Do offshoring firms reduce their domestic employment? This column examines plant-level evidence from Germany, using difference-in-differences matching techniques. It says that the positive productivity effect of offshoring dominates possible downsizing effects, raising domestic employment at the establishment.
It is probably fair to say that the effects of the growing international fragmentation of production chains on home country labour markets are still not fully understood. In recent decades, firms in industrialised countries have increasingly engaged in offshoring, by either relocating low-skilled, labour-intensive production steps to foreign affiliates (vertical FDI) or by buying intermediate inputs from unaffiliated foreign suppliers, i.e. international outsourcing (we follow Helpman (2006) in defining offshoring as comprising both vertical FDI and international outsourcing).
In theory, a higher degree of offshoring might have positive or negative effects on a plant’s employment. Positive employment effects could arise if cost savings rendered firms more competitive and increased their global market share. Negative effects could result from downsizing and relocation of production abroad.
Which channel dominates is ultimately an empirical question. Unfortunately, results of empirical studies have so far been mixed. Studies based on macro-data tend to find insignificant or small negative employment effects of offshoring, and studies based on micro-data find both positive and negative employment effects. For instance, Becker and Muendler (2008) investigate the effects of vertical FDI on employment and find that German multinationals expanding abroad experience fewer worker separations at home. However, most existing studies have not been able to disentangle the positive productivity and the negative downsizing channels.
Micro-evidence from Germany
In a recent analysis of a representative sample of German establishments, we are able to identify the channels that determine the employment effect of offshoring on a particular establishment (Moser, Urban and Weder di Mauro, 2009). Our data also allows us to apply difference-in-differences matching techniques, a non-parametric estimator that is robust to non-linearity and heterogeneity of relations across individuals and therefore generalises regression analysis.
We find that an average offshoring establishment has higher employment, higher productivity, and higher domestic and foreign market share than if it did not engage in offshoring. Furthermore, its production depth remains unchanged, indicating that offshoring predominantly operates through a substitution of foreign for domestic suppliers, rather than through a reduction of home production. This result enables us to isolate a positive productivity effect from offshoring on employment. However, employment in an establishment decreases – relative to its counterfactual – when it simultaneously engages in offshoring and restructuring of the home plant. Therefore, we are also able to isolate a negative downsizing effect of offshoring on employment.
We conclude that, on average, the productivity effect dominates possible downsizing effects. An important caution is that these results at the plant-level cannot simply be extrapolated to the economy-wide level, since offshoring plants might be destroying jobs in the domestic supply industry, which cannot be traced in our data. Moreover, we can only determine differential employment effects of offshoring plants but not aggregate employment effects in the economy if general equilibrium effects of offshoring on non-offshoring plants exist.
A by-product of our analysis is that offshoring combined with restructuring is more likely in plants that are technological laggards. One may suspect that plants that fall behind in the technological race are more likely to be forced to undergo accelerated adjustment and that these plants use offshoring, spin-off, and closing of plants as a measure to catch up. It would be desirable if future research further investigated the underlying causes for positive and negative offshoring effects. One possible conjecture is that positive employment effects of offshoring may be more pervasive in branches and firms that are competitive and innovative at home. Negative effects may be a form of survival strategy for firms that have fallen behind.
Becker, S. and M.-A. Muendler (2008), “The Effect of FDI on Job Security,” The B.E. Journal of Economic Analysis and Policy, Vol. 8, p. 1-44.
Helpman, E. (2006), “Trade, FDI, and the Organization of Firms,” Journal of Economic Literature, Vol. 44, pp. 589-630.
Moser, C., Urban, D. and B. Weder di Mauro (2009), “Offshoring, Firm Performance and Establishment-level Employment: Identifying Productivity and Downsizing Effects,” CEPR Discussion Paper Series, No. 7455.