May 12–17, 2008

1. Offshoring and Productivity: A Micro-data AnalysisJianmin Tang and Henrique do Livramento Presentation to The 2008 World Congress on National Accounts and Economic Performance Measures for Nations May 12–17, 2008

2. Outline • Introduction • Objective • Data • Offshoring and its Associated Factors • Offshoring and Productivity • Conclusion

3. What is offshoring? Between countries Within countries Between Firms OFFSHORING Within Firms • This paper covers • Material offshoring (both international outsourcing and insourcing) • R&D service offshoring (only international outsourcing)

4. Introduction Firms are heterogeneous even in the same industry • Not all firms will participate in offshoring • Participants may pursue different offshoring models • They offshore to different geographical locations • They may obtain different productivity dividends from offshoring • Geographical locations of offshoring may matter for productivity • Better to use micro data with information on geographical location

5. Introduction (continued) Offshoring may depend on many factors • Transaction costs • relationship-specific investment, • contractual incompleteness, • search efforts, • transportation costs, and • coordination and communication costs • Market conditions of foreign suppliers • trade liberalization, • reduction in FDI restrictions, • the availability of cheap skilled labour, and • the ability to produce and supply high quality products and services • Firm-specific factors • productivity level, • the skill level of workers and managers, and • size • Offshoring is not for every firm and every foreign location

6. Introduction (continued) Different offshoring business models • Simply replacing expensive domestic suppliers by cheap foreign suppliers • Offshoring low productive and low value added components, • Employing foreign expertise (e.g. R&D services) and using high-tech components abroad for designing quality products, or • Offshoring due to adopting foreign technologies (e.g., investing in foreign M&E) • Offshoring is associated with different business models or organization, which leads to different geographical locations

7. Introduction (continued) Possible productivity dividends from offshoring • The composition effect • Moving up the value chain • Focusing on high value added component • Introducing high quality products • Specializing and obtaining economy of scale • Focusing on competency • The innovation effect • Facing intense international competition • Exposing to the world technology frontier and best management practices • The effects may depend on offshoring business models and geographical locations • Geographical location of offshoring may matter for productivity dividend

8. Objectives • What factors are associated with material or R&D offshoring? • Is material or R&D offshoring associated with plants’ productivity? Does the geographical location of offshoring matter for the association?

9. Data The Statistics Canada’s 2005 Survey of Innovation (SI) • 6,143 plants in logging and manufacturing industries with at least 20 employees and $250,000 in revenue • The response rate is 72% • One-time cross-sectional, covering the year of 2004 (for the purpose of this study) • Outward-oriented business activities with geographical locations • Percentage of total expenditures on raw materials and components from overseas (material offshoring) • Percentage of R&D services contracted out to independent foreign firms (R&D offshoring) • Other plants and operations in the firm (multinationals) • Percentage of investment on foreign M&E • Percentage of revenue from exporting • Other important variables • Percentage of workers with university education • Plant size

10. Data (continued) The SI was linked to 2002 and 2004 Annual Survey of Manufacturers (ASM) • 6,109 in-sample manufacturing plants, representing a subpopulation of17,367 manufacturing plants. • Production data

11. Offshoring and Its Associated Factors

12. Hypothesis 1 Offshoring is associated with: • outward-oriented business activities • being multinationals (establishing foreign affiliates through FDI) • adoption of foreign technology (investment in foreign M&E) • exporting • plant-specific factors • productivity level • skill level of workers and managers • plant size

13. outward-oriented business strategies Being a multinational • intra-firm trade accounted for significant part of imports (47% in U.S. in 2005). • most of the intra-firm transaction is associated with intermediate inputs Adopting foreign technologies • requiring specific materials or accessories from the foreign manufacturers • requiring the manufacturers’ expertise (R&D services) Exporting (indirectly influencing) • forcing the firm to improve its cost-competitiveness by exposing a firm to international competition • better understanding local markets • lower offshoring transaction costs due to established networks

14. Plant-specific factors Productivity level • offshoring is often considered to be endogenous to productivity (Amiti and Wei (2006). • high-productivity firms more likely engage in offshoring activities than low-productivity firms (Antràs and Helpman 2004) Skill level • knowledge and skills are required to coordinate the complexity involved in offshoring • skilled workers are required to specify R&D projects for offshoring and to develop absorptive capacity to benefit from R&D offshoring. Plant size • Large firms are perceived to be more likely to engage in offshoring than small firms. • the cost of financing offshoring projects is lower • larger benefit from economies of scale • lower risk of offshoring due to its large scope

15. Regression model 1

16. Estimation results: material offshoring and the associated factors Note: t-statistics are in parenthesis. “*”, “**”, and “***” denote significance at 10%, 5% and 1%, respectively.

17. Estimation results: R&D offshoring and the associated factors Note: t-statistics are in parenthesis. “*”, “**”, and “***” denote significance at 10%, 5% and 1%, respectively.

18. Productivity and Offshoring

19. Hypothesis 2 • Productivity (MFP) is associated with offshoring and the association differs across geographical locations • The composition effect • Moving-up the value chain • Specializing and obtaining economy of scale • The innovation effect • Increased competition • Exposure to advanced technologies and business practices • These effects may differ across geographical locations

20. Regression model 2

21. Control variables Fuel and power consumption per worker, as a proxy for capital intensity • working capital stock is highly correlated with fuel and power consumption • industry differences in energy intensity are accounted for by industry dummies. Being multinationals • multinationals are more productive than non-multinationals (Baldwin and Gellatly, 2007) • scale, scope, diversified markets, • unique technology, and superior business organizations Skills • important for technology adoption and innovation • Forming and managing business organizations Size, operating location and industry dummies • introduced to capture specific effects from differences in local business environment, financial and technological opportunities across different size groups, operating locations and industries.

22. Estimation results: offshoring and productivity

23. Concluding remarks • Material offshoring was highly associated with firms’ outward-oriented business activities including foreign operation, investing in foreign M&E, and exporting, after controlling for offshoring and operating locations advantages, and industry-specific effects. • For R&D offshoring (international outsourcing only), it is found that it was mainly associated with investment in foreign M&E. • Material offshoring is positively associated with productivity and the association is significantly larger for material offshoring to non-U.S. countries than for material offshoring to the U.S. after controlling for other effects including being multinationals, the education level of workers, and plant size.

24. Concluding remarks (continued) • The results should be interpreted with the understanding: • The results are only about association not about causal relationship • No delayed effects • The result that material offshoring to non-U.S. countries tends to be associated with higher productivity than material offshoring to the U.S may be justified by higher transaction cost associated with material offshoring to non-U.S. countries.