Offshoring: What Pushes Workers Out of the Game? Evidence from Global Value Chains

Over the past decades, two developments critically influenced the reputation of offshoring. Encouraged by declining transportation and coordination costs, entrepreneurs increasingly unbundled production processes and relocated different activities across countries. At the same time, high income countries experienced a profound decline in the employment of low skilled manufacturing workers. With regard to the simultaneous occurrence of these two phenomena, it seems evident that there exists causality between the emergence of global value chains and declining manufacturing employment.

The question which aspects of offshoring harm low skilled workers has been subject to controversial debates in both a theoretical and empirical context ever since. Regarding theory, there are for example Feenstra and Hanson (1995 & 1997) who show that offshoring leads to a decline in relative employment and wages for unskilled workers in the offshoring country. Yet, there is also a theoretical approach like the one of Grossman and Rossi-Hansberg (2008) highlighting positive productivity effects for (low skilled) workers if their tasks are moved offshore. Considering empirical studies, papers rather identify detrimental results for low skilled workers. Recent publications like the one of Autor et al. (2013) or Ebenstein et al. (2014) identified rather detrimental effects for workers pointing to the rising unemployment of low skilled workers and downward pressure on wages of those performing routine tasks.
In view of the growing complexity of global value chains, it is important to base empirical studies on data which accurately depicts value and factor flows among country-sectors. For that reason, this paper uses data from the World Input-Output Database (WIOD) on 14 manufacturing industries in 16 high income countries between 1995 and 2008 in conjunction with the production decomposition method presented in Miller and Blair (2009). Following this approach, the paper ties up with the research question of Feenstra and Hanson (2001) by tracing the international capital and labor use in production. Importantly, this strategy allows to assess offshoring from two different perspectives:
Besides the consideration of an individual sector’s own upstream value chain, the paper also investigates the fact that offshoring also occurrs in value chains of domestc downstream clients hence fostering competition pressure faced by an industry.

Regarding the former perspective, figure 1 provides interesting insights into the development of capital and low skilled labor use in value chains of manufacturers between 1995 and 2008. Decomposition results from 1995 (on the x-axis) are plotted against decomposition results in 2008 (on the y-axis). Thus, points above the 45-degree line indicate that the value added share of the regarded production factor increased whereas points below the 45-degree line indicate that its share declined.


Figure 1: Capital and low skilled labor in production in 1995 (x-axis) and 2008 (y-axis)

In line with the findings of Timmer et al. (2014), it can clearly be seen that the use of foreign capital in production increased substantially during the regarded time span, while the use of low skilled labor -located domestically and abroad- declined. Still, out of the total low skill labor use, a demand shift towards foreign low skilled workers can be detected.
To determine a statistical relation between these findings and the observation of a declining wage share of low skilled workers, these decomposition results were used in a regression within a translog cost function framework à la Feenstra & Hanson (2001). The analysis shows that low skilled manufacturing workers were in particular negatively affected by the growing deployment of their foreign competitors closely followed by the increasing use of foreign capital in production. Recalling the conflicting theoretical implications of offshoring, this result clearly contradicts the model implications of Grossman and Rossi-Hansberg (2008) as it emphasizes that the relocation of low skilled labor tasks to foreign destination harms low skilled workers.

Moreover, in order to explore consequences of increased foreign competition in domestic downstream value chains, the previous regression framework is extended by an indicator capturing the extent of foreign competition. Accordingly, the degree of competition is measured as the share of foreign value added from a particular industry used in production of domestic downstream clients.


Figure 2: Degree of competition in domestic downstream industries in 1995 (x-axis) and 2008 (y-axis)

A glance at this indicator shows that almost all country-sectors in the sample experienced an increase in foreign competition in the value chains of domestic downstream clients. The intergration of this variable in the previous regression framework reveals an additional channel how low skilled workers are affected by offshoring: Regression results furnish proof to the existence of defensive skill biased innovation as suggested in the model of Thoenig and Verdier (2003). Consequently, the rise in foreign competition in domestic downstream value chains urged firms to undertake investments in order to prevent the immitation of prducts and processes by foreign competitiors. As these invesments shift the demand for production factors towards capital and more skilled labor, it becomes apparent why low skilled workers are negatively affected by this increased competition.

References

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