International Outsourcing and the Productivity of Low-Skilled Labor in the EU

By Egger, Hartmut; Egger, Peter | Economic Inquiry, January 2006 | Go to article overview

International Outsourcing and the Productivity of Low-Skilled Labor in the EU


Egger, Hartmut, Egger, Peter, Economic Inquiry


I. INTRODUCTION

In recent years, international outsourcing (international fragmentation of the value-added chain) has become one of the core interests in international economics, and it is now seen as an important source of the observed change in factor productivity and factor rewards in the recent past (see Feenstra and Hanson 1999). However, from a theoretical point of view, the impact on factor productivity and factor rewards is not clear-cut but critically depends on which factors are substituted by the international fragmentation of production, which sectors are engaged in international outsourcing, and the intersectoral and international mobility of factors. (1) In addition, factor and product market imperfections affect the outcome (at least in the short run).

Empirical research has predominantly been concerned with the effects of outsourcing on the U.S. labor market (Feenstra and Hanson 1999; Siegel and Griliches 1991; Slaughter 2000; etc.). Research on the importance for European economies has predominantly concentrated on the effects of trade with less developed countries on labor markets rather than focusing on direct measures of outsourcing (Anderton and Brenton 1999; Greenaway et al. 1999, 2000; Hine and Wright 1998; etc.). (2)

This article combines trade statistics for intermediate goods imports and information from input-output tables to construct a conceptually narrow measure of outsourcing (i.e., intermediate goods imports from the same industry (3)) to investigate its effect on the productivity of low-skilled labor. Due to the lack of skill-specific wages at the industry level of the European Union member countries, this has to be done in a primary production function approach. We choose a nested Constant Elasticity of Substitution (CES) framework, which is sufficiently flexible (see Perroni and Rutherford 1995) and less demanding than other flexible functional forms in terms of the parameters to be estimated. To investigate the robustness of our findings, we additionally estimate a translog specification. (4)

Interestingly, in the nonlinear CES framework we find a Hicks nonneutral augmenting effect of outsourcing on physical capital and high-skilled labor (both relative to low-skilled labor) of approximately the same size. In the short run, outsourcing exhibits a negative effect on real value added per low-skilled worker. This might be caused by imperfections on factor and product markets. In the long run, outsourcing increases real value added per low-skilled employee. The average annual change in the outsourcing to output ratio in EU manufacturing amounted to 3.2%. According to our simulations, the observed change in EU outsourcing since 1993 alone accounts for a long-run effect of about 6.0% of the observed change in the real value added per low-skilled worker.

II. THEORETICAL BACKGROUND

In general, the value added of industry i is given by

(1) [Y.sub.i] - [summation over j [not equal to] i] [D.sup.i.sub.i] - [n.summation over j=1] [O.sup.j.sub.i] = [Q.sub.i](V.sub.i]),

where [Y.sub.i] is the real value of commodity i produced in industry i, [D.sup.j.sub.i] is the real value of domestically sourced intermediate good j, and [O.sup.j.sub.i] describes the real value of the imported intermediate good j employed in the production of industry i. Throughout the analysis, we focus on the role of [O.sup.j.sub.i]. [Q.sub.i] is the value added produced at home with a vector of input factors [V.sub.i]. For notational simplicity, we omit time and country indices in the theoretical part of with a translog specification. the article. Using a CES specification for the production of [Q.sub.i], gives (5)

(2) [Q.sub.i]= [A.sub.i]{[delta][K.sup.*-[rho].sub.i] + (1 - [delta])[L.sup.*-[rho].sub.i]}.sup.r/[rho]],

where [A.sub.i] subsumes information about the level of technology, the degree of competition and the level of outsourcing activities. …

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