Does Material and Service Offshoring Improve Domestic Productivity? Evidence from Japanese manufacturing industries

1. Does Material and Service Offshoring Improve Domestic Productivity?Evidence from Japanese manufacturing industries Keiko Ito (Senshu University) Kiyoyasu Tanaka (Institute of Developing Economies) WIOD Conference on Industry‐Level Analyses of Globalization and its Consequences Technische Universitaet Wien, Vienna May 26-28, 2010

2. Motivation • Progress in fragmentation of production processes and the international division of labor in East Asia • Increase in offshoring to Asia contributed to skill-upgrading in Japan (Ahn et al. 2008, etc.) • Statistical evidence so far that offshoring enhances productivity is still weak • Particularly, on the effects of service offshoring, empirical evidence is scarce

3. Definition of offshoring • Olsen (2006) • “Offshoring” refers to : “Relocation of jobs and processes to any foreign country without distinguishing whether the provider is external or affiliates with the firm” “International outsourcing”: relocation of business activities to unaffiliated foreign firms + “International insourcing” : relocation of business activities to affiliated foreign firms

4. The purpose of this study • Utilizing the comprehensive I-O Tables, relatively detailed industry-level data, and trade statistics, we measure the size of offshoring of material inputs and services inputs, and examine the trend and characteristics of offshoring for Japanese manufacturing • Using industry-level data, we investigate the impact of offshoring on domestic productivity for the case of Japanese manufacturing • Test for the presence of productivity-enhancing effects for both material offshoring and service offshoring • Examine how the effects differ for offshoring to different regions and of different activities

5. Potential impacts of offshoring on productivity • By relocating inefficient tasks to low-cost countries, the unit cost of the firm’s product falls (=cost savings) • By offshoring less productive stages of production process, firms can shift corporate resource to high-productivity activities (product development, process innovation, etc.) (=restructuring) • The use of new varieties of imported material or service inputs may increase productivity (=variety effect)  Technological innovations (ICT, transportation), erosion of trade barriers

6. Previous studies (Industry-level studies) • Egger & Egger (2006): EU mfg. 1992-97 Offshoring has a +tive effect on low-skilled worker labor productivity in the long run • Amiti & Wei (2006, 2009): US mfg. 1992-2000 (TFP & LP) Service offshoring (++) Material offshoring (+) • Daveri & Jona-Lasinio (2008): Italian mfg. 1995-2003 Material offshoring (+) Service offshoring (0) • Lin & Ma (2008): Korean mfg. 1985-2001 Marial offshoring (+) Service offshoring (-)

7. Previous studies (Micro-level studies) • Görg & Hanley (2005): Irish electronics firms (1990-95) Material offshoring (+) only for plants with low exp intensities Service offshoring (0) • Görg, Hanley & Strobl (2008): Irish mfg Service offshoring (++) only for exporters -- service offshoring requires knowledge to search for partners • Hijzen, Inui & Todo (2006): Japanese mfg (1994-2000) Offshoring (+) 4x greater effect than domestic outsourcing • Fariñas & Martín-Marcos (2008): Spanish mfg (1990-2002) Offshoring (+)

8. Unclear effects of service offshoring • McKinsey Global Institute (2005, 2008) US service offshoring to India  + on US economy Germany & France  -tive • Daveri & Jona-Lasinio (2008) - transitional adjustment costs? ( low re-employment rates, less flexible labor mkt, low job creation) - most productive services are offshored to escape existing inefficiencies at home? ( insufficient liberalization) • Lin & Ma (2008): language barriers • MGI (2005) : wage levels of destination countries, competitiveness of the home country, ownership structure of affiliated offshore providers

9. Measurement of offshoring • Offshoring =(imported intermediate inputs from all industries) / (total non-energy intermediate inputs) • Material offshoring: z=MO (j=mfg. industries) • Service offshoring: z=SO (j=offshorable services) - telecommunications, insurance, finance, business services, information services • Data: 1990, 1995, 2000 I-O tables (benchmark) Trade statistics (MOF, Japan), METI extended I-O Tables, BOP statistics, JIP database 2009

10. Table1. Material & service offshoring in Jpn mfg US: 0.18-0.29 % Italy & Korea: 1+% US: 12-17 % Italy & Korea: 20+%

11. Estimation model • Production function • Regression Model • Include industry dummies & year dummies • Include one-year lags of offshoring variables • Endogeneity --- Use Value added per worker as a dependent variable • Data for S, M, L, K --- JIP Database 2009, 1988-2004

12. Table 3. OLS estimates of the effect of offshoring on TFP (1)

13. Table 3. OLS estimates of the effect of offshoring on TFP (2)

14. Robustness checks • Labor productivity (VA per worker) specification Material offshoring  +tive & significant (Table 4) • TFP growth specification Material offshoring  +tive & significant • Additional controls (Table) • Material offshoring: +tively associated with domestic productivity • Service offshoring: insignificant

15. Table 5. OLS estimates of the effect of material offshoring to Asia on TFP

16. Table 6. OLS estimates of the effect of information services offshoring on TFP

17. Summary of the results • Material offshoring: +tively associated with domestic productivity • Service offshoring overall: insignificant • Material offshoring to Asia : +tive & significant • Material offshoring to NA & EUR: insignificant  Characteristics of destination country do matter  Offshoring to low-cost region brings greater productivity gains • Information service offshoring: +tive & significant • Business service offshoring: insignificant

18. Effect of service offshoring on productivity • Business services involve a substantial amount of judgment & communication b/w clients & professionals • These tasks need to be standardized & reorganized in order for foreign firms to provide them from a distance • Peculiarities of Japanese language & business culture may be a barrier

19. Conclusion • Material offshoring has a positive effect on productivity while service offshoring does not. (in line with previous results of Italy & Korea, but at odds with results of U.S.) • Although the level of service offshoring is still low, increase in info service offshoring would improve productivity. • However, it has been pointed out that the corporate organization of Jpn firms is not well suited to standardized IT systems. (decision-making processes require substantial interdivisional comm. ) (Motohashi 2008) • Firms which restructure their IT management method would be able to benefit from offshoring of services. • Material offshoring to Asia has a positive effect on productivity. The large differences b/w factor prices at home & Asian countries, coupled with geographic proximity, appears to have yielded a productivity-enhancing effect.

20. Future research • Peculiarities of the Japanese business practice or peculiarities of the Japanese langugage & culture?  examine effects of “international” outsourcing and “domestic” outsourcing of business services • Effects of offshoring on various types of workers (low-skilled or high-skilled workers) • Productivity effect of service offshoring by region

21. Thank you!