Academic journal article Economic Inquiry

Offshoring Production: A Simple Model of Wages, Productivity, and Growth

Academic journal article Economic Inquiry

Offshoring Production: A Simple Model of Wages, Productivity, and Growth

Article excerpt

I. INTRODUCTION

The theme of globalization has evolved with the changing emphasis of the debate on the costs and benefits of greater integration of the world economy. In the beginning, the debate focused on free trade. Then during the 1990s significantly greater growth in foreign direct investment (FDI) over that in trade in goods and services made FDI, and related issues such as labor and environmental standards, the main theme of globalization. Over the last decade, the emergence of China and India has highlighted the importance of intra-industry trade and the offshoring of different stages of production. The debate on the consequences of globalization continues with offshoring as the main focus now.

Sharply differing views on offshoring have created confusion in major industrial nations about its economic consequences. Offshoring is seen chiefly as a cost-saving strategy for firms, who at times see it as their only means of survival. It has also been associated with increased profitability, enhanced productivity, and stronger long-run economic growth. Shifting the spotlight from profits to people, typically consumers should also benefit from the lower prices that follow such cost-saving strategies. Yet these same consumers, relabeled as workers, tend to be at the center of widespread public concerns associated with offshoring: loss of jobs, lower wages, and in turn, lower standards of living.

The impact of offshoring is not the same for all industries and workers in society. In particular, the skill levels of workers play a decisive role in determining who gains and who loses. Offshoring activities are often thought to exploit lower labor costs in the South, making newly employed Southern workers better off at the expense of displaced lower skilled workers in the North. This is also sometimes associated with additional downward pressure on the wages of other workers still employed in the home country. Grossman and Rossi-Hansberg (2008) have gone one step beyond traditional trade models to show how offshoring of particular tasks could have a positive impact on the real wages of all workers. While they study international trade in tasks in a setting where skills are homogeneous within each sector, we focus on the consequences of offshoring caused by the intersectoral mobility of workers with heterogeneous skill levels. Indeed, the impact of this sectoral reallocation of labor and/or manufacturing activities on the fate of workers has recently been emphasized by several articles such as Olsen (2006) and Bernard, Jensen, and Schott (2004): some workers move to inferior jobs, while others are promoted to new jobs created by opportunities opened up through trade. This double dimension could reveal a number of missing links between offshoring and the labor market that are not explained by traditional trade models.

We construct a simple theoretical model of offshoring to explain a number of contradictory stylized facts about offshoring and the labor market in the U.S. manufacturing sector over the last decade. Figure 1 illustrates the recent offshoring trend and, in particular, highlights the sharp escalation in the offshoring activities of U.S. manufacturing firms since 2004. While the first panel shows total real imports of goods in the United States, the second and third panels show a rise in U.S. direct investments abroad and an increase in imports from foreign affiliates to parent firms in the United States. Our model offers a possible explanation of how these trends can be associated with a series of stylized facts for the U.S. labor market over the same period, namely a simultaneous (1) fall in manufacturing employment, (2) rise in manufacturing productivity, and (3) reduction of wages in the manufacturing sector. Figure 2 summarizes these trends and shows how the growth in offshoring and the fall in employment have been accompanied by an increase in productivity in this sector on the one hand and lower real wages since 2004 on the other. …

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