Outsourcing versus integration at home and abroad Stefano Federico (Bank of Italy) December 2008 Vienna

Motivation Bernard, Jensen, Redding and Schott (2007, JEP): “Further progress (…) will require explicit consideration of the boundaries of the firm, including the decisions about whether to insource or outsource stages of production, and whether such insourcing or outsourcing takes place within or across national boundaries” (p. 128, italics added)

Framework Firms in need of inputs choose both location and organizational form IntegrationOutsourcing At home Domestic integration (DI) Domestic outsourcing (DO) Abroad Foreign integration (FI) Foreign outsourcing (FO)

Related literature Theory Antràs (2003) Antràs and Helpman (2004, 2008) Grossman and Helpman (2004, 2005) Empirics U.S. trade data: Antràs (2003), Yeaple (2006), Nunn and Trefler (2008), Bernard et al. (2008) Firm-level data: Tomiura (2007), Defever and Toubal (2007)

Our contribution (1) For each firm, we observe % inputs acquired from: domestic affiliates (DI) domestic non-affiliates (DO) foreign affiliates (FI) foreign non-affiliates (FO) Improvement on previous literature Studies based on trade data do not observe domestic inputs

Our contribution (2) Only “subcontracting” inputs are considered Intermediate goods and services, in conformity with the acquiring company’s projects, technologies or prototypes Fully consistent with theory (relationship-specific investments) “To us, outsourcing means more than just the purchase of raw materials and standardized goods. It means finding a partner with which a firm can establish a bilateral relationship and having the partner undertake relationship-specific investments (…)” (Grossman and Helpman 2005, italics added)

Productivity ordering AH(04) f i > f o AH(04) f i < f o GH(04) Foreign integration 123 Foreign outsourcing 211, 4 Domestic integration 342 Domestic outsourcing 43 Source: adapted from Spencer (2005).

Headquarter intensity Integration will be preferred to outsourcing when the contribution of final-good producer is larger …i.e. in industries with high intensity in headquarter services (capital intensity, skill intensity, R&D intensity, advertising intensity, etc.)

Data and sample Survey on Italian manufacturing firms (Mediocredito Capitalia), 7th ed. Period: 1997 ( for balance-sheet data) Our sample: 3,819 firms (4% of universe) Biased in favour of medium-large firms

Sourcing strategies FIFODIDONo Note: Sourcing strategies are not mutually exclusive % of firms (on sample)

Econometric analysis: 1 A given characteristic of firm i (VA, L, TFP, etc.) Dummies for each sourcing strategy (relative to the baseline group DO) Set of controls: industry, area, export status

Size and productivity premia VaLVA/LTFP OLS TFP FE TFP LP FI FO DI P-value tests FI=FO0.00 FI=DI FO=DI N. Obs.1,316 All coefficients are significant at 10%. Coefficients for industry, area and export status dummies are not reported.

Econometric analysis: 2 Inputs from foreign affiliates on foreign inputs Inputs from domestic affiliates on domestic inputs TFP – fixed effects Indicator of headquarter intensity (  next slide)

Headquarter intensity Industry- level Firm- level Capital intensityK j /L j SCALE j K i /L i Skill intensityH j /L j W j /L j H i /L i R&D intensityR&D j R&D i

Foreign integration (1)(2)(3) TFP i,FE.174***.165***.147*** K j /L j.058 H j /L j.213 R&D j SCALE j.044** W j /L j.066 K i /L i.038* H i /L i.024 R&D i R-sq N.Obs.298

Domestic integration (1)(2)(3) TFP i,FE.084***.083***.076*** K j /L j.040** H j /L j.060 R&D j SCALE j.027** W j /L j.034 K i /L i.036* H i /L i R&D i.873 R-sq N.Obs.1,283

Economic significance Foreign integration A one standard deviation increase in TFP results in a.21/.25 standard deviation increase in the share of foreign integration A one standard deviation increase in capital intensity results in a.11/.12 standard deviation increase in the share of foreign integration Domestic integration Smaller values (.12/.14 for TFP,.07/.13 for capital intensity)

Robustness Additional explanatory variables: Firm’s wage costs Firm age Demand cyclicality Demand seasonality Area dummies U.S. headquarter intensity measures (NBER) Alternative methods: Tobit Probit SURE

Conclusions Productivity ordering: FI>DI>FO>DO Consistent with ordering assumed by Antràs and Helpman (2004), except DI>FO in our case To our knowledge, first estimation for all four organizational forms Integration is more likely in capital- intensive industries Controlling for both skill intensity and R&D intensity Consistent with theory (Antràs 2003) and previous evidence