What are the effects of offshoring?

By Paul Walker 12/03/2014

Not what you may think.

The Economist‘s blog Free Exchange has a posting that looks at research on the effects of offshoring and its results may well not be what you expected.

The Free Exchange posting looks at new research that draws on a U.S. pilot study utilising the 2010 National Organisations Survey (NOS). The NOS collected data on the sourcing practises of American firms, and did so according to eight standardised business functions: primary business function (i.e., the company’s core activity), R&D, sales and marketing, logistics, customer service, administration, information technology (IT) and facilities. This enabled the researchers to see precisely which functions were being offshored—and what impact such shifts had back home.

Although 23% of American companies undertook some offshoring, when it came to their primary business functions—which account for two-thirds of domestic employment—an average of only 4% by cost was offshored. For large goods-producing companies the figure was much higher, at 10.5%. Because the products those manufacturers make tend to be highly visible (e.g., smartphones, clothing), this increases the impression that masses of American jobs are being exported. As co-author Tim Sturgeon of MIT points out, the researchers found “a tale of two economies”: large manufacturers, and everyone else. “Services, health care, public agencies and small firms of all kinds tend to be very domestically oriented,” he notes. And these types of organisation account for about 80% of America’s employment.

The second surprise was that the majority of offshoring (57% by cost) was to locations with costs that were the same as or higher than America, such as Canada and Western Europe, rather than to low-cost developing countries (29%)—the ones typically suspected of gobbling up American work. By way of explanation, the researchers note that Western Europe and Canada are America’s largest and oldest trading partners, and point to a long history of foreign direct investment by American firms in these regions. Presumably, at least some of this investment and sourcing is reciprocated, though it will fall to future studies to determine how much. Interestingly, mid-cost emerging economies were almost entirely out of the mix, caught in what Mr Sturgeon calls the “middle income trap”—they are neither sufficiently attractive markets in their own right nor sources of cheap labour.

In terms of jobs, the researchers found that the more companies offshored a particular function, the fewer low-paid jobs they had in the same function at home. An obvious reason for this could be that offshoring is siphoning away low-paid jobs. It is possible, however, that cost-reductions enabled by offshoring raise overall demand for firms’ products, and therefore increase the demand for skilled workers in tasks that haven’t been outsources.

Perhaps the most interesting points in the quote are the point about the small manufacturing and service sectors being “domestically oriented” – remembering the large contribution these sectors make to local employment – and the point about the substitution of low-paid jobs for high-paid jobs. Fewer low-paid jobs is what many people would expect offshoring to lead to but the increase in high-paid jobs is more unexpected.