FOREIGN OUTSOURCING OF GOODS AND SERVICES

FOREIGN OUTSOURCING OF GOODS AND SERVICES
1 A Model of Outsourcing 2 The Gains from Outsourcing 3 Outsourcing in Services 4 Conclusions FOREIGN OUTSOURCING OF GOODS AND SERVICES

© 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor
Introduction The provision of services or the production of various parts of a good in different countries that are then used or assembled into a final good in another location is called foreign outsourcing, or simply outsourcing. Trade in intermediate inputs, which can cross borders several times before being incorporated into a final good. It is a relatively new phenomenon which arose with the decline in the costs of transportation and communication © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Introduction Is outsourcing different from the type of trade we studied in the Ricardian and Heckscher-Ohlin models? Outsourcing results in lower prices, but changes the mix of jobs in the U.S. In some ways outsourcing is similar to immigration as U.S. companies can employ foreign labor although those workers still live in their own countries. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Is Trade Today Different From the Past?
We discussed in previous chapters how trade has evolved over time, so is the type of trade done today different from that done in the past? Figure 7.1 shows that U.S. trade has shifted away from agriculture and raw materials, toward manufactured goods. The share of capital, consumer, and automotive goods has increased from 10% of imports and 20% of exports in 1925 to 65% in 2005. These goods are much more likely to have the production sent overseas through outsourcing. Given the changes in the share of trade in these products, we can see that the type of trade has changed greatly from the past. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.1 (a) Figure 7.1 (a) U.S. Import and Export Industries, 1925–2005 Shown here are the percentage of U.S. imports accounted for by these five categories: foods, feeds, and beverages; industrial supplies; capital goods; finished consumer goods; and automobiles. The share of capital plus consumer goods together has increased from 10% of imports in 1925 to more than 50% in Along with automobiles, capital and consumer goods are most likely to have a portion of their production process sent overseas through outsourcing. Source: Bureau of Economic Analysis. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.1 (b) Figure 7.1 (b) U.S. Import and Export Industries, 1925–2005 Shown here are the percentage of U.S. exports accounted for by these five categories: foods, feeds, and beverages; industrial supplies; capital goods; finished consumer goods; and automobiles. The share of capital plus consumer goods together has increased from 15% of exports in 1925 to more than 50% in Along with automobiles, capital and consumer goods are most likely to have a portion of their production process sent overseas through outsourcing. Source: Bureau of Economic Analysis. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Model of Outsourcing To develop the model of outsourcing, we need to distinguish all the activities used to produce and market a good or service. Figure 7.2 (a) describes the activities in the order in which they are performed. However, for outsourcing, it is more useful to look at the activities according to the ratio of skilled to unskilled labor they use which is shown in figure 7.2 (b). We start with the less skilled activities and move to more complex components and then onto the more skilled labor activities. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Model of Outsourcing Figure 7.2 Figure 7.2 The Value Chain of a Product Any product has many different activities involved in its manufacture. Panel (a) lists some of these activities for a given product in the order in which they occur. The value chain in (b) lists these same activities in order of the amount of skilled/unskilled labor used in each. In panel (b), the assembly activity, on the left, uses the most unskilled labor, and R&D, on the right, uses the most skilled labor. Because we assume that the relative wage of skilled labor is higher at Home and that trade and capital costs are uniform across activities, there is a point on the value chain, shown by line A, below which all activities are outsourced to Foreign and above which all activities are performed at Home. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Model of Outsourcing Value Chain of Activities The whole set of activities we just described is sometimes called the value chain for the products. Each activity adds more value to the combined product. Some of the activities can be transferred to other countries when it is more economical. By looking at activities in terms of their relative amount of skilled labor, we can predict which ones are likely to be transferred abroad. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Model of Outsourcing This prediction depends on several assumptions: Relative Wage of Skilled Workers We assume that Foreign wages for unskilled and skilled workers are less than those at Home. W*L < WL and W*S < WS Additionally, we assume the relative wage of unskilled labor is lower in foreign than at home. W*L / WL and W*S / WS Remember that unskilled labor in developing countries typically receives especially low wages. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Model of Outsourcing Costs of Capital and Trade Must take into account extra costs of doing business in the foreign country. Higher prices to build a factory or for costs of production. Extra costs in communication or transportation. In making a decision to outsource, the firm will balance the saving from lower wages against the extra costs of capital and trade. We assume that these extra costs apply uniformly across all the activities in the value chain—a somewhat unrealistic assumption. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Model of Outsourcing Slicing the Value Chain Based on our previous assumptions, it will make sense for the firms to send the most unskilled-labor intensive activities abroad and keep the more-skilled labor intensive activities at Home. In figure 7.2 that might be all activities to the left of the vertical line A. This is referred to as slicing the value chain. Activities to the left of line A are sent abroad because the cost savings from paying lower wages in Foreign are greatest for the less-skilled labor intensive activities. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Model of Outsourcing Relative Supply and Demand for Skilled Labor For Home we graph the relative demand for skilled labor at Home, S/L against the relative wage, WS/WL for activities to the right of line A. The relative demand curve slopes downward because a higher relative wage for skilled labor would cause home firms to substitute toward less-skilled labor in some activities. The relative supply curve is upward sloping because a higher relative wage for skilled labor will cause more skilled individuals to enter the industry. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Model of Outsourcing Figure 7.3 Figure 7.3 Relative Demand and Supply for Skilled/Unskilled Labor In panel (a), we show the relative demand and supply for skilled labor at Home, S/L, depending on the relative wage, WS/WL. The equilibrium relative wage at Home is determined at point A. In panel (b), we show the relative demand and supply for skilled labor in Foreign, S */L*, depending on the relative wage, W*S/W*L. The Foreign equilibrium is at point A*. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Changing the Costs of Trade
Change in Home Labor Demand and Relative Wage When costs of capital or trade decline in Foreign, there is an incentive to shift more activities to Foreign. The activities shifted to Foreign are less skill-intensive than the ones left at Home. The range of activities now done at Home are more skilled labor intensive on average. Figure 7.4 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Change in Home Labor Demand and Relative Wage The Home relative demand curve will shift right. Remember this graph shows the relative demand, not the absolute quantity of labor demanded. We would expect the absolute demand of skilled and unskilled workers to decrease with increased outsourcing. BUT, relative demand increases because the activities still done at Home are more skill-intensive than before. The relative wage of skilled labor will increase due to outsourcing. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.5 (a) Home Country Relative demand increases because the jobs done at home are now more skill intensive than before. Skilled/Unskilled Wage, WS/WL Home Supply B The relative wage of skilled labor increases due to outsourcing. A Figure 7.5 Change in the Relative Demand for Skilled/Unskilled Labor With greater outsourcing from Home to Foreign, some of the activities requiring less skill that were formerly done at Home are now done abroad. It follows that the relative demand for skilled labor at Home increases, and the relative wage rises from point A to point B. The relative demand for skilled labor in Foreign also increases because the activities shifted to Foreign are more skill intensive than those formerly done there. It follows that the relative wage for skilled labor in Foreign also rises, from point A* to point B*. Home Demand Skilled/Unskilled Labor, S/L © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.5 (b) Foreign Country The activities outsourced to Foreign are more skill intensive. On average, economic activity in Foreign is more skill intensive, so the relative demand for skilled labor increases Skilled/ Unskilled Wage, W*S/W*L Foreign Supply B* A* Figure 7.5 Change in the Relative Demand for Skilled/Unskilled Labor With greater outsourcing from Home to Foreign, some of the activities requiring less skill that were formerly done at Home are now done abroad. It follows that the relative demand for skilled labor at Home increases, and the relative wage rises from point A to point B. The relative demand for skilled labor in Foreign also increases because the activities shifted to Foreign are more skill intensive than those formerly done there. It follows that the relative wage for skilled labor in Foreign also rises, from point A* to point B*. The relative wage of skilled labor increases in Foreign Foreign Demand Skilled/Unskilled Labor, S*/L* © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

From this model we can see that both countries experience an increase in the relative wage of skilled labor due to increased outsourcing. As activities in the middle of the value chain are shifted from home to Foreign, they raise the relative demand for skilled labor in both countries because these activities are the least skill-intensive of those formerly done at Home but the most skill-intensive of those done in Foreign. Compare this to the predictions from our previous models. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Change in Relative Wages in the United States
Since the early 1980s, the wages of skilled workers have risen relative to those of unskilled workers in the U.S. as well as other countries. Use data from the manufacturing sector on “production” (unskilled) and “non-production” (skilled) workers. Figure 7.6 shows the average annual earnings of non-production workers relative to production workers in U.S. manufacturing from 1958 to 2001. Figure 7.7 shows a steady increase in the ratio of non-production to production workers employed in U.S. manufacturing until the early 1990s. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.6 Figure 7.6 Relative Wage of Nonproduction/Production Workers, U.S. Manufacturing This diagram shows the average wage of nonproduction workers divided by the average wage of production workers in U.S. manufacturing. This ratio of wages moved erratically during the 1960s and 1970s, though showing some downward trend. This trend reversed itself during the 1980s and 1990s, when the relative wage of nonproduction workers increased (with a slight dip in 2001). This trend means that the relative wage of production, or unskilled, workers fell during the 1980s and 1990s. Source: National Bureau of Economic Research (NBER) productivity database. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.7 Figure 7.7 Relative Employment of Nonproduction/Production Workers, U.S. Manufacturing This diagram shows the employment of nonproduction workers in U.S. manufacturing divided by the employment of production workers. There was a steady increase in the ratio of nonproduction to production workers employed in U.S. manufacturing until the early 1990s. That trend indicates that firms were hiring fewer production workers relative to nonproduction workers. During the 1990s, there was a fall in the ratio of nonproduction to production workers, with a leveling off and slight increase most recently. Source: NBER productivity database. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Relative Employment of Non-production Workers The only way both of these could increase is if there was an outward shift in the relative demand for non-production (skilled) workers during that time period. This would lead to a simultaneous increase in their relative employment and in their wages. We can see this in figure 7.8 where we plot the relative wage and employment of non-production workers from 1979 to 1990. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.8 Figure 7.8 Supply and Demand for Nonproduction/Production Workers in the 1980s This diagram shows the average wage of nonproduction workers divided by the average wage of production workers on the vertical axis, and on the horizontal axis the employment of nonproduction workers divided by the employment of production workers. Both the relative wage and the relative employment of nonproduction, or skilled, workers rose in U.S. manufacturing during the 1980s, indicating that the relative demand curve must have shifted to the right. Source: NBER productivity database © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Explanations The evidence from the manufacturing sector in the U.S. is strongly consistent with our model of outsourcing Another possible explanation is called skill-biased technological change. Increased use of computers. Which factor has had a bigger impact on wage inequality? Studies attempting to answer this question mostly focus on the measurements in terms of some underlying variables. The number of computers and other high-technology equipment used in manufacturing industries. Imports of intermediate inputs into manufacturing industries. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

One of these studies is summarized in Table 7.1. One goal of the study is to explain the increase in the share of total wage payments going to non-production labor in U.S. manufacturing industries from 1979–1990 (part A). The second goal is to analyze the increase in relative wage of non-production labor in particular over the same period (part B). Outsourcing is measured as the intermediate inputs imported by each industry. High-technology equipment is measured as either the share of the capital stock or capital flows. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Table 7.1 Table 7.1 Increase in the Relative Wage of Nonproduction Labor in U.S. Manufacturing, 1979–1990 This table shows the estimated effects of outsourcing and the use of high-technology equipment on the wages earned by nonproduction (or skilled) workers. Part A focuses on how these two variables affect the share of wage payments going to nonproduction workers. Part B shows how these two variables affect the relative wage of nonproduction workers. Source: Robert C. Feenstra and Gordon H. Hanson, 1999, “The Impact of Outsourcing and High-Technology Capital on Wages: Estimates for the United States, 1979–1990,” Quarterly Journal of Economics, 114(3), August, 907–940. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Both outsourcing and high-tech equipment are important explanations for the increase in the relative wage of non-production/production labor in U.S. manufacturing. However, it is difficult to judge which is more important because the results depend on how we measure the high-tech equipment. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Change in Relative Wages in Mexico
Our model of outsourcing predicts that the relative wage of skilled labor will rise in both countries. We have seen this for the U.S., but what about for Mexico? Figure 7.9 shows the relative wage of non-production labor in Mexico from 1964–1994. Data comes from the census of industries in Mexico which occurs infrequently. We can see the data seem to follow the same trends that we saw in the U.S. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.9 Figure 7.9 Relative Wage of Nonproduction/Production Workers, Mexico Manufacturing This diagram shows the wage of nonproduction workers in the manufacturing sector of Mexico divided by the wage of production workers. After declining during the 1960s and 1970s, this relative wage began to move upward in the mid-1980s, at the same time that the relative wage of nonproduction workers was increasing in the United States (see Figure 7-6). The relative wage in Mexico continued to rise until 1994, when NAFTA began. Sources: Robert C. Feenstra and Gordon H. Hanson, 1997, “Foreign Direct Investment and Relative Wages: Evidence from Mexico’s Maquiladoras,” Journal of International Economics, 4, May, 371–393; and Raymond Robertson, 2004, “Relative Prices and Wage Inequality: Evidence from Mexico,” Journal of International Economics, 64, December, 387–409. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

After 1994, the change in the relative wage of non-production workers in Mexico depends on whether we look at the maquiladora sector or the non-maquiladora plants. The maquiladora sector represents plants near Mexico’s border with the U.S. engaged in outsourcing. For the maquiladora sector, we see real monthly income rising faster than wages for production workers, meaning a continuing rise in the relative wage of non-production (skilled) workers. For the non-maquiladora plants in the rest of Mexico, the evidence is that the relative wage of non-production workers fell after 1994. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

The Gains from Outsourcing
We have shown that outsourcing can shift the relative demand for labor, and raise the wage for skilled workers; decreasing the relative wage for unskilled workers However, outsourcing reduces production costs which, in a competitive market, reduces prices so outsourcing benefits consumers. Do the overall gains outweigh the losses? © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

A Simplified Outsourcing Model
Suppose there are only two activities: components production and research and development (R&D). Assume components is unskilled labor intensive. The costs of capital are equal in both activities. Compare the no-trade situation to an equilibrium with trade through outsourcing. The two kinds of labor are free to move between the two activities. Graph a production possibilities frontier (PPF) for the firm between components and R&D activities—figure 7.10. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Production in the Absence of Outsourcing Suppose that the firm, initially, cannot engage in outsourcing. An isoquant is used to determine how much of the final good is produced. Similar to a consumer’s indifference curve except, instead of utility, it illustrates production of the firm. A curve along which the output of the firm is constant despite changing combinations of inputs. This isoquant is tangent to the PPF showing this is the highest amount of product that can be produced with current amounts of components and R&D. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.10 R&D Home firm PPF Relative price of components = (PC/PR)A No-trade Home firm equilibrium QR A Figure 7.10 No-Trade Equilibrium for the Home Firm The PPF shows the combinations of components and R&D that can be undertaken by a firm with a given amount of labor and capital. In the absence of outsourcing, the firm produces at A, using quantities QC of components and QR of R&D to produce amount Y0 of the final good. The line tangent to the isoquant through point A measures the value that the firm puts on components relative to R&D, or their relative price, (PC /PR)A. Amount Y1 of the final good cannot be produced in the absence of outsourcing because it lies outside the PPF for the firm. Y1 Home firm isoquants Y0 QC Components © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Equilibrium with Outsourcing Now suppose the firm can import and export its production activities through outsourcing. The quantity of the final good is no longer constrained by the Home PPF. Output rises to Y1. Assume the world relative price of components is cheaper than Home’s no-trade relative price. With a lower relative wage of unskilled labor in Foreign, components assembly will also be cheaper in Foreign. Home will want to outsource components, which are cheaper abroad, while Home firms will be exporting R&D, which is cheaper at Home. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.11 When the firm outsources, they now face the world relative price of components at B and use a new mix of inputs based on the new world price Given the firms production abilities from the isoquants, we can see the firm can now produce Y1 at C using corresponding levels of R&D and Components This means the firm will export R&D and import Components. The increase in production from Y0 to Y1 are the gains from outsourcing Before outsourcing, Home starts at A, the no-trade equilibrium. They can only use what they have R&D World relative price of components = (PC/PR)W1 No-trade relative price of components = (PC/PR)A (PC/PR)A B Home firm exports of R&D No-trade Home firm equilibrium A C Figure 7.11 Outsourcing Equilibrium for the Home Firm In the presence of outsourcing, the Home firm will do more R&D and less component production, at point B. The Home firm then exports R&D activities and imports components at the world relative price of components, which allows it to produce the amount Y1 of the final good. The difference between Y0 and Y1 represents the gains to the Home firm from outsourcing. Y1 Gains from Outsourcing Y0 Home firm imports of components Components © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Gains from Outsourcing Within the Firm The increase of final goods produced (Y0 – Y1) is a measure of the gains from trade to the Home firm from outsourcing. Because more of the final good is produced with the same overall amount of skilled and unskilled labor available in Home, the Home company is more productive. Its costs of production fall. Price if the final product falls. The gains for this company are therefore spread to consumers as well. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Terms of Trade We now need to consider the impact on a country’s terms of trade. (PEX/PIM) Home terms of trade are (PR/PC)W1 since Home is exporting R&D and importing components. A rise in the terms of trade indicates that a country is getting a higher price for its exports, or paying a lower price for its imports. Fall in the Price of Components Suppose there is a fall in the relative price of component production. Maybe Foreign improves its productivity in components. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Terms of Trade Figure 7.12 World relative price of components = (PC/PR)W2 Relative price of components falls leading to a new relative world price (PC/PR)W2 This leads to new use of inputs at B’, new production at Y2, and new use of inputs at C’ Home gains from increased production The firm now exports less R&D and imports more components R&D Y2 World relative price of components = (PC/PR)W1 B’ Home firm exports of R&D B C’ A C Home gains from trade when relative price of components falls Figure 7.12 Fall in the Price of Components If the relative price of components falls from (PC /PR )W1 to (PC /PR)W2, then the Home firm will do even more R&D and less components production, at point B ’ rather than B. The increase in the terms of trade allows the Home firm to produce output Y2 at point C ’, and the gains from trade are higher than in the initial outsourcing equilibrium (points B and C ). Y1 Home firm imports of components Components © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Terms of Trade Fall in the Price of R&D Samuelson was referring to this when he stated that outsourcing might allow developing countries to gain a comparative advantage in those activities where the U.S. once had the comparative advantage. For example, as Indian companies like Wipro engage in more R&D, they compete directly with American companies exporting the same services. Competition can lower the world price of R&D services. A fall in the world relative price of R&D will lead to a steeper price line (PR falls). Home shifts production to point B′′, and by exporting R&D and importing components, moves to point C′′. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Terms of Trade Figure 7.13 (PC/PR)W1 World Relative Price of Components(PC/PR)W3 After the costs of R&D fall, the world relative price gets steeper at (PC/PR)W3 R&D (PC/PR)A The country shifts production reducing R&D and increasing Components, moving from B to B” B Y3 Home firm exports of R&D B” Terms of trade loss leads to reduced production to Y3, and reduced exports and imports C A C” Figure A Fall in the Price of R&D A fall in the relative price of R&D makes the world price line steeper (PC /PR)W3. As a result, the Home firm reduces its R&D activities and increases its components activities, moving from B to B ’’ along the PPF. At the new world relative price, the Home firm faces a terms-of-trade loss and can no longer export each unit of R&D for as many components as it could in the initial outsourcing equilibrium. The final good output is reduced from Y1 to Y3 at point C ’’. Notice that the final good output Y3 is still higher than output without trade, Y0. After the fall in the relative price of R&D, there are still gains from trade relative to no-trade (point A) but losses relative to the initial outsourcing equilibrium (points B and C ). Y1 Y0 Home firm imports of components Components © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Terms of Trade Fall in the Price of R&D Remember Home is exporting R&D and importing components in the initial outsourcing equilibrium: terms of trade are PR/PC. When the price of R&D falls, Home terms of trade have worsened and Home is worse off compared to initial outsourcing equilibrium. There are still Home gains from outsourcing at C′′ as compared to the no-trade equilibrium at A. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

US Terms of Trade and Service Exports
We now want to examine the evidence for the U.S. to test Samuelson’s theoretical argument. Merchandise Prices Figure 7.14 shows the terms of trade for the U.S. for merchandise goods (excluding petroleum). Service Prices For trade in services such as R&D, it is very difficult to measure their prices in trade. However, we can collect good data on air travel Terms of trade in air travel equals the price that foreigners pay for travel on U.S. airlines divided by the price that Americans pay on foreign airlines (shown in figure 7.14). © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.14 Figure Terms of Trade for the United States Shown here are the U.S. terms of trade for merchandise goods (excluding petroleum) and for air travel services. The terms of trade for merchandise goods fell from 1987 to 1994 but has been rising since then. The terms of trade for air travel services is more volatile, falling from 1995 to 2002 and rising thereafter. In sum, though, we do not see a pattern of declining terms of trade in either of these industries. Source: Bureau of Labor Statistics. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Service Prices There is no evidence to date that the falling terms of trade that Samuelson was concerned with has occurred for the U.S. Service Trade While standard prices are not available, the amounts of service exports and imports for the U.S. are collected annually. The data is shown in Table 7.2 for 2005. The fact that exports exceed imports in many categories of Table 7.2 means that the U.S. has a comparative advantage in traded services. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Table 7.2 Table 7.2 U.S. Trade in Services, 2005 ($ millions) This table shows U.S. exports and imports in the major categories of services trade for 2005. Source: U.S. Bureau of Economic Analysis. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

The surpluses in “other business services” for the U.S., UK, and India since 1982 are graphed in figure 7.15. This area has been growing steadily since about 1985, and shows a very similar pattern to the trade surplus from the UK, its chief competitor. India’s surplus only began growing a decade later The U.S. and UK have continued to increase their surpluses in other business services even as India and other developing countries have become world competitors. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Figure 7.15 Figure 7.15 Trade Surplus in Business Services This figure shows the trade surplus in “other business services” for the United States, the United Kingdom, and India from 1982 to The United States and the United Kingdom have the highest surpluses worldwide in business services, while India has had a significant surplus in these service exports only since Indian net exports of business services have grown by more than $6 billion since 1997, while U.S. net exports have grown by less than $2 billion. Source: Mary Amiti and Shang-Jin Wei, 2005, “Fear of Service Outsourcing: Is It Justified?” Economic Policy, April, 308–347. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Impact of Outsourcing on US Productivity
Before we focused on the impact of outsourcing on the relative wage of skilled labor, but we have not looked at the positive impact of outsourcing on productivity. We will measure the outsourcing of material inputs and of service inputs. In the U.S., the amount of imported service inputs is small but growing. Measured as a share of total inputs purchased, imported services were 0.2% in 1992 and grew to 0.3% in 2000. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Table 7.3 shows the impact of service outsourcing, materials outsourcing, and high-technology equipment on manufacturing productivity measured by estimating value-added per worker. Table 7.3 © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

We see that these three factors explain between 18% and 26% of the increase in value-added per worker. We conclude that service outsourcing together with the increased use of high-tech equipment can explain as much as one percentage point of productivity growth per year. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Outsourcing in Services
Outsourcing that occurred from the U.S. in the 1980s and 1990s was often in manufacturing activities Today the focus is on the outsourcing of services, especially to India. Two questions often raised are: Does it contradict our ideas about international trade, such as the principle of comparative advantage? In what goods or services will the U.S. or European countries retain their comparative advantage? © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

The Logic of Service Outsourcing Ricardian Model In the Ricardian model, comparative advantage is determined by the difference in productivities across countries. Countries with low overall productivity have lower wages. In service activities, however, Indian workers are probably equally productive with their counterparts in developed countries. If we measure the productivity of call centers relative to the productivity of manufacturing industries, this ratio is much higher in India than in the U.S. According to the Ricardian model, India has a comparative advantage in service activities because its opportunity cost is relatively low. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Outsourcing Model In the outsourcing model we presented earlier, we used the value chain to show that Home would produce the most skill-intensive activities and Foreign would produce the least skill-intensive activities. That assumption is contradicted by the outsourcing of business services to India. Activities such as writing computer code and other R&D activities done in India are very skill intensive. We will examine our previous assumptions one at a time. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Outsourcing Model Our first assumption was that wages in general and the relative wage of unskilled workers were lower in Foreign than in Home. Given data, we can see that the relative wage of unskilled labor is indeed lower in India than the U.S. Our second assumption was that the extra costs of capital and of trade in Foreign were spread uniformly over all the activities in the value chain. When a Home firm decides which activities to outsource, it will base that decision only on labor cost savings Because Foreign has lower relative wages, it will make sense to outsource unskilled labor-intensive activities. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Outsourcing Model The second assumption does not hold in India. The actual costs of outsourcing relatively unskilled manufacturing activities to India are much greater than the costs of outsourcing skilled service activities. Manufacturing requires transporting component parts to India which has a poor transportation infrastructure. Outsourcing skilled service activities requires no transportation of parts Service activities do not rely as much on transportation but instead require reliable and cheap communication. The communication infrastructure is very good in India and they have a large number of well-educated individuals who speak English. This makes sense for the U.S. and Europe to engage in service outsourcing with India, where India has a comparative advantage. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Outsourcing Microsoft Windows
Microsoft Corp., in Seattle, WA, does not load their own upgrades of the Windows software onto its own computers. Wipro, an Indian high tech firm, manages Microsoft’s computers in the nighttime hours in Seattle, which is daytime in India. This is called “infrastructure outsourcing” and the remote management of computer resources is just one example of service outsourcing. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

Outsourcing Microsoft Windows
During the non-operating hours, Wipro remotely accesses their computers, performs routine maintenance, trouble-shoots for viruses, repairs corrupt files, and checks for other problems. The computers at Microsoft are better than when the employees left the night before, which makes those employees more productive in their own computer work. © 2008 Worth Publishers ▪ International Economics ▪ Feenstra/Taylor

FOREIGN OUTSOURCING OF GOODS AND SERVICES

Similar presentations

Presentation on theme: "FOREIGN OUTSOURCING OF GOODS AND SERVICES"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

FOREIGN OUTSOURCING OF GOODS AND SERVICES

Similar presentations

Presentation on theme: "FOREIGN OUTSOURCING OF GOODS AND SERVICES"— Presentation transcript:

Similar presentations

About project

Feedback