Outsourcing, Offshoring and Productivity:
Measurement Issues
Susan Houseman
Upjohn Institute for Employment Research
Presentation prepared for World Congress on National Accounts and
Economic Performance Measures for Nations
Session 3 – May 16, 2009
Outline
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Distinguishing import price measurement issues related
to product variety v. outsourcing & offshoring
Outsourcing and offshoring
o Definitions
o Causes
Problems measuring input price changes with changes
in sourcing
Evidence on growth of outsourcing & offshoring
Why measurement issue important
Distinguishing from Import Prices and Gains from Variety
Literature

Recent literature focuses on problems in measuring
prices in trade models with product differentiation &
monopolistic competition
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Debate on whether growth in trade → growth in
“variety” of goods
o Feenstra (1994), Broda & Weinstein (2006), Feenstra,
Reinsdorf, & Slaughter (2008), Arkolakis, et al. (2008)
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If growth imports → increase variety, consumer surplus
from variety not measured: price index growth
overstated, domestic output growth overstated,
productivity overstated
Distinguishing from Import Prices and Gains from Variety
Literature

Models assume separability between domestic &
imported goods – substitution between domestic and
imported goods not explicitly considered
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Any bias to price index theoretically depends on low
substitutability of new varieties:
o “when existing varieties are close substitutes to new or
disappearing varieties, changes in variety will not have a
large effect on exact price index.” (Broda & Weinstein
2008)
o Offshore outsourcing primarily concerns the substitution
of relatively homongeneous foreign inputs for domestic
inputs
Outsourcing & Offshoring
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Use broad definition:
o Change in sourcing of inputs in the production of a good
or service
Types of outsourcing & offshoring:
o Switch from something produced internally in
organization to domestic supplier (domestic outsourcing)
o Switch from producing internally to foreign supplier
(offshore outsourcing) or to foreign affiliate (offshoring)
o Switch from domestic to foreign supplier (offshore
outsourcing)
Outsourcing & Offshoring
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Examples:
o Manufacturer outsources labor services to staffing
agencies
o Manufacturer offshores first stage of production of good,
keeps final finishing of product in U.S.
o Bank offshores back office functions
o Retailer shifts from domestic to imported goods or
manufacturer switching from domestic to imported inputs
Driving force of outsourcing & offshoring:
o Factor price arbitrage: substitution of lower priced input
for internally or domestically produced good or service
o Reducing production costs for any given good or service,
not increase in product variety
Offshore Outsourcing & Offshoring
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Trade models of comparative advantage appropriate for
offshoring phenomenon
o Product cycle theory of international trade (Vernon 1966)
o Complicated by fact that much of trade occurs within
financially related parties & production of single product
or service may become divided among countries
Growth of offshoring outsourcing & offshoring driven
by confluence of factors:
o Reduction tariffs (Feenstra, Reinsdorf, & Slaughter 2008)
o Reduction transportation & communication costs
o Economic & political reforms major parts of the world –
China, Eastern Europe
o Rapid economic development many countries
Problems measuring input price changes with changes in
sourcing
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Price measurement system assumes stable sourcing
patterns
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Important set of cases in which input price drop
associated with outsourcing & offshoring not measured
– even when goods & services homogeneous
o Real value of outsourced or offshored input understated –
price index growth overstated,
o Real domestic output and/or sector value-added growth
overstated,
o Aggregate and/or sectoral productivity overstated
Problems measuring input price changes with changes in
sourcing (cont.)
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Certain tasks outsourced or offshored – labor input now
becomes purchased services or materials input—no
price drop measured across input categories (Houseman
2006, 2007)
o
o
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Wage cut effected via wage reduction to employees – no first
order effect on measured productivity
Wage cut effected by firing employees, outsourcing or
offshoring task to lower paid workers → drop in input price
not measured, productivity overstated
Shift from domestic, internal production to domestic
contractor or offshore
o “slicing the value chain” (Krugman 1996), “intra-mediate
trade” (Antweiler & Trefler), “disintegration” (Yuskavage
et al. 2008)
Problems measuring input price changes with changes in
sourcing (cont.)
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Shift from domestic, internal production to domestic
contractor or offshore – Affects measurement for goods
& services:
o Services: Mann (2004) emphasizes lack of prices for
services – need to develop with growth services
offshoring
o Goods example: First stage of production of good sent
overseas – final finishing kept in U.S. → new imported
good not previously observed → price drop not measured
Shift from domestic supplier to foreign supplier
o No link between domestic price series & import price
series → input price drop not captured
o Business Week furniture example (Mandel 2007)
Shift from one foreign supplier to another
o Price drop captured only if importer the same
Size of any bias to output & productivity measures
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Don’t know – But body of evidence suggests growing
importance of outsourcing & especially offshore
outsourcing/offshoring
o Rapid increase in imports relative to GDP
o Growth of imports dominated by growth of imports
from developing countries – especially China
o Studies indicate rapid shifts in sourcing of intermediate
inputs
Growing Importance of Imports from Developing Countries
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Imports as percent GDP
grew from 10.8% in 1989
to 17.0% in 2007
Developing countries—
growth non-oil imports:
o
o
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56% 1989-2000
70% growth 2000-2007
Imports and Exports as
Percent of GDP, 1989-2007
30
Imports + Exports
25
20
Growth imports from
China especially
dramatic:
15
13% growth non-oil
imports 1989-2000
39% growth 2000-2007
5
o
o
Imports
Exports
10
0
1989
1992
1995
1998
2001
2004
2007
Evidence of growth of outsourced and imported
intermediate inputs
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Domestic providers of
outsourcing services –
significant growth in share of
GDP 1982-2006: 7% to 12%
Domestic outsourcing esp.
strong durable manufacturing
Substantial substitution
imported inputs for domestic
inputs in production of goods
& services 1997-2005
Manufacturing Real Output and
Employment 1989-2007
(Indexes, 1992=100)
170
Value-added
150
130
Sectoral Output
110
90
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Growth imported
intermediates esp. strong
manufacturing – accelerated
1997-2005
Employment
70
50
1989
Yuskavage, Strassner, Medeiros (2008);
Kurz & Lengermann (2008)
1992
1995
1998
2001
2004
2007
Why Measurement Issues Important
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Potential bias to sector and aggregate output &
productivity measures – real value of outsourced &
offshored goods & services understated
Data measurement issues preclude answering key
questions about offshoring – What impact does
substitution of lower-cost imports for domestically
produced goods & services have on:
o Employment, esp. manufacturing employment?
o Wages and wage inequality?
o Consumer prices?
Data not suited for answering these questions
o Structure of sourcing assumed stable
o Price drops associated with outsourcing & offshoring not
adequately measured
o Studies biased against finding impacts
Other measurement issues related to growth of
globalization
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Reclassification of manufacturers to wholesalers
Timeliness of BEA benchmark I-O tables and validity
of import comparability assumption
Measurement of services offshoring among
multinationals
Intangible assets
Data point from the furniture industry
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Manufacturer produced desk in Holland, Michigan:
o
Cost of production
$3,750
o
Sale price
$5,000
o
Profit
$1,250
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Shifted production to the Philippines
o
Cost of production
$ 500
o
Sale price
$4,500
o
Profit
$4,000
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Example illustrates
o
Cost savings/input price declines can be large
o
Manufacturer becomes wholesaler
o
Changes in CPI from domestic to imported good may not be good
measure of input price change