MASTER THESIS AUTHOR
MSC FIB ZEESHAN ABBASI
ADVISOR
Tor Eriksson
Foreign Outsourcing – A Myth or Menace?
Impact of outsourcing on Employment, productivity and Growth
Evidence from Danish and UK manufacturing
Aarhus School of Business
1
Abstract
In the changing global market place role of outsourcing is increasingly crucial for
firms to remain competitive. The media hype that surrounds outsourcing is often based
on stereo types and myths that are far from hard facts. The purpose of this paper is to
provide an inside into the recent upsurge in the foreign outsourcing in United Kingdom
and Denmark. Paper identifies the UK & DK industries that have experience high
intensity of outsourcing in last two decades and possible job losses that may have
resulted from it. Paper attempts to understand the outsourcing in the changing
international trade environment and provide post outsourcing analysis on productivity
growth on outsourcing industry and impact of outsourcing on foreign country where
outsourcing take place.
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TABLE OF CONTENTS
1. INTRODUCTION 4
1.1 Problem Statement 7
1.2 Delimitation: 9
1.3 Data 9
1.4 LITERATURE REVIEW 10
2. WHAT IS FOREIGN OUTSOURCING AND HOW CAN WE MEASURE IT?
12
2.1 Foreign outsourcing: 12
2.2 Measure of Foreign outsourcing - Discussion 14
2.3 What Industries are affected by Outsourcing? – Data Analysis 17
3. OUTSOURCING AND EMPLOYMENT 22
3.1 Theoretical Framework 22
3.2 Labor Market Rigidities: 23
3.3 Empirical Analysis – Does Outsourcing Destroy Jobs? 26
3.4 Regression Results 28
4. DRIVERS OF FOREIGN OUTSOURCING: 35
4.1 Globalization & International Transaction Cost 36
4.1.1 Cost of trade barriers 37
4.1.2 Transportation cost 38
4.1.3 Information Costs 39
4.1.4 Capital Transfer Cost 40
4.2 Outsourcing and Competition: 42
3
5. OUTSOURCING & PRODUCTIVITY – IMPACT ON LOCAL PLANT 44
6. EFFECT OF OUTSOURCING ON HOST COUNTRY 48
7. Outsourcing Impact on the local Firms 52
7.1 Outsourcing & Economic Performance 55
8. SYNERGIES FROM OUTSOURCING INTERACTION 57
9. CONCLUSION: 58
REFERENCE LIST: 61
Appendix = 1 Industry classification 67
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1. Introduction
“All fixed fast-frozen relations, with their train of ancient venerable prejudices
and opinions are swept away, all newly formed ones become antiquated before they
can ossify. All that is solid melts into air, all that is holy is profaned, and man is at last
compelled to face with sober senses, his real conditions of life, and his relations with
his kind. The need of constantly expanding market for its products chases the
bourgeoisie over the whole surface of the globe. It must nestle everywhere, settle
everywhere, and establish connections everywhere.
Marx and Engels (1973, p. 83)
The famous words of Marx might be a source of inspiration and hope for the preachers
of free trade and globalization. Though it was a hard sell for the former U.S.
presidential hopeful, who was fighting a close contested presidential Election amidst of
popular public discontent and fear of job losses resulting from foreign outsourcing in
United States. Senator John Kerry managed to put a political spin on the issue of
foreign outsourcing. Awkwardly admitting that foreign outsourcing was a reality,
though, at the same time he managed to blame outsourcing as a bad policy, he was
quoted saying "Because of George Bush's wrong choices, this country is continuing to
ship good jobs overseas - jobs with good wages and good benefits," "My value is good,
old-fashioned four words: 'Made in the USA."1
The opposing views of Senator John Kerry show the significance of the recent debate
on the foreign outsourcing. Confusion and fear over businesses moving part of their
production abroad at the cost of domestic employment are debated far beyond U.S.
borders. According to the IMF working paper (WP/04/186) “there were 2,634 reports
in US newspapers on foreign outsourcing between January and May 2004, mostly
focusing on the fear of job losses. Similar report appeared in the news publications in
United Kingdom, France, Germany and other industrialized countries00
1 The Washington Times (http://washingtontimes.com/national/20040920-123916-5429r.htm)
5
“This is the law of the jungle turned into a constitution. I do not want a constitution
that imposes a principle – free and unfettered competition – with which I do not
agree.” asserted socialist French Senator, Jean-Luc Melenchon campaigning for no
vote in EU referendum on European constitution. The strong sentiment from French
senator is not a rarity these days. A recent survey conducted by the French polling
institute SOFRES2 following up to the French referendum on European constitution
conclude that 46 percent of those who voted no in French referendum listed fear of
unemployment as the main reason for their decision. Worries about outsourcing and
the arrival of lower-paid workers from new EU member countries played a large
part in the debate preceding the referendum. Similarly French public opinion has been
echoed in other Western European countries with varied enthusiasm.
However, there is something very ironic about the recent debate on foreign
outsourcing. Foreign Outsourcing is not a trend or innovative concept of 90’s. The
roots of foreign outsourcing could be traced back to decades. Outsourcing strategies
have been used by the companies/countries for long period of time. In early years of
US History, America's covered wagon covers and clipper ships' sails was a job
outsourced to workers in Scotland. Similarly with raw material imported from India,
England's textile industry became so efficient in the 1830s that eventually Indian
manufacturers couldn't compete, and that work was outsourced to England.3 Similarly
the manufacturing or Textile jobs in U.S. that are outsourced to developing countries
today were originally outsourced from Massachusetts to South Carolina because
companies encountered an economic benefit in moving to south. Sirohi (2004). More
recently, Multinational companies like Nike and Toyota have used outsourcing
2 KWR Special Report Waiting for the French – The May 29th Referendum, By Scott B. MacDonald
(KWR international)
3Globalvision-ABriefHistoryofOutsourcing
An essential part of today's global economy, outsourcing has been occurring for decades
Terri Kelly, a freelance journalist, community college instructor, and intercultural conflict mediator in
Portland, Oregon.
6
strategies to create more specialized knowledge, to gain from economies of scale and
cheap labour costs for considerable amount of time.
So outsourcing is not something new, similar to the concept of outsourcing, the stereo-
types attached to the foreign outsourcing and global-trade are not new either. Abraham
Lincon was quoted saying “I don’t know much about tariff. But I know this much,
when we buy manufacture good abroad, we get the goods and foreigner gets the
money. When we buy the manufactured goods at home, we get both the goods and
money.”4 Responding to the loss of employment in India following the outsourcing of
textile industry to United Kingdom India's governor general, William Bentinck, wrote
to his superiors in London in 1834 "The misery hardly finds parallel in the history
of commerce,"
The sentiment expressed in statements by Senator John Kerry, Abraham Lincon and
French senator Jean-Luc are very is very similar in substance. The all seemed to echo
the popular political stereo types that we have learned to live with in last few decades.
We hear them now and again, the evil of globalization and international trade,
globalization and how it relates to job losses and trade. Punch lines with various spins
like "exports equal jobs," "imports kill jobs” and "offshore R&D” is not good.
At the same time we have witnessed an era of unprecedented globalization driven by
free movement of goods, services, investment, capital flows and technological
advancements. Emergence of economic blocs in North America, Europe and Asia
Pacific has caused greater integration of world economy. We have seen how a cool and
steel community (ECSC) can transform itself into powerful Economic
union/community (EEC) that accounts for the 7% of world population and one third of
global trade in goods and services. Gradual removal of trade barriers and expansion of
intra-European trade has helped Europe to embark on a unique project in the form of
monetary union. Removal of exchange rate risk, single interest and reduced transaction
4 Dani Rodrick-journal of Economic perspective-volume 12, fall 1998-page 3-8
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cost has helped European companies to expand their products and production in other
European countries to maximize their potential and to be competitive on global
market.
So, if we accept that Stereo types about globalization/international trade/outsourcing
have been around forever, as it seems, and still the people and courtiers have
committed themselves to the course of globalization and further integration of trade,
then where lies the problem?, Is current debate about outsourcing is just a media hype?
Or is it due to information bias about what outsourcing really is? Could the current fear
of outsourcing be an irrational response to the other micro-economic problems in
respective countries? Or is it rational fear? Is outsourcing really causing
unemployment and loss of trade? Is it as bad as it made out to be? In order to properly
understand the precise meaning of all this, one should take account of a whole series of
factors weighing on the internationalization of employment, such as the positive and
negative effects of trade.
1.1 Problem Statement
The core objective of this paper is to Enhance Our Knowledge and Better Understands
the Concept Of foreign Outsourcing in order to establish what are the facts and what
are the hypes about international outsourcing are. More precisely thesis intends to
answer the following question:
1. Has there been a significant increase in outsourcing in UK and Danish
manufacturing industries, what industries are affected?
2. Is there a relationship between foreign outsourcing and job losses in UK
and Danish manufacturing industries? If yes
3. What has caused the sudden increase in the outsourcing intensity?
4. Does outsourcing boost the productivity growth of home industries?
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5. What impact foreign outsourcing has on the host country (china)?
Before we can identify and assess industries affected by outsourcing, one has to
properly define and measures the effect of outsourcing. There is no universally
accepted method of measuring outsourcing in economic literature. Measures of
Outsourcing vary from Outward processing estimates to FDI as a proxy of foreign
outsourcing. Each of these methods has their strength and flaws. The choice of method
is generally driven by research design and convenience. In this paper I have decided to
use FH (Feenstar Hanson) broad measure for outsourcing, the measure uses foreign
imported inputs to capture the outsourcing intensity. Measure is one of most efficient
in the sense that it captures the modern need of the firm to disintegrate the production
process and replace it with foreign input. I supplement this method with the Net import
penetration index to rank the industries in terms of import competition. Idea is that
firm with the high excessive import may be more vulnerable to foreign competition
and outsourcing.
The Outsourcing measurement will help us to identify the industry that is affected by
foreign outsourcing. Once we have identified the industry that is being affected by the
foreign outsourcing, we will be able to measure there is relationship with job losses
and outsourcing through regression analysis. In presence of low price foreign
competition one would expect domestic companies to respond by looking for low
cost solution through relocation in low cost country or by substituting the domestic
operation with foreign inputs. In both case we could expect a significant decrease in
employment in domestic UK and Danish manufacturing industries.
If there are indeed job losses in the UK and Danish Manufacturing industries, how
could we possibly explain them, what has cause sudden increase in the outsourcing
intensity. A host of the factors such low domestic productivity, poor quality suppliers,
focus on foreign export market and ease of international trade could be responsible for
that. I will look at what are the drivers of the foreign outsourcing, changes in the
international environment and globalization may be a good point to start, since trade
liberalization in last 30 years has changed the panorama of international trade.
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In post outsourcing era it may be beneficial to explore the effect of productivity growth
in the UK & Danish manufacturing industries by using the value added. It will help us
assess the direct benefit of outsourcing.
Finally it is crucial to understand the effect of outsourcing in the host country. I will
use foreign direct investment as proxy to the foreign trade to understand the
outsourcing impact. Although FDI might not capture the full effect of foreign
outsourcing, it will give us a good sense. FDI are important to the growth for
developing and they result in the knowledge and technological spillover which are
crucial for sustainable economic growth.
1.2 Delimitation:
The thesis solely focuses on United Kingdom and Denmark. Primarily choice of DK
and UK as a country of origin was driven by the fact the most of the recent literature
focuses on Untied States where effect of outsourcing is somewhat different that one
would expect in EU. It is widely accepted that United States labor market is much
more "flexible" than those in Europe. Secondly the choice is interesting by the mere
fact that two economies differ considerably in terms of size which will be interesting to
see since higher UK trade will infer its relative propensity to be more competitive to
international trade.
Paper does not deal with skill biased technology change which might also have
significant impact on the employment reduction. In addition effect of the wage
adjustment is not at eh center of this paper given very reason than we work the labor
market that may be rigid. Statistics to identify the relationship used in this paper is by
the choice of the design to analyze the effect on individual industries. In addition paper
is economic scientific, means statistics or regression is used as a supplement.
1.3 Data
Basic data used in this paper is obtained from OECD Stand industry database, which
covers based on ISIC rev 3. 29 Danish UK manufacturing industries have used in the
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analysis. Complete list of the industries could be seen in Appendix One. Period
covered is from 1980-2003.
1.4 Literature Review
Literature regarding international trade and its impact on the different stake holders of
the economy has long-standing tradition in economic research and often used as
starting point for foreign outsourcing research. Though foreign outsourcing has never
been the canter of it, as result, literature on foreign outsourcing is somewhat less
profound and restricted to certain geographical and subject areas, even though its
growing with an impressive rate in recent years.
Lawrence (1994) analyzes the relationship between low-wage international
competition and wage performance in the Developed Countries in the 1980s. He
argues that poor average US wage performance reflects slow domestic productivity
growth rather than international competition. He goes on to assert that employment
and wage behaviour in US multinational has much to do with technological change
rather than trade and increased international sourcing. He concludes that Imports by
U.S. multinationals are too small to effect the domestic employment and wage change.
Fenestrate and Hanson (1995) used import of intermediate inputs by domestic firms to
measure the impact of foreign outsourcing on labour demand, the affirmed that If firms
respond to import competition from low-wage countries by moving non- skill-
intensive activities abroad then trade will shift employment towards skilled workers,
thus import of intermediate inputs has directly contributed to an increase in the relative
demand for skilled labour in united states.
Fenestrate and Hanson (1996) further consolidated there research following year by
using four digit SIC import data from NBER trade database with disaggregated data on
input purchases from the Census of Manufactures. They constructed industry-by-
industry estimates of outsourcing for the period 1972-1990, they results further
validate their initial finding that outsourcing has contributed to an increase in relative
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demand for skilled labour. They asserted that outsourcing can account for 31-51% of
the increase in the relative demand for skilled labour that occurred in United States.
Campa and Gold (1997) measured outsourcing using data from imported inputs in
various industries for Japan, united states and united Kingdom. Input output tables they
used did not classify the imported input so proximate the imported inputs by using the
import penetration data. the concluded that there was a doubling of the share of the
intermediate good in all countries except Japan.
Bazen and Cardbeat (2001) used sectoral data for the period 1985-92 to evaluate the
impact of trade in France. They concluded that lower relative import prices have
impact both on employment and their wages. Their research found that international
trade reduced the relative employment of low skill workers in the first half of the
period and reduce their relative wages in the second half. They found that effect is
more pronounced in sectors where the skill intensity of production is initially low.
Egger and Egger (2001) find that there is a negative effect of international material
outsourcing on the productivity of low-skilled workers in the short run, but a positive
effect in the long run. They found that international outsourcing of materials
contributed to 3.3 percent of real value added per low skilled worker in the EU from
1993 to 1997. They attribute the negative short-run effect to imperfections in the EU
labor and goods markets.
Olsen, Ibsen and Nielsen (2004) analyzed the Danish textile and clothing industry
using the detail industry employment data. They reported that although there is decline
of employment in Danish textile industry by more than 80 percent from 1975 to 2000
as consequence of foreign outsourcing, though majority is rehired in the same industry
by mid 1990s.
Baily and Lawrence (2005) explored the link between foreign outsourcing and job
losses in manufacturing industry and service sector. They discovered that from 2000 to
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2003 only about 11 percent of the jobs were lost in the manufacturing sector as a result
of outsourcing, they further implied that the job loses in the service sector were even
lower.
2. What is foreign Outsourcing and How Can we measure it?
Before we can start discussion what is the appropriate measure for the foreign
outsourcing and how it could be justified, we clearly need to define and understand
what foreign outsourcing is. To define Outsourcing in a single sentence is not easy
task, definition of what constitutes outsourcing, offshoring or foreign/offshore
outsourcing is variable and terminologies are interchangeably used for the same
concept and are often misleading. According to the working paper by “Danmarks
Nationalbank” there is no official definition of what constitute outsourcing, offshoring
or offshore/foreign outsourcing5, thus it is very important that we clearly foreign
outsourcing.
2.1 Foreign outsourcing:
Outsourcing refers to the fragmentation of a production process in sequential stages
through development of new input-output relations with other firms, or through
production displacement to other locations. In addition firm outsourcing decision could
include production activity (intermediate inputs, raw material or recycling) or service
activity (customer support, logistics or maintenance).
However general definition is somewhat vague since term outsourcing could be local
or regional displacement as was in the case of Citibank several years ago when they
decided to move their credit card processing unit in New York area to South Dakota to
benefit from low cost and less rigid financial regulations.6 Or outsourcing could also
be across borders where multinationals own subsidiary in a foreign country or it could
5 Urik Bie, offshore outsourcing, Danmarks nationalbank workign paper 2005-22
6 Robert W. Mcgee, Outsourcing – An ethical anlysis of an internacional trade issue, 2005
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be a new relationship with the domestic or foreign supplier at the cost of internal
production. Figure one clarify all possible mode that are available to a firm that is on
the verge of indulging in the foreign outsourcing.
Figure 1 presents possible modes in which outsourcing and offshoring could occur.
There are three separate trajectories towards outsourcing or off shoring. Figure depicts
Figure 1 Possible Outsourcing Modes
Source: constructed by the author
situation of company having 100 percent production in house and considering
outsourcing: Our hypothetical company could outsource in three ways. First,
companies may outsource within the region or country, that would be referred as
domestic outsourcing. Second, companies may also decide to source from overseas
locations by establishing foreign affiliates or fully own subsidiary, categorized as
offshoring. Third, firm may opt to outsource from foreign supplier, in which case firm
will be opting for foreign outsourcing.
Keep in-house
Domestic division
Domestic Outsourcing
Third Party
Domestic Suppliers
Off shoring
Foreign affiliates
(FD I & international trade)
Offshore outsourcing
Third party
Foreign suppliers
Domestic Overseas
Location Decision
Outsourcing Off shoring
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In this paper international outsourcing, defined as the procuring of service or material
inputs by a firm from a source in a foreign country. This includes both intra-firm
international outsourcing (which the foreign provider of the input is still owned by the
firm) and arm’s-length international outsourcing (by which the foreign provider of the
input is independent from the firm using the input).7
2.2 Measure of Foreign outsourcing - Discussion
As of today a single direct and reliable measure of international outsourcing does not
exit. And there is no universally accepted method to capture the effect of foreign
outsourcing. International trade and economic statistics provides little help since most
of the statistics (e.g. OECD Variables and Computations) is focused on intra industry
trade and broad measure of international trade, which fail to capture the different
modes from which outsourcing could occur.
One of the reasons why measuring outsourcing activity has been challenging using
basic economic data is nature of foreign outsourcing, as World Trade Organization
(2005: 267) argues that one of the root causes for this is outsourcing refers to
management decisions made at the micro-level that cannot be easily linked to trade
statistics that are collected on the national and sector levels. The foreign outsourcing
could occur through different channels and it effect could be embodied in varies
different economic variables.
Outsourcing could take place through outward processing trade, where an organization
export of intermediate inputs for further processing abroad, and the re-export of these
products back home. First, OPT has been a popular mode of outsourcing in textile and
clothing sector, some up-stream value chain function were performed abroad and
7 Terms Foreign outsourcing, outsourcing or offshoring might be used interchangeably in this paper,
though all three refer to the same definition.
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goods were re-imported. Second, Outsourcing could be embodied in imported parts or
intermediate inputs (from same or different industry abroad) if firm decide to substitute
domestic supplier with foreign entity or Outsourcing numbers could simply be
reflected in import of final product if firm decide to move production abroad.
.
The different modes of outsourcing pose a challenging dilemma for the effective
measurement of foreign outsourcing. Researchers have used various different methods
to compute the extent of outsourcing, theses method range from using foreign direct
investment (FDI) to imported Intermediate inputs as proxy of outsourcing, though
none of the methodology used is complete, each of the method has its strength and
flaws.
FDI methodology consists of measuring the scale of relocation abroad through foreign
direct investment. FDI method takes into account a capital flow to the destination
country where a new affiliate is established or the capacity of an existing affiliate is
expanded. In general FDI method assumes that financing abroad of an activity is
identical to stopping the same activity in the country of origin. However FDI method
has some limitation. It does not take account of relocation in the form of foreign
supplier. It also operates on the faulty assumption that all direct investment in a foreign
country is necessarily the result of relocation, because FDI outflow does not have to
mean the cessation of the same activity in the compiling country.
Outward processing trade is an interesting measure of outsourcing because it
systematically record the international transaction at export and re-import stage, it
clearly isolate outsourcing from rest of the international trade. Though problem with
OPT is that it only represent small proportion of international outsourcing. OPT fails to
represent outsourcing intensities or change that might be due to increasing amount of
imported inputs used in the final production or increase in the import of final product,
in addition OPT is used by a relatively small number of industries.
Increase in Import penetration has also been used as proxy to the Foreign outsourcing.
It provides good general overview, though it has similar limitation as FDI method,
closure or reduction in domestic plant will result in increase imports to meet the
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domestic demand, though its difficult to isolate the outsourcing effect since increase in
import could also be due increase in domestic demand or increase in OPT trade. The
strong point of this method is depth of data, detailed industry level and countrywide
import data allow us to really pin down the origin and destination of the trade. Thus,
import data could be a good supplement to the other outsourcing measure to do an in-
depth analysis.
Finally, one of the most popular proxy or measure for foreign outsourcing in academic
literature is use of imported intermediate input. This method focuses on the foreign
content of domestic production by taking into account the share of imported
intermediate inputs in production. The logic behind this measure is the fact that
increased outsourcing activity is expected to increase the import of intermediate goods
as outsourcing firms replace intermediate stages of their domestic production with
foreign production, or shift their purchases of inputs from domestic to foreign
suppliers in order to save costs. The method that was originally introduced by Feenstra
and Hanson (1996) considered as a measurable indicator that can be tied directly to
outsourcing activity and it’s been widely use in Foreign outsourcing literature.
Data for fenestrate imported intermediate data is derived from input output (I/O) table.
These tables generally break down the inputs received by each industry according to
the industry of origin and their source and state the value added by the industry itself –
the sum of which is an industry’s total output. Starting from this index Feenstra and
Hanson (1996) get a narrow measure of outsourcing by considering only those inputs
that are purchased from the same industry as the good being produced. Then they
loosen their definition and include input purchased from all industries and term this
measure as Broad outsourcing. Finally they calculate what they call differential
outsourcing as the difference between their broad and narrow outsourcing measures.
The Feenstra approach is the best outsourcing estimate that we have so far though it’s
not without flaws, though one should note that Feenstra method will not include the
outsourcing of the final production stage (as in the case of outward processing trade or
import of finished goods) will not be captured by input-output tables.
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2.3 What Industries are affected by Outsourcing? – Data Analysis
In this paper I measure foreign outsourcing by using to two step approach. First i will
use NET Index of international competition (ICNET) form OECD to classify the
industries by the intensity of international competition. Index is based on net
penetration ration and calculates the excess of imports over export. I believe it’s a
good starting point to get an overview since outsourcing should have effect both on
import and export of an industry. Index is calculated as:
Second i will use the Feenstra-Hannson broad measure for foreign outsourcing to look
more specifically if there has been a sharp rise in the use of the imported intermediate
inputs. Choice of broad measure is based on data availability and research design.
OECD stan database or Eurostat input out tables do not distinguish between imported
and domestic intermediate inputs, thus I have used import penetration data for each
industry to proximate the amount of imported intermediate goods. Campa and
Goldberg (1997) used similar method in their four-country study of manufacturing
industries. The input-output tables used by them do not differentiate between domestic
and imported inputs; so Campa and Goldberg combine them with data on import
penetration to derive a similar measure.
The more obvious reason to use broad measure of outsourcing is capture bigger
picture. Like in most studies outsourcing is consider as simple BUY or MAKE
decision. Narrow outsourcing would capture most of the outsourcing if that was the
case, since most trade will occur in the same industry.
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However the choice is no that simple, a complex manufacturing of cars or airplanes
does not provide with the luxury to manufacture everything in house. Firm rather have
to outsource process or buy product like tires and metal to domestic or foreign supplier
in different industries. Thus replacement of domestic supplier with foreign agent will
not be captured in the narrow outsourcing which focuses on the same industry. So the
FH (Feenstra & hanson) wide measure would be the most appropriate. The measure is
calculate as
Outitwide
= IMPit * Sit
Yit
Where IMPit denoting imported intermediate inputs, and Yit8 the production value of
industry i at timet, Sit denotes the share of imports from industry i abroad that is
consumed by the domestic industry i.
Figue shows the calculation for net import penetration and growth rates of intermediate
inputs for 29 manufacturing industries in Denmark from 1980 to 2003. Industries are
divided into three groups by the level import intensity. High import competition refers
to the industry where net import penetration are more than 30 percent, Medium import
intensity refers to the industry where import penetration is o-30 percent and low import
penetration refers to the industries where net import ratios are negative refers to the.
The determination of import competition is arbitry and differs in the case of United
Kingdom.
The Table provide with some interesting results. Looking at high competition industry
we can see very high net import penetration ratios, which would indicate that
industries overall dependency on imports, though some these industries might be
depended on the import by their nature, thus effect of outsourcing on this industry
8 Yit =(total production of industri+imports by industry with Impit denoting imported intermediate
inputs and Yit the production value of industry
i at time t. Sit denotes the share of imports from industry i abroad that is consumed
by the domestic industry ii-exports)
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would not be significant. We can see exactly that happing from calculation of
outsourcing in case Basic Metal, Non ferrous metal and pulp and paper product
industries. On the other hand Office accounting and machinery and leather industry
reflect different pattern, both net import penetration and outsourcing intensity has
increase significantly in the industry
Table 1 Outsourcing Measure for Denmark
Looking at the medium competition industries, we see more progressive trend in terms
net import penetration in wearing and apparel, textile and radio television and
communication equipments. Though increase in outsourcing industry is impressive. In
wearing apparel outsourcing has increase by three fold and in textile it has double from
in last 23 years. Majority of industries that find in this could be classified as moderate
to low technology industries or relatively more labor intensive. Low growth rates in
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import penetration also tell us that outsourcing intensity in these industries has been
accompanied by the export growth. Looking at low import competition we could see a
more stable picture, except of Shipping and boats, and transport equipment and Food
products, where outsourcing is notable, outsourcing in most of the industries has
grown over time, though it is weak. Most industries that have not experienced
substantial growth in this group belong to the high-technology group
The table shows the outsourcing measure for the United Kingdom. High import
competition industries are classified as those that have average net import ratio of
more 15 percent during 1980-2003. Medium competition are those with net import
penetration less than 15 percent and Low import industries classified as those having
negative net import ratios.
Table 2 Outsourcing measure for UK
Source: Created by author, Basic data fro OECD
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In general thesis provides strong evidence of increasing outsourcing intensity in United
Kingdom. 12 out 29 industries have experienced substantial increase in the outsourcing
intensity. Amount of imported intermediate input used in the leather, textile and
apparel industries have tripled from 1980 to 2003, the average growth rate in net
import penetration gives the similar picture. Data depicts slightly different picture than
that of Denmark, in the UK data set some Low Import competition industries have
experienced smart increase in outsourcing intensity. Amount of intermediate inputs
used in the pharmaceutical and chemical industries have doubled in last 23 years. Most
of these industries are considered to be high technology industries, which provides
with the interesting mix of labor or low technology (textile and apparel) industries and
high technology (chemical and pharmaceuticals) industries. This could also be
evidence of the fragmentation of production process theory presented by (feenstra
1998) and has been actively discussed by the academic researchers. Since most these
industries have also experienced substantial export growth and import of input could
indicate firms decision to exploit the productivity gains by obtaining cheap inputs.
Table 3 – Industry ranked by outsourcing intensity
Source: Created by Author
Table shows the top fives industries by their outsourcing intensity in Denmark and
United Kingdom. One should not be surprised with the presence of the apparel and
leather industries in both groups, labor intensive nature of the textile and leather
industry makes it ideal choice for outsourcing to the low cost nations where these
products may be performed for cheaper labor cost. However presence of
pharmaceutical industry and electrical machinery in UK dataset and radio and
communication equipment in Denmark is interesting and it might indicate that
outsourcing is not only limited to the labor intensive industries and trend is extending
to the other industries.
3. Outsourcing and Employment
3.1 Theoretical Framework
In order to measure the effect of outsourcing on employment I will use Stopler-
Samuelson (SM) theorem as a theoretical base. SM theorem analyzes an economy with
two factor of production Skilled/low skilled and unskilled labor and they are fixed in
supply. Good Y and X are classified as skill intensive and labor intensive/less skill
intensive. The SM theorem is based on the assumption that production take place
under constant returns and prices of skill and low-skill Labor intensive goods are
determined by the world market and wage rates of skilled an unskilled labor are
determined by reactions in domestic market.
According to the SM theorem labor is perfectly mobile between two sectors thus
change in price due to import competition will push price of good X low skill (labor
intensive) down, prompting a production shift from product X to product Y as
production of product X is not profitable anymore. The result of the shift will be
excess supply of labor toward firm Y which produces relatively high skilled product
using skilled labor, the flow of excess supply will cause reduction in wage of low
skilled labor and both sectors will become more intensive in unskilled labor.
Putting it into international trade perspective, under perfect competition, the relatively
abundant factor (skill-capital intensive product in case of Denmark & UK) will gain
while the scarce factor will loose when the economy is opened to the world market.
This is because, due to trade, the relative price of the exported good (that mainly
employs the abundant factor and is therefore relatively cheap) will rise with the
additional demand from abroad whereas the relative price of the imported good (Labor
intensive product like textile and clothing) will fall. The increase in demand for the
export good also causes an increase in demand for its production factors (skilled labor
in case of Denmark and UK). However, because the export good uses more of the
abundant factor, the demand for this factor will rise more than proportionally. On the
other hand, the falling price in the sector that is competing against the imported goods
will mainly decrease demand for the scarce factor. This will make its price (wage) go
down. However, Full employment outcome with different allocation of labor between
23
sector – and more inequality in relative wage is possible only if factor of production
completely mobile between sectors. In the absence of labor market flexibility in terms
of wage adjustment and mobility between sectors, the impact of the change in the
production factors will be on the employment of the production factors. Thus it is vital
analyze the labor market structure in Denmark and UK.
3.2 Labor Market Rigidities:
Labor market legislations normally put in to place to protect employees from Unfair or
discriminatory actions on the part of employers. In doing so it also raises the effective
cost to firms of employing workers and raise the effective cost of adjusting levels of
employment. In Stopler Samuelson the main source of inflexibility is cause by the
labor market rigidities. Rigidities in the labor market artificially created by the
government rules regarding hiring and firing of the employment, collective bargaining
and high Union involvement.
Figure 2: Labor Market Rigidities 2000
United States
Un ited Kingdom
Switzerland
Sweden
Spain
Slo v ak Repub lic
Po rtu gal
Po land
No rway
New Zealand
Neth erlan ds
Luxembou rg
Ko rea
Jap an
Italy
Hungary
Germany
Fran ce
Fin land
Denmark
Czech Repub lic
Can ad a
Belg ium
A us tria
A u s tra lia
0,0
10,0
20,0
30,0
40,0
50,0
60,0
70,0
80,0
90,0
100,0
0,0 10,0 20,0 30,0 40,0 50,0 60,0 70,0 80,0 90,0 100,0Trade union density (% )
Collective bargaining coverage (%)
Source: OECD Employment Outlook 2004
24
Figure 2 show summarizes the structure of wage determination systems and the extent
of coordination in wage bargaining, both variables are important to see the full picture
of union involvement in labor market. Trade union density refers to number of persons
actively participating in union activity. While collecting bargaining coverage refers to
the unions ability represent the percentage of the employees in bargaining process.
Denmark seems to have a very high union density and bargain coverage, 70 percent of
the employees are represented in data which infers a very high bargaining power of
trade union in setting minimum and standard wage setting/adjustment. On the other
hand data from United Kingdom depicts a quite different picture, only 30 percent of
the employees are represented by the unions and coverage of collective bargaining
seems to be quite low, which would infer a relatively less rigid labor market. However
drawing a conclusion on just two variables would be too little.
Figure 3 represents the OECD index of employment protection Labor standard.
Employment index measures the strength of the legal framework governing hiring and
firing. The countries are ranked from 1–20, with 20 being the most strictly regulated.
Figure 3: Index of Employment Protection
Source: OECD Employment Outlook
Surprisingly Hiring and firing cost in United Kingdom is relatively higher neither than
Denmark, which suggest that the U.K. economy might not be as flexible, Denmark
seems to have lower hiring and firing costs. Hiring and firing cost are important
employment adjustment mechanism during economic expansion contraction. Oecd
25
index of Labor standard index refers to the strength of the legislation governing a
number of labor market of the labor market. The index being scored from 0 (lax or no
legislation) to 2 (strict legislation) on each of the five dimensions that is working time,
fixed-term contracts, employment protection, minimum wages and employees
representation rights. The picture is somewhat mix United Kingdom seem to have very
weak legislation in this area, whereas case of Denmark is not far away, which is
ranked 2 on the scale.
Looking through three indexes we could safely say that both countries seems to have
serious problem fulfilling the assumptions of Stopler Samuelson theorem. Denmark
has relatively more rigid market than United Kingdom, Trade union bargaining power
in Denmark could have serious effect on the employment of unskilled labor since
wages are determined though collective bargaining between employers and trade
unions and minimum wage is guaranteed. Thus in reduction in the wages would not be
possible in the face of price decrease of low-skill (labor intensive) goods and
adjustment will take place through employment reduction. Though both countries
seem to have problems in terms of labor protection policies and could not consider at
par with the United States which consider being a flexible labor market.
In case of UK, rigidities arise through protection of employment, high hiring and firing
cost will reduce the perfect mobility in the sectors as mentioned by SM theorem, when
sector are not fully mobile reallocation of resources that allow product mix (from labor
intensive to skill intensive goods in case of DK and UK which will effect the wages of
low skill worker) to take place will not happen, as a result firm that keep in the
business of producing the skill intensive goods will suffer from negative economic
profit as adjustment in the wages is not possible and price of good have fallen, as
consequence firm will have to no option but opt for the redundancy or look for the
cheap imported input, which in turn has negative effect since it will effect the domestic
production of intermediate goods, thus employment of low skilled labor will be
effected.
26
3.3 Empirical Analysis – Does Outsourcing Destroy Jobs?
Figure 4 shows the employment development in the Danish and UK manufacturing
industries over last 22 years. Change in the employment is calculated as change in the
number of employees in the corresponding industries. The numbers of job losses over
the entire period are starling and widespread in the case of united Kingdom. Picture in
the case of Denmark is slightly less grim and some industries e.g. Pharmaceutical and
Aircraft industries have actually avoided the downward spiral. Case Pharmaceutical
industry is interesting since it is ranked in terms of import competition and has not
experienced growth in the net import penetration ration, which relatively high across
the time period studied in this paper. Same goes for the iron and basic metal
industries.
Figure 4: Employment development in DK & UK 1980-2003
-100,00%
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Source: Created by the author, data from Oecd
Losses in textile sectors in both countries are significant, 82 percent of the workers in
UK textile countries have lost their jobs compare to 60 percent in Denmark. Similar
trend appears in wearing apparel and leather industries, which would indicate possible
27
effect of outsourcing according to Samuelson theorem as both sectors are consider
labor intensive. Figure 4 also provide some conflicting numbers, UK has also
experience sharp decline in the Electric machinery and Radio, TV and communication
industries which are relatively more skill intensive, while Denmark has managed to
avoid any possible employment loss in theses sectors, which could attributed be to the
existing high outsourcing intensity in theses sector or that restructuring in this sector
has taken place before 1980s or there may be no link to outsourcing and there might be
other variables that may have cause this effect.
In order to examine whether outsourcing indeed have impact on employment and
increasing outsourcing intensity is to blame for the high employment losses in the
manufacturing sector we will use econometric estimation of demand for labor (L) by
ordinary least squares estimation (OLS) for selected 26 manufacturing industries.
ln Lit = a0 + a1 lnW it + β ln IMPit + δ ln Yit
Where:
W = Change in the wage rate
IMP = Change in outsource intensity
Y =Change in total production
it = Particular Industry in time t
Choice of methodology is important to calculate the effect of outsourcing on
employment, Academic literature on outsourcing refers to the series of measure that
have been utilized with different level of effectiveness. The choice of the demand of
labor was driven by the availability of relevant data and precedent in international
research literature. The method has been widely used to study the effect on
international trade and outsourcing. The factor demand approach is based on the theory
of the representative firm. The idea of the representative firm implies that all firms
share the same technology and produce on the same scale. The labor demand approach
thus represents a partial equilibrium framework, as it is implicitly embedded in a single
sector setting. For the representative firm, labor supply can be considered perfectly
elastic so that firms decide on labor demand, for given wages. The focus is on
28
analyzing labor demand rather than wages. Given wages, firms minimize costs by
determining the profit-maximizing set of inputs.9
So in order to maximize the profit firm will replace the costly domestic production
with foreign output or outsourcing. In this context we would expect positive
relationship between change in employment demand and total output (production).
While an increase in the wage rate will have negative effect on the employment, and
will lead firms to substitute away from the more expensive domestic inputs from their
own production or supplier to a more cost competitive supplier abroad where wage
cost are low, thus we also expect a negative relationship between outsourcing intensity
and employment growth.
Magnitude of direct outsourcing effect in regression coefficient would be somewhat
more moderate. First, in our analysis we have used the value of imported intermediate
input rather than the quantity, since intermediate is of cheaper cost the real
replacement impact on domestic production may not be captured. Second replacement
of domestic production may not be fully captured by the intermediate output as firm
may import the product at the final stage of production.
3.4 Regression Results
Regression results of Danish manufacturing industries have been summarized in the
table4. Danish Electric Machinery and Equipment industry was emitted from the
analysis due to technical data problem. The results have divided in three parts; Red
letters show the industries that have experience the highest outsourcing intensity over
the period, blue letters represent the industries with highest net import penetration and
bold Black letters show other industries where regression results are significant. In
general Results show that 14 out 25 manufacturing industries are statistically
9 Alexander Hijzen, 2005 - A BIRD’S EYE VIEW OF INTERNATIONAL OUTSOURCING: DATA, MEASUREMENT AND LABOUR DEMAND EFFECTS
29
significant, the employment in these could be explained by the reduction in Output,
increase in wage rate and outsourcing intensity.
Looking more closely in sector that have experienced high level of outsourcing
intensity we could say model explains the 59, 30 and 26 percent variation in the
dependent variable in the textile, Leather industry and other transport equipment
which is relatively high.
Table 4: Regression results Denmark 1981-2002
Source: Authors calculation (basic data obtained from OECD STAN Database)
In Hi import competing/import dependent industries Railroad equipment, office
accounting and iron steel industries seem to suffer most form the high wages,
Outsourcing is also an important source of unemployment in Iron and Transport
vehicle industries. Coefficient of wages is very high in the all the industry except
pharmaceutical, ships and boats, which demonstrate the wage sensitivity of these
industries, similar conclusion could be drawn about output, firms decision of
30
relocation abroad seem has negative effect on domestic production. Outsourcing
coefficient is relatively high for the low skill labor intensive industries like textile,
wood product, pulp and paper, non metallic, which indicate that outsourcing plays
sever role in employment reduction in this industries. However changes in
employment in chemical industry, which is classified as relatively hi-skill industry,
could also is blamed at outsourcing.
To conclude we could say that Industries failure to absorb import price competition
through downward wage adjustment result in the reduction of domestic production and
jobless. Fact that outsourcing industry is could be present in some Danish
manufacturing industries, a good example in our data is wearing apparel sector which
has experience significant job loss and high outsourcing intensity, though our method
may not capture it due to the fact many apparel product are important as final goods.
UK regression results presented in table 5 are more upbeat than those of Denmark,
Statistical results for 24 out 26 industries have are significant. About 75 percent of
variation in employment could be explained in 5 high outsourcing intensity industries
Table 5 Regression result for UK 1981-2002
31
Source: Own calculation (Basic data from OECD Stan database)
marked in red. Outsourcing coefficient in three industries are extremely high, that
might explain the 80 percent employment reduction in UK textile industries. In general
Labor intensive industries are the one hardest hit, though there no special exception,
only pharmaceutical, printing and office accounting and computing machinery have
managed to escape the full blow of restructuring, increasing outsourcing intensity ratio
inn pharmaceutical firm from 1980 to 2003 might have hinder the job growth in this
Sector.
The appalling regression results of United Kingdom could partly be explained by
going back to net import competition data that we have calculated. It seems apparent
that in the case of United Kingdom net import penetration ratios were more favorable.
Net import penetration measures the intensity of competition based on import and
export and point to the fact that UK industries were more active in the international
market. Thus change in the international prices due to increasing import competition
might have more serious consequences for them, since home production may not serve
export market abroad due to obvious competitive disadvantage and home producer will
also to incoming producer from abroad.
To conclude we could say that outsourcing has cause a significant amount of job losses
in labor intensive sectors in both Denmark and United Kingdom. In the case of United
Kingdom evidence is widespread in the majority of the industries, while In the case of
Denmark relatively high skill intensive industries like chemical and pharmaceutical
industries are not affected.
In order to further strengthen out hypothesis that it is actually outsourcing that has
cause widespread job losses across manufacturing industries we could decompose the
imported intermediate input to see their origin. If the share of imported intermediate
input from low cost or developing countries is on the rise than we could say that trend
of outsourcing is the culprit. However Stan bilateral industry database doesn’t not
provide with luxury to decompose the import data for three reasons (a) Data is covered
for selected countries and does include grouping from developing countries, (b) Time
period is somewhat limited and (c) the most importantly it uses slightly different
32
classification system and is no compatible with classification system that we have in
this paper. Nevertheless I have tried to construct some graphs from Stan bilateral
database in order give us overview of general trend in these imported intermediate
inputs form their origin for the industries that have experience the highest outsourcing
intensity and job losses
Figure 5: Outsourcing by Origin (% of total imported input by DK)
Source: Constructed by Author (Data from Stan Bilateral database)
First graph in the figure 5 represent the three textile industries that have worst job
losses in Danish manufacturing. The trend in the graph could not have more clearly;
there is a rise of 40 percent in non OECD trade, which indicates the share of
developing countries. If that share to be doubtful due to the vast number countries that
are sampled together, we could just look at the china, a classic developing country with
33
abandoned of cheap labor and basic infrastructure. The share of China over laset15
year has risen nearly nonexistent to the 20 percent of total intermediate input in three
textile sectors. At the same time we could see that trade from OECD and EU 15
countries has declined systematically, which would vindicate that due to import
competition imported intermediaries from these countries are not competitive
anymore. Picture for the other transport is also similar. There was 46 percent job loss
in other transport industry, graph sows that trade with non oecd countries has doubled
in last 15 yaers and there is decline in trade form OECD countries. Other two
industries show somewhat more stable picture though there is slight tendency of
increasing trade with non-OECD compare to OECD.
Figure 6: Outsoaring by Origin - (% of total imported inputs by UK)
Source: Constructed by Author (Data from Stan Bilateral database)
Increase in the imported inputs form Non OECD countries for Untied in three textile
sectors is impressive and China captures the good part of changing trade share
imported input from haven to 20 percent alone during last 15 years. Figure 6 depicts
the similar story across the panel. There was 40 and 50 percent job loss over the
studied period in electric and TV, Radio and communication industry respectively.
34
From the graph we could say where its coming form, share of developing countries in
both sector has almost tripled, similar trend observed for the electric machinery. Once
again it´s validate the regression output that in the Case of United Kingdom
outsourcing is not limited to the low skill labor intensive goods, though tendency of
job losses in these industries is less sever than those of labor intensive industries.
So if there widespread job loses in the low skill labor intensive industries in Denmark
and United Kingdom due to outsourcing and trend is moving toward more skill
intensive industries (pharmaceutical) in Denmark and already persistent in UK, how
could we possible explain?, Is it pure evil? Should the countries move back to the
protection era and cut international trade ties to protect their labor?
To draw conclusion like this based on just one side of the story, i.e. job loses in
domestic market would not be appropriate and unscientific. In order to properly
understand the phenomenon we must look at the broader picture by looking at what
drives the outsourcing in order to determine the impressive increase in the outsourcing
intensity over last 23 years. W should also look at the impacts of outsourcing on
industry productivity in post outsourcing era. Most importantly one must not turn a
blind eye to the receiving country i.e. where production is shifted.
35
4. Drivers of Foreign Outsourcing:
Impressive growth in outsourcing intensity over last 23 years demonstrates its
importance in national manufacturing industries for Denmark and United Kingdom.
However in order to fully understand what has caused this tremendous growth and it’s
present and future consequences, one must look outsourcing though global perspective.
Appendix 2 provide a framework to understand the changing pace of outsourcing
through global integration and it’s impact on the firm.
When firms decide on where to outsource their business needs and processes based on
a rational business assessment of economic efficiencies and comparative advantages, a
number of positive outcomes could happen. The cost to consumers of the products and
services these companies provide could go down. The quality and the range of
products and services go up, as companies pour more resources into research,
development and innovation.
Fundamentally changes in global environment facilitated by the technological advance
and reduced trade barriers could affect the firm in two specific ways. First, it creates a
even playing field between domestic and foreign producer, In this open market
domestic producer will have to compete with low cost producer from developing
countries. Second, it provides motivation for domestic firm benefit from outsourcing
productivities, and may cause dominal effect. Before looking at each of the effect in
detail we must first look through how international trade integration (globalization) has
changed the global economic environment. More precisely
(a) We should look at how globalization has changed economics of international trade
(outsourcing) over the years.
(B) What impact these changes have on domestic competition.
36
4.1 Globalization & International Transaction Cost
One of the pioneers on outsourcing research Robert C Feenstra (1998) describe “The
decades leading up to 1913 as a golden age of trade and investment worldwide, an
era that was ended by World War I”. Table 6 shows the level of merchandise trade
relative to GDP. The level of merchandise trade that was experienced during the
golden era in 1913 was not reached by Denmark until 1980 and in the case of United
Kingdom barely reached the level by 1990. Of course one should be careful when
taking into account such general trade statistics because many OECD countries in the
post world war era have moved to the service industry, thus true GDP composition
may and growth may not be capture by total merchandise trade. Even though they
Table 6: Ratios of Merchandise Trade to Industry Value-Added (Percent)
Provide some very interesting insight into the trade integration. Just like feenstra´s
golden age of trade, we could also call the post 1913 period as Dark Age of trade, at
least until 1970, which is generally marked by the era of protectionist policies. Most of
the countries experienced stagnant and declining trade growth in this period. However
post seventy era has once again has seen amazing growth, in case of Denmark
Merchandise trade rose from 65 percent to 90 percent of industry value added. Though
change in the case UK was more moderate in 80´s and more pronounce in 1990s. The
trend in the growth is compatible to my calculation of outsource intensity, Outsourcing
growth seems to replicate the trade in the merchandise. In order to better understand
37
how changes in global environment drive growth I will Amelung (1190) Transaction
cost model.
Appendix 2 shows the graphic version of transaction cost theory. According to the
Amelung transaction cost theory there are three kind of kind of costs that are
associated to the international transaction. The costs are classified as Information
costs, which include cost of searching for information and communication cost, Cost
of good transfer, which include actual transportation cost and costs of trade barrier and
transport insurance cost and Capital transfer costs which include transfer fees and costs
of capital controls and financial insurance cost. Amueling transaction model place
increasing importance on development of the transaction cost factor. Model is
particularly interesting to measure the recent technological breakthrough in
information and communication technologies, development of efficient transportation
network at relatively lower cost and lower tariff, all three factors have severe impact
on international trade.
4.1.1 Cost of trade barriers
Reduction in trade barrier is fundamental to international trade growth, non-artificial
trade barriers like tariff, import, excise duties, inefficient good handling at port and
vague clearing and forwarding procedure have negative impact on the international
trade growth. Last two decades have seen a dramatic reduction in the international
trade barriers.
Figure 7: Trend in the International Tariff rate from 1980-2000
38
Figure 7 show the trend in the international tariff rates from 1980 to 2000. It clearly
splits the tariff reduction two stages. Period between 1980-1991 is marked by
relatively moderate decline in the of both developed and developing countries, the
percent decline from 1980 to 1991 is about 5 percent in both groups. The second stage
presents a more dramatic decline high income countries, reduction in tariff is about 15
percent in developing, while 5 percent in developing countries
4.1.2 Transportation cost
A country’s effective export competitiveness is determined by its productive capacities
as well as its ability to bring goods to foreign markets at the lowest possible cost and
under conditions required by importers and consumers. The efficient transportation is a
major element of supply capacity and is largely determined by the availability, quality
and cost of transport and logistics services. Innovation of containers in 1980s has
clearly emerged as the technological concept governing the transport of trade in
manufactured goods. The majority of international trade is containerized, irrespective
of the mode of transport used. The growth of containerization has resulted in changes
in transport patterns and practices. It has both and quality effect in terms and safety
and storage.
Figure 8: Freight Ration by Country Group Of Import Value
39
Source: UNCTAD – Globalization and facts 2004
Figure 8 shows the trend in ocean freights and air transportation costs. Ocean freights
have declined significantly since 1940, however their downward progression 1960 to
1980 has been moderate and steady. Significant decline of international ocean freight
in 90´s is significant for the cross border trade growth and may be link to the increase
in international trade.
4.1.3 Information Costs
The last two decades of 20th centaury have been characterized by the major
technological advances. Specially 1980s and 1990s have seen major breakthrough in
the information and communication technological. The internet revolution has changed
the way we live every day life, it has the way we get information, the way we do
business an spend leisure time. There is hardly any part of the economy which is not
affected by the internet revolution. At the same time cost of these services has declined
significantly.
Improved and low cost information and communication technologies (PC, fax machine
and modems etc) are crucial for the outsourcing intensity. Figure 9 shows reduction in
the telephone and satellite charges. Satellite charges have taken a free fall in 80 an
telephone charges (cost of telephone is measured as three minute call form new York
to London) have hit the rock bottom in 80s and 90s.
40
Figure 9: Cost information ICT
The reduction these cost are very important as provide firms to efficiently control the
activities affiliates in the host countries and help them keep in constant contact with
their supplier. In addition, Internet revolution has substantially reduced the cost
information searching, ready made database of foreign supplier on internet are
constantly update and provide a very useful too at extremely low cost In addition it
also provides additional information about the potential supplier’s quality of products,
customer relation and on time delivery traits for the experience of other buyers.
Constant communication through email at fraction of cost and sharing of
organizational database across border through networking has enormous productivity
potential.
4.1.4 Capital Transfer Cost
Capital cost are characterize as the costs that come up due to financial transactions
from, e.g. payment of imported good. The cost of capital transfer barriers is made of
two factor direct and indirect control. Direct control put a strict limitation on foreign
monetary transaction. These are similar to that of quantitative restrictions on imports
of various goods and services. They also include foreign ownership and investment
restriction in particular sectors.
Figure 10 : Evolution of financial opennesss
41
Source: The Impact of International Financial Integration on Industry - Ellen
Vanassche1, Katholieke Universiteit Leuven – Belgium 2004
Indirect capita control raises the cost by discouraging capital transfer through
discriminatory or double taxation of cross border capital flows. By taxing foreign
money required to purchase foreign goods and services, capital controls cut the
quantity imported and/or raise the domestic relative price of imports. Capital control
costs are closely related to the development of international trade and growth. Figure
10 presents the evidence of capital control OECD and developing countries, Zero
referents a regime of strict capital control, while one represent no capital account
restriction. We can see that there is clear trend in OECD countries to move towards
more liberal capital regime in order reduce cost and boost trade. In case of developing
countries is somewhat unclear, though there hesitance towards more liberal capital
regime may linked to the development in their respective economies. Conclusion is
based on the fact the shift towards more liberal regime in Developing countries has
taken moment in late 80s when, role of state was redefined through deregulation,
privatization and de-monopolization on unprecedented scale to stimulate the economic
growth. Reduction capital and foreign exchange control was part of the drive, from
experience of the OECD countries we may infer that economies may tend to move free
capital control regime at certain stage of economic maturity.
42
There is another important source of capital transfer cost raised by the (Matthias
Busse). He points out that international trade of commodities deliberately includes
risks due to the lack of enforceable property rights and contracts. Foreign governments
or contracting parties may abuse this lack of enforcement and may default on a
contract. In order to protect firms against these risks, they may seek special insurances
against default, such as letters of credit or export guarantees by governments and
banks.
4.2 Outsourcing and Competition:
Global economic integration through the reduction of trade barrier, technological
advances, reduced cost of capital and transportation efficiencies have altered the
environment in which firms operate. While globalization offers unprecedented growth
and development opportunities for firm, it also increases competitive pressures on
them. Globalization removes the traditional protection and amnesties that firm enjoy in
domestic markets, and force the national producers to compete in the international
market with the producer from low wage countries. In essence it increases the
predetermined costs for firms that lag behind; those lagging firms thus risk becoming
marginalized.
An open and liberalized world changes the rules of the game and raises the stakes. The
only viable way for firm to prosper in this market is to focus on its competitiveness,
thus increasing firm competitiveness has become a major challenge in the globalize
economy. Competitiveness is defined as the ability to provide products and services as
or more effectively and efficiently than the relevant competitors. In the traded sector,
this means sustained success in international markets without protection or
subsidies.10Competitiveness of an enterprise could be attributed to numerous variables
like investment intensity, technological know how, quality of inputs and managerial
capabilities. Though in manufacturing industries labor productivity or better said total
labor cost is important. Thus companies and industries that are involved in labor
intensive and low skill products like apparel, clothing, footwear and office and
10 The competetive institiute
43
accounting machinery will be faced with the severe import price completion from the
countries that abandoned in labor and have comparatively low cost.
Table 7 Average Annual wages ($)
Source: OECD Data
Table 7 shows the Average annual wages in the Denmark, United Kingdom and
developing countries. In general difference between developing and developed
countries is astonishing, average annual income of a Danish worker is 4872 U.S.
dollars, while an Indian worker receives a astonishing 39 dollars per year and Chinese
worker make 125 dollar over the year. The difference between DK/UK and China is of
particular interest.
The divide between two countries is huge and hard to comprehend. Even though the
cheap labor cost will be crucial element for the competitive advantage for the Chinese
or Indian manufacturers it has to be coupled with other operational efficiencies in
order to gain the upper hand. Once these companies reach the minimal technological
know how, operational efficiencies and skill, they will tend to challenge their
competitors on the side of the globe. That has been the case in many Danish and UK
manufacturing industries. Import competition from low wage countries has pushed
western manufacturer to look for the ways to cut their production cost in order to
44
survive. According to the survey11 conducted by the International labor organization
Cost reduction was the prime reason for the companies to indulge in the outsourcing.
5. Outsourcing & productivity – impact on local plant
Continuous improvement in the productivity is crucial for the growth and survival of
an efficient organization. Productivity also plays important role in the Income growth
of a country and it’s competitiveness in international market. Productivity refers
developing techniques which enable existing goods and services to be produced more
efficiently, or which expand the range or quality of goods and services which can be
produced.
Figure 11: Productivity Framework
11 Peter Auer, Geneviève Besse and Dominique Méda (eds.) 2004 -Offshoring and the Internationalization of Employment
-A challenge for a fair globalization? – International labor statistics.
Capital Intensity Outsourced inputs Quality of Labor Quality of Capital
Total Factor Productivity
Improved
Competitiveness
Skill
Development
Higher
INDUTRY
GDP
Qualitative Inputs Quantitative Inputs
45
Source: Created by Author
Figure 11 provides a framework to understand the way productivity affects the
manufacturing firm on the plant level, which in turn contribute to the industry GDP.
Qualitative and quantitative inputs are equally important and inter dependent to reach
the overall productivity goal. The best way to look at the framework is as a chain,
which ultimately leads to higher growth and provider further impetus to re-invest in
qualitative measure to boost the knowledge in skill level. Outsource inputs in the
framework could be a lifeline for the productivity of the manufacturing industries
suffering from import competition from low wage countries.
International outsourcing effects productivity of a manufacturing plant in number of
Ways. First, firms could benefit form outsourcing by slicing up the value chain, when
goods are produced in a multistage production process each good involves different
stages from basic upstream production to the eventual completion of the final good in
the downstream stages. By moving some of these processes abroad or replacing them
by cheap foreign inputs a firm can inject a massive dose of productivity in that
particular process and overall productivity of the good.
Second, by indulging in the business of foreign outsourcing firm could have access to
the higher quality of goods than those available domestically due to specialization of
foreign trader in that particular process. Therefore increasing use of internationally
traded inputs could result in a direct boost in productivity for the manufacturing firm.
Table 8: Productivity in UK manufacturing (Value added per employee –million of DKK)
46
Source: constructed by Author, Data from OECD Stan database
Thirdly, by Outsourcing the whole upstream production process firm can benefit form
moving its focus on more specialize or high skilled part of the production process
which could in turn result in higher productivity gain.
Table provides the change in the productivity for UK manufacturing industries from
1980 to 2003. Productivity is calculated as value added divided by the number of
employees in the corresponding sectors; measure is often used as labor productivity.
Though variable of labor productivity does not provide us detailed picture of the
productivity gains in terms of production factor, it does give us sense of direction. We
have to be careful when drawing a connection between productivity numbers and
outsourcing, productivity gains in figure may also represent a good chunk of
productivity gains by using the other factors like technological breakthrough in
production process or radical change in design of production process. Even though we
could assume that a good deal of productivity gains in these industries may have come
from outsourcing.
Looking at the table we could see most the industries have experience smart growth
over the last 23 years. We could also infer that pharmaceutical and textile sector has
47
significantly benefited by the outsourcing strategies, its share of proclivity growth is
higher than that of average UK industry. we could see that textile industry has
experienced higher productivity during the period between 1990-2002, this the period
where relatively large layoffs have taken place in textile industries and numbers might
reflect the efficiency gains through the replacement of domestic production by foreign
inputs. Similar pattern is repeated in the UK pharmaceutical industry that has
experienced outstanding productivity growth during the 1990-2002, this is the period
where outsourcing intensity has actually doubled. Radio television and office
accounting industry show similar trend.
In the case of Denmark productivity growth is somewhat more moderate, though its
not a surprise given the outsourcing intensity in Danish manufacturing industries was
weaker than that of United Kingdom. If we look at the table 9 in the next page we
could see that productivity growth is visible both in the five sectors marked with red
color, these are the sectors that have experience highest increase in outsourcing
intensity, however its difficult to isolate the effect of outsourcing due to the high
average productivity growth most of the Danish manufacturing sector.
Table 9 Productivity growth in Danish manufacturing (value add per employee in million Dkk)
Source: Constructed by author using OECD data
48
Even though pattern in the productivity growth in textile sector does coincide with the
increasing outsourcing intensity in the sector and increasing job losses in three textile
sectors. The productivity growth in Pharmaceutical industry is outstanding, sector is
not listed as one with the highest increase in the outsourcing intensity, though its worth
noticing that it has high dependence on the foreign inputs in our sample and that could
be a reason for the spectacular among other things.
To conclude we could say that outsourcing does have positive effect on the
productivity growth of Danish and UK manufacturing industry. Industries that have
experience high growth in the manufacturing or one with high dependency on foreign
inputs seem to have relatively higher productivity growth. Intensity of productivity
growth is higher in United Kingdom that that of Denmark, which is compatible with
the fact that UK companies tend to invest more in outsourcing strategies.
6. Effect of Outsourcing on Host country
Host country effect of outsourcing is crucial to assess the overall impact of
outsourcing; the host country effect of outsourcing is not the usual one that is
mentioned in the newspaper or TV and still relatively uncharted territory in the general
public domain. Outsourcing is important for providing countries with capital and, more
importantly, technologies for production and for gaining access to export markets. In
reality outsourcing could be force of transformation and key for developing countries
for the long term sustainable economic growth. In general economic literature
measures the effect of outsourcing on host country through Inward Foreign Direct
Investment. FDI is usually defined as ownership of foreign capital or stake in the
capital of foreign entity; it includes corporate activities such as building plants or
subsidiaries in foreign countries.
The impact outsourcing on the local economy could vary depending on the mode of
outsourcing strategy. In primary mode Multinational Company’s decision to involve in
FDI is usually considered as a trade-off between supplying a market by exports or by
local production. In classic Multinational FDI model basic consideration is given to the
costs of supply and decision are made on strategic level, perceived future benefits
49
drive the strategy and focus is kept on the possible efficiency gains that may lead to
increase in the competitive level of the Firm.
Choice to move production abroad is made because marginal cost, transport costs, and
delivery time might be high or it could be driven by Multinationals failure to tailor the
product to local circumstances. Investment based on this kind of rationality is
described as horizontal FDI, Companies like Nike have been using this kind of FDI
made to outsource the downstream production functions and trend has been replicated
by the large number of firm looking though vertical integration efficiencies.
In the second mode Vertical FDI or Outsourcing investment is rather driven by need.
The motivation is to take advantage of cheap labor to shift the labor-intensive parts of
the production in low wage countries. Major difference between two modes of FDI is
the change in the intensity of domestic competition and productivity gains by local
firm through knowledge and technology spillovers. Horizontal FDI are relatively more
oriented towards local market and often used as export base, their effect on the
domestic competition might be significant. Whereas vertical FDI or outsourcing by
need is rather more outward oriented and ignore the domestic market, partially
spearing the domestic competitions.
In this paper we do not distinguish between two modes of FDI, Changing nature of
international competition has caused firms to adapt to changing business environment
by locating in the low cost countries. In the case of United Kingdom international
trader intensity in pre outsourcing era was quite high many firms were active in the
International market before international trade boom, many of these companies were
serving foreign countries by export mode. Change in the international
prices/competition will force them to move abroad not by choice but to remain
competitive and hold on to the market share. In this case a firm which relocates major
part of his production abroad through subsidiary or joint venture may serve local
market through subsidiary. Thus firm will have focus on local market and will serve as
an export base for the parent economy.
Figure 12 - FDI Sock Denmark, UK and China
50
FD I stock- M illions $
-
200 000
400 000
600 000
800 000
1 000 000
1 200 000
1 400 000
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Outw
ard FdI -DK & UK
-
50 000
100 000
150 000
200 000
250 000
300 000
350 000
Inward FDI- China
United K ingdom Denm arkChina
Source: Created by author, data from unctad
Figure shows the change in the change in the outward FDI for Denmark and UK stock
from 1980-2005 and inward FdI for china. The growth in the last 10 years is
exceptional and show that its one of the favorite spot for foreign outsourcing or FDI
investment. The growth in the outward FDI stocks replicate the growth in the
outsourcing intensity and the size of the stock is staggering that would explain the
exposure of the UK companies in international trade. For Denmark the trend is similar,
increasing outward investment has increased substantially.
I have chosen china as host country due to the mere fact that china’s Trade with United
Kingdom and Denmark has increased substantially in last 23 years as send from
decapitation of outsourcing by origin in the earlier chapter. China fits the perfect
profile of outsourcing country, a outcry with abundant cheap labor and basic
infrastructure that is prerequisite for foreign outsourcing. Not to mention China’s
economic integration in the world economy is, already, one of the major events of the
past decades. In 2003, it was already the sixth largest economy in the world, at market
exchange rate 4, the fourth-largest global trader and the major recipient of foreign
direct investment in the world.12
12 Jorge Blazquez-Lidoy, Javier Rodriguez and Javier Santiso – Chinese trade impact on latin american market -2004
51
Figure 13: Organizational Framework for FDI
Organizational framework for FDI from (Mayer 2003) is a very useful tool to
understand the effect of outsourcing through FDI. Framework takes the holistic
approach where firms decision to decide investment mode depends on the set of many
external and internal factors. Many of these external factors like Capital restriction and
artificial competition law (protection laws) have been considered deterrent to
international trade and the removal of these barriers is partially responsible for the
boom in outsourcing and international trade in general. According to the Mayers
(2003) a firm could further influence this variable by the investment presence in the
foreign country, which could result in the further increase in the international trade or
more favorable business conditions. Nevertheless, most important part the framework
focuses interaction between foreign outsourcer and local firm and its impact on over
all economy. In this paper we will focus on two aspects organizational framework:
First we will look how local company may benefits from the presence of foreign
producer in the domestic market through knowledge and technology spillover, We
will also investigate if there is general evidence of skill upgrading in the local market
52
We will look at the welfare effect on the economy, knowledge spill and skill upgrading
may be source productivity in the industries and increasing FDI and trade should be
positively related to the general economic growth.
7. Outsourcing Impact on the local Firms
The most import asset for any organization is the firm-specific advantages, which are a
set of knowledge-based assets such as technological and organizational capabilities.
These capabilities could be technical knowledge of the production process or
organizational efficiencies that range form data mining to customer intelligence. Most
developing countries lack technology capability and FDI can serve to facilitate
technology transfer and reduce the technology gap between developing countries and
industrial countries. In fact, it is suggested that spillovers or the external effects from
FDI are the most significant channels for the dissemination of modern technology
(Blomstrom, 1989)
Technology and knowledge spillover could occur in many different situations. In very
basic scenario transfer of knowledge will occur when a foreign outsourcer transfer
knowledge to its subsidiary in foreign country. Tendency of transfer is variable and
evolves overtime with firm maturity and local market sophistication. Transfer of
Knowledge depends to extent that it serves the subsidiary to achieve it objectives and
its role in the local competitive environment. Moreover, subsidiaries facing
competition from technologically by advanced local firms may meet that challenge by
upgrading technology with additional support from the parent company hence, the
technology transfer within a parent company and subsidiary can be expected to
increase with the technological sophistication of the local environment
Second, knowledge transfer could also take place in arms length transaction where
firm gives licenses or franchise to foreign supplier. In this case foreign operator will be
obliged to transfer the product or process knowledge to local producer to achieve the
standard quality. In turn the local supplier might improve on that process or technique
53
to achieve higher productivity and will technological upgrade in the industry as other
competitors will try to reduce the productivity gap with their own innovations.
Third, Knowledge transfer occurs when outsourcing firm contract foreign supplier to
replace the domestic process of production in home country. In this case the foreign
firm has to provide certain standard specification of the product, thus giving away
valuable knowledge that has been accumulated over the years. In some cases foreign
contractors constantly work with the local producer to improve the products, thus there
is constant transfer of ideas and knowledge.
The spill over on to the local firms of the foreign technology could be explained by
demonstration effect and labor turnover in first two cases. Demonstration effect refers
to the fact that local firms may adopt technologies introduced by foreign firms through
imitation or reverse engineering. While In labor turnover scenario Staff and workers
trained or previously employed by the foreign companies are may be the source of the
knowledge transfer. They may transfer important information to local firms by
switching employers or may contribute to technology diffusion by starting their own
firms. In third case of spillover, the very supplier could be the source of the knowledge
spill over as it shares the improvement in the production process and technology
through the supply of inputs to local producers.
Figure 14: Value Added in Chemical, textile and total Mnf 1980-2005 (% GDP)
54
Source: World Bank – constructed using WDI Online
The direct effect of knowledge spillover will be on the productivity of the local
producer through improvement in the product and process design and technological
advancement in the process. Figure 14 provides the value added for Chinese total
manufacturing, textile and chemical industry. The graph does not any significant
changes in the pattern. Though there is slight improvement in the value added by the
chemical industry, which is consider to be relatively more skill intensive. Absence
impact of value added is not so strange since productivity is dependent many different
variables, improvement in technology and process knowledge is just one part of it and
development in value added could be shadowed by other factor.
In the run the Outsourcing decision of the foreign company coupled with the
knowledge diffusion could cause skill up grading in the Chinese manufacturing. The
process that are considered low skill intensive in Denmark and united Kingdom may
be considered high skilled in the Chinese economy, thus providing motivation for the
local labor and population update their skill in order the rap the higher economic
benefit. This skill upgrading in the long run coupled with knowledge diffusion
technology spill over will result in the development more skill intensive manufacturing
55
products in China, and we would expect a relative decline in the more labor intensive
sectors.
Figure 15: Chinese export to rest of the world 1980-2005
Total exports of China to the rest of the world, in US$1,000, 1980-2005
0
100,000,000
200,000,000
300,000,000
400,000,000
500,000,000
600,000,000
700,000,000
800,000,000
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Primary agricultural products Primary mineral products
Machinery & equipment Office machines, telecomm. equipment & electrical machinery
Clothing & apparel accessories, textiles, footwear Other manufactures
Source: Linda Y. Yueh (Chinese statistical year book)
The figure 15 shows changing pattern of Chinese manufacturing, from virtual non
existence in 1980s machinery & equipment has emerged as one the main exporting
sectors of the Chinese economy. Development in the telecommunication equipment
and electric machinery is even more prominent; the sector has emerged as a leader in
the Chinese manufacturing and taken over the more labor intensive textile sectors.
Emergence of these two sectors as leader would vindicate of theory of knowledge
spillover and skill upgrading as both of these sectors are considered relative more skill
intensive.
7.1 Outsourcing & Economic Performance
Generally outsourcing has positive effect on the overall economy of the host country
through direct and indirect effects. Firm decision to relocate in the foreign country has
direct effect on the employments as it creates demand for labor. It also help country
56
improves its trade balance as local production replaces imports and country is used as
an export base. It also provide impetus for the local and central government to redefine
the laws and rules relating to foreign trade, capital restriction, labor laws and
competition laws that will have positive effect and long term impact on the overall
performance of the economy.
Dollar Kraay (2001a) shows the developing countries that had the largest increase in
the trade share between late 1970s and mid 1990s (called “globalizes”) experienced on
average a much larger increase in income per capita during the 1990s than did not
globalizes. They further concluded that trade volumes are important determinant of
changes even after taking account of variety of other determinants of growth and of
possibility that growth could cause the increase in the trade.
Figure 16 : China’s Real GDP per Capital & Trade openness
Source: Paul Mason, IMF – pdp/01/04
Figure shows the relationship between real GDP and openness of the economy
(computed as total of import and export to GDP). It provide interesting information, if
we look at the period from 1960-1980 the growth is stagnant, this is period marked by
the trade protection policies, volume of trade in this period is quite low. On the hand
the boost in the growth coincides with period of high influx of foreign direct
investment, and economic liberalization in china. Trend in the graph vindicates the
57
conclusion of the Dolla and Kraay that influx of trade is positively associated with
economic growth. However the most important source of sustainable economic growth
comes from knowledge spillover and skill upgrading as it motivates people to climb
the ladder of economic prosperity by acquiring skills and education in order to get
accer to higher economic wages.
8. Synergies from Outsourcing interaction
Outsourcing may be a zero a sum game for the developing countries if looked through
short term pessimistic perspective. Increase in outsourcing does cause a significant
amount of job losses. However short term trend without a long term perspective is
useless and does not depicts the whole picture. A zero sum outsourcing could be a
source for the long-term prosperity and growth for both developing and developed
countries if is taken as an opportunity to re adjust economic disparities in the global
economy through global trade ingeneration.
For the developed countries outsourcing is painful in the short term since they have to
bear the heavy cost mass layoffs and readjustment cost in labor intensive
manufacturing sector. However it also provides them with the opportunity re-adjust
the rigidities (labor market laws) in the economy that may have worsened the situation.
Above all outsourcing provides developed countries with the opportunity to shift the
structure of the manufacturing sector from low skill intensive activates to more
specialize high skill production. This will provide platform for the future competitive
advantage for Danish and UK industries.
The benefits for the developing countries are not only restricted to the productivity
gains that have been discussed in paper. Cheap product from low cost countries also
provide low income group in the developed countries with the cheaper alternative and
eventually enhance their purchasing power, thus giving this group opportunity to send
more money on the relatively height technology products produce in developing
58
countries. In addition lower input from cheap countries help developed countries keep
the price inflation low.
UK and Denmark could also benefit in the long run from the improvement in living
standards in the China, FDI, technological and knowledge spillovers provide
tremendous potential for the economic growth and development for China. Increase in
the real income will cause Chinese customer to demand more high skill intense goods,
thus opening up huge market for Danish and UK firms that are specialized in hi
technology goods. UK and Danish hi technology companies that are already in some
kind of outsourcing might even benefit to a greater extends by profiting from the
existing market knowledge. Finally, outsourcing provides with most important benefit
of all by lifting millions of people out of poverty through economic growth and
welfare.
9. Conclusion:
After studying different aspects of foreign outsourcing and their potential impact on
the different stakeholder of the economy, it is not possible to outright reject all the
skepticism and stereo types attached to the foreign outsourcing. However a systematic
look provides a framework to understand evolution of the phenomenon.
There has been significant increase the outsourcing intensity in manufacturing
industries in Denmark and United Kingdom from 1980 to 2003. The outsourcing
intensity is relatively higher in UK manufacturing than that of Denmark. Labor
intensive industries seem to be the prime target of outsourcing, Leather and footwear,
wearing apparel and textile industries have experience the highest outsourcing
intensity in both countries. In the case of united Kingdom relatively more skill
intensive industries like pharmaceutical, radio and television and communication
industry shave also suffered from high outsourcing intensity, which indicates
outsourcing phenomenon is not only limited to low skill intensive industries. It is also
worth mention to note that industries that are ranked high import exposure (based on
59
net import penetration ratio) e.g. iron and steel and Non-ferrous metal have not
experienced dramatic increases in our sample. The reason for that could be that they
are already dependent on the foreign inputs and restructuring has already taken place.
Regression analysis using demand factor of labor confirm our hypothesis that
outsource does have negative effect on the employment. In the case of Denmark 14 out
25 manufacturing industries resulted positive with statistical significance, the
employment in these industries could be explained by the reduction in Output, increase
in wage rate and outsourcing intensity. Strongest effect of job losses is evident in the
apparel and rail road equipment. UK regression results presented are more upbeat than
those of Denmark, Statistical results for 24 out 26 industries are significant. About 75
percent of variation in employment could be explained in 5 high outsourcing intensity
industries. Thus confirming the hypothesis that outsource has negative effect on
employment.
Decomposition of outsourcing by origin further vindicate that there is sudden rise
imported inputs from low wage countries is the most probable cause of the
employment loss in developing countries. To understand the phenomenon we explore
look at he driver of foreign outsourcing. The world economy has gone through the
transformation in last 30 years. Traditional artificial and non artificial trade barriers do
not exist anymore. The revolution in communication technologies coupled with the
low cost of transportation economic liberalization has changed the face international
trade. National markets are no longer protected and the globalization of the industry
taking place. Changing environment put the local producer from Denmark and UK in
the same playing field as the producer from China, who obviously has comparative
advantage through access to cheap labor.
Since both Danish UK market posses some level of rigidities, adjustment of wages can
not take place and firm has no choice to look for the low cost inputs in the foreign
market where wages are low. The preventive action of the domestic firm results in the
reduction of the local output and job losses.
60
As a consequence of domestic UK and Danish firm to move part of the production
plant abroad or replace it with supplies from low wage countries results in the direct
productivity effect on the plant level. I have found positive productivity growth in the
both Danish UK manufacturing. Results in the pharmaceutical industry that has high
outsourcing intensity through out our sample are exemplary, since pharmaceutical has
not experienced such high unemployment. It indicate that outsourcing could be
strategic when used skill intensive industries, where Danish and UK industries have
comparative advantage.
The impact of outsourcing in Chinese market is also very favorable; outsourcing is an
important Source of FDI. Presence of foreign Danish or UK results in the knowledge
and technology transfer through demonstration, labor turnover and direct relationship
with foreign supplier, these spillovers are crucial for sustainable economic progression.
To conclude we could say that outsourcing high short term cost in terms job losses in
the domestic market, even though it helps firm to improve productivity and remain
competitive in the in international market, which in turn should boos the performance
of home country. On other hand outsourcing is critical for developing countries like
china and give them hope and strength to climb on the ladder of economic properity.
61
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Chnages In the Global Environment
Trade Liberlaization
Technological
THREAT:
Increase Import competetion
Increase Domestic competetion
OPPERTUNITIES:
Aceess to W
orld m
arkets
Posible Productivity gains
New
Business Oppertuntities &
Threats
Reduced Transaction internacional
transaction cost
Startegic response by firm to defend
& enhance competeive porition
Increase Outsourcing
Intesnsity
Improvered T&C techjnologoies at low cost
Hassle free- Cost effeceient access to int.
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