions that require these tasks have seen their wages rise. Interactions between offshorability (or, more accurately, tradeabilty) and comparative advantage can explain both the overall widening of the wage gap in the US, as well as disproportionate gains for workers at the top of the skill distribution and disproportionate relative losses for workers in the middle of the distribution. Non-routine and communication intensive occupations are concentrated at both the top and the bottom of the skill distribution in the US. However, US workers at the top of the distribution also perform the jobs in which the US has comparative advantage. Thus we should expect these high-skilled, high-wage workers to gain the most from the increased tradeability of certain tasks both because the areas they specialise in are activities that are more in demand in the US as trade expands and because they are made more productive by the availability of cheaper complementary low-skilled tasks through offshoring. Middle-skilled workers gain the least, as they are not in occupations for which the US has comparative advantage and are also more likely to perform routine, easily offshorable tasks. Workers at the bottom of the distribution are not in sectors in which the US has comparative advantage, yet many of the tasks they perform are either non-routine manual or location specific and thus less vulnerable to offshoring than middle-skill jobs.

The conclusion Oldenski reaches is,

New evidence shows that there is indeed a link between offshoring and relative declines in the wages of middle-skilled workers. However, it also shows that offshoring has had a positive effect in terms of increasing the demand for workers in the most highly skilled, highly paid jobs. Given the benefits of offshoring, the policy message this election season should not be to try and restrict offshoring, but rather to find ways to match workers to the areas where labour demand is growing. This paper suggests that a focus on training workers to perform more highly skilled, non-routine and communication intensive occupations is one component of that policy.

  • Oldenski, Lindsay. (2012), (Offshoring and the Polarization of the US Labor Market), Working Paper.