Outsourcing Types, Relative Wages, and the Demand for Skilled Workers: New Evidence from U.S. Manufacturing

By Chongvilaivan, Aekapol; Hur, Jung et al. | Economic Inquiry, January 2009 | Go to article overview

Outsourcing Types, Relative Wages, and the Demand for Skilled Workers: New Evidence from U.S. Manufacturing


Chongvilaivan, Aekapol, Hur, Jung, Riyanto, Yohanes E., Economic Inquiry


I. INTRODUCTION

The pivotal roles of international outsourcing and skill-biased technology in explaining the dramatic increase in relative wages of skilled workers in industrialized economies have been extensively documented and analyzed in the literature. (1) In this literature, the notion of outsourcing is typically confined mainly to the imported intermediate inputs. For analytical purposes, using imported intermediate inputs can be justified, given that imports of intermediate inputs should be expected to affect the relative demand for manufacturing workers and relative wages; (2) nevertheless, some important insights into the role of different types of outsourcing cannot be sufficiently emphasized.

In principle, firms differ in the extent of their specialization in activities along the vertical chain of production. Some firms may engage in many activities along the chain, extending from upstream (intermediate inputs) production to downstream (final goods) production, while some other firms may specialize in either upstream of downstream production. The upstream production of intermediate inputs may involve an intensity of skills different from that of the downstream production of final goods. For instance, General Motors may outsource activities that deal with the product design and the production of high-tech components (upstream activities) and may specialize in car production (downstream activity), whereas Apple may outsource the production of its iPod players (Apple's downstream activity) and specialize in research and development and product design (upstream activity). Consequently, it seems unrealistic to assume that upstream outsourcing should have the same impact on the relative demand for skilled workers as downstream outsourcing.

Outsourcing or contracting out some activities along the vertical chain of the production process enables firms to specialize in other activities along the vertical chain where they have a comparative advantage. Firms that specialize in downstream production may outsource their upstream materials, while firms that specialize in upstream production outsource their downstream materials. Both types of firm may also outsource their services, for example, repair and maintenance services for machinery, communication services, financial services, and information technology services, in order to focus on their core activities. (3) If upstream production is more skill intensive, outsourcing downstream production can reduce their dependency on unskilled workers and hire more skilled workers to take advantage of the increasing productivity of the upstream activities driven by specialization. Given this difference in skill intensity along the production chain, the negative impacts on the relative skilled labor demand would likewise be expected if they outsource upstream production. Obviously, types of outsourcing that are different may have different impacts on both the demand for skilled workers and the relative wages. Therefore, focusing on the various types of outsourcing activities should enable us to get richer results. To the best of our knowledge, these refined notions of outsourcing have largely been unexplored in the literature. (4)

A study by Amiti and Wei (2006) is perhaps the closest to our paper. Their paper analyzes the impacts of both materials and service outsourcing on overall labor productivity. They argue that, by engaging in materials and service outsourcing, firms can delegate parts of the production process that are inefficient to other more efficient firms. They can then focus on those activities in which they have comparative advantage and increased output. Consequently, the average productivity of the remaining workers should increase. It should be noted, however, that Amiti and Wei (2006) only look at aggregate workers; they do not really examine the impact of outsourcing activities on the demand for skilled workers relative to that for unskilled workers. …

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