Offshoring and Immigrant Employment: Firm-level theory and evidence

Transcription

1 Offshorng and Immgrant Employment: Frm-level theory and evdence Gorgo Barba Navarett () Guseppe Bertola () Alessandro Sembenell () December 2008 Abstract: In an Italan dataset wth frm-level nformaton on the share of foregn producton n total sales and that of mmgrant workers n domestc employment, we document a negatve and sgnfcant relatonshp between those two varables across frms wthn each provnce and ndustry. We propose and solve a smple model where frms may relocate abroad only productons stages that n domestc plants would be dsproportonately performed by mmgrant workers. In the model, such offshorng s proftable only f varable cost savngs more than offset the fxed cost of delocaton. In the data, nstrumental varable regressons ndcate that frm-specfc productvty and manageral structure ndcators are mportant determnants of frm-level propenstes to offshore and, through that channel, of the sze and composton of domestc employment. JEL: F2; J61 () Unverstà d Mlano () Unverstà d Torno. We gratefully acknowledge useful comments receved on prevous drafts at ISIT, Erwt, ECARE, Unverstat de Grona, World Bank, Georgetown Unversty, New York Unversty, and Fondazone Agnell. We are also grateful to Lorenza Mola for helpful suggestons, to Captala for provdng the data, and to Fondazone CRT - Progetto Alfer for fnancal support n the framework of the Centro Stud Luca d Aglano research project on Mgraton and Frms Moblty.

2 1. Introducton Offshorng of producton to low-wage countres s often blamed for job destructon and mmgrant nflows also appear to threaten the employment opportuntes of unsklled workers n rch countres. The causes of these phenomena and the polcy reactons motvated by employment and wage concerns are tghtly related (as dscussed n e.g. Jones, 2005). Lberalzaton of trade n goods trggers relocaton of producton from advanced to less developed countres f foregn labor costs are low. But the extent to whch foregn wages fall short of domestc ones also affects mgraton ncentves, and reflects obstacles to mgraton flows. Immgraton may or may not affects domestc wages and employment (as dscussed n Borjas 2003, Ottavano and Per 2005 and 2006, Per and Sparber 2007), and may through that and other channels nfluence the attractveness of offshorng optons and the vablty of manufacturng producton n developed countres. Ths paper takes emprcal and theoretcal steps towards a better understandng of frmlevel lnks wthn ths ntrcate set of nteractons. A survey of Italan manufacturng frms offers valuable nformaton on the ncdence of producton offshorng and the share of foregn born workers n domestc plants. The descrptve statstcs we examne n Secton 2 ndcate that only some frms offshore producton, that these frms are larger and more effcent, and that they employ a smaller share of blue-collar workers (and relatvely more foregn-born workers). In Secton 3 we characterze theoretcally the relatonshp between these varables n a model of frm-level decsons to offshore portons of the producton process. We suppose that offshorng producton entals a fxed cost, and s therefore optmal only for hghly productve (hence larger) frms; that only a subset of a frm s varable producton actvtes are canddates for offshorng; and that these actvtes employ dfferently sklled workers. Secton 4 confronts wth the data the model s predctons regardng the roles of heterogenety across frms of margnal costs and fxed offshorng costs n selectng frms that do and do not offshore wthn a local labor market, and of labor skll dfferences across dfferent producton actvtes and across domestc and mmgrant workers n explanng why the two groups of frms employ dfferent shares of foregn-born workers. Controllng for provncal locaton and ndustry, regresson evdence ndcates that ndcators of frm-level productvty and manageral structure are sgnfcantly and sensbly related to offshorng decsons, and have statstcally and economcally sgnfcant effects on 2

3 frms propensty to employ mmgrant workers. Secton 5 concludes dscussng the results mplcatons for broader ssues and further research Related lterature Much has been wrtten on the mpact of offshorng and other forms of nternatonalzaton on the relatve demand for sklls. In a representatve-frm Hecksher-Ohln framework, Feenstra and Hanson (1996) show that fragmentaton leads to an ncrease n the relatve demand for sklls and n wage dfferentals n the North. Many emprcal studes have tred to estmate these effects on data where the wage gap between sklled and unsklled workers n advanced countres grows n parallel wth flows of mports of manufactured products from developng countres. Ths lterature generally measures offshorng ether on the bass of nput-output tables or of trade data (by lookng at ntrandustry trade) or by combnng the two. Some consder the aggregate of all mported nputs; others dstngush between nputs orgnatng from developng countres and from ndustralzed countres. Usually, a translog cost functon specfcaton s estmated, addng measures of offshorng and of techncal change or R&D nvestment to control for the effect of sklled based techncal change on the sklled-labor cost share. Feenstra and Hanson (1996a, 1996b and 1999) and many follow-up studes on US data fnd evdence of a role for offshorng that s szable, f not as mportant as that of techncal change, n determnng ncreases n the wage share of sklled workers. 1 We buld on a recent hghly nfluental strand of lterature, revewed n Helpman (2006), whch studes the role of heterogeneous frm-level compettveness n shapng nternatonal actvtes. Meltz (2003) and Helpman, Meltz, and Yeaple (2004) focus on the choce of the output market (home vs. foregn) and of how to serve t (exports vs. FDI); Antras and Helpman (2004) on the choce of where to source nputs (nshorng vs. offshorng) and how (nsourcng vs. outsourcng); Grossman, Helpman and Szedl (2006) explore the jont choce of both 1 Slaughter (2000) s also on the US; Ekholm and Hakkala (2005) on Sweden; Egger and Egger (2003) on Austra; Anderton and Brenton (1998) and Hjen, Gorg and Hne (2005) on the UK; Helg and Tajol (2005), on Italy and Germany; Falk and Koebel (2002) also on Germany and Strauss-Khan (2003) on France. Amt and We (2005a,b) on the US and the UK look at the effects on total labor demand and productvty of servce offshorng; Egger and Egger (2006) examne the effects on the productvty of low skll workers. 3

4 nternatonalzaton patterns. In the equlbrum of these and other models, only the more productve frms fnd t optmal to engage n nternatonal actvtes entalng a fxed cost. 2 Our man focus s on the choce to offshore part of the producton process to a foregn country. We model the choce n terms of a tradeoff between lower producton costs n the foregn locaton and the cost of coordnatng fragmented producton (see Jones and Kerzkovsk, 1990; Jones, 2005 for dscussons of the structure of such costs). We dsregard organzatonal choces and assume a sngle ntegrated output market, n order to focus on the mpact of offshorng on the level and skll composton of employment n domestc plants. 3 Yeaple (2005) smlarly ams at characterzng the nteracton between nternatonal actvtes and domestc employment, n the presence of frm and/or worker heterogenety. We focus on mperfect substtutablty across dfferent types of labor, however, whle Yeaple models worker heterogenety n terms of effcency unts and shows that frms engaged n nternatonal actvtes endogenously employ more sophstcated technologes and more productve workers. Our emprcal analyss focuses on relatonshps between offshorng and labor demand at the frm level, rather than at the ndustry level. Few earler papers explot frm or plant specfc evdence and, to the best of our knowledge, none specfcally relates a broad measure of offshorng to the structure of the work force. Gorg and Hanley (2004) examne the effect on total labor demand for a sample of Irsh plants by estmatng a dynamc employment equaton where offshorng (measured by mported ntermedates) s ntroduced as a demand shfter. They fnd that offshorng has a negatve effect on short term plant-level labor demand. Head and Res (2002) and Hansson (2005) consder more drectly the effects on the skll composton of the labor force, for Japan and Sweden respectvely. These studes are based on the actvtes of multnatonal frms, and fnd that the skll ntensty of home actvtes ncreases wth the share of foregn actvtes carred out n labor ntensve countres. 2 In other models heterogenety n the access nto the export market s not drven by fxed costs. Bernard, Eaton Jensen and Kortum (2002) obtan heterogenety n the decson to export by assumng a model of Bertrand competton and Meltz and Ottavano (2005) by usng lnear demand systems across a contnuum of varetes. 3 Other theoretcal contrbutons analyze the lnk between offshorng and the demand for sklls n representatve-frm settngs. See Jones and Kerzkowsky (1990) and Jones (2005). Egger and Egger (2003) also examne whether the effect s dfferent under a compettve or a unonzed labour market for unsklled workers. Markusen (2006) also studes how standard theores of nternatonal trade and FDI can explan the effects of the off-shorng of hgh sklled servces. 4

5 As regards the lnk between offshorng and employment of mgrant workers, the relevant lterature has mostly focused on whether mgrant flows and FDI are substtute or complements for a gven locaton (country, provnce, regon etc.) or par of locatons: frm-level evdence s not abundant, but Murat and Paba (2004) document that offshorng s less prevalent (and mmgrant employment more prevalent) at small frms n Italy. If the share of unsklled workers s larger among mmgrants than among natves, as s realstc n Italy and n other advanced countres, the possblty to employ foregners locally affects the costs and benefts of offshorng low-skll actvtes. 2. Data and descrptve statstcs We analyze the Captala-Uncredt survey of 4289 Italan manufacturng frms, carred out n 2004 wth current and retrospectve yearly nformaton for Lke the earler waves of a long-runnng seres of smlar surveys, the dataset ncludes all Italan frms wth more than 500 employees as well as a representatve sample of smaller frms, stratfed on geographcal area, ndustry, and sze. Besdes standard frm specfc varables, ncludng balance sheet entres, the data also report detaled nformaton on nternatonal actvtes. As regards the relatonshp between nternatonalzaton and frm characterstcs, the data appear to conform to smlar datasets from other countres. Benfratello and Razzoln (2007), for example, fnd that larger and more productve frms are more lkely to export some of ther producton and to produce abroad n order to serve foregn markets. Crucally for our purposes, the survey features addtonal detal as to the sze and purpose of each frm s foregn operatons, ncludng nformaton as to whether foregn operatons are meant to supply ntermedate parts, and data on the composton of domestc employment nclude the percentage of foregn workers. Table 1 reports descrptve statstcs for the man varables used n the emprcal analyss. The dstrbutons of sales, valued added, and employment s heavly skewed, and the ratos of sales and value added to total employment are very heterogeneous across frms. Skll levels are 4 In the emprcal analyss we excluded form the sample frms wth ncomplete nformaton or wth extreme observatons for the varables of nterest. The Data Appendx outlnes the sample selecton procedure n detal. 5

6 poorly measured n the data, whch only dstngush blue and whte collar workers, but what evdence s avalable also ndcates hgh heterogenety across frms: the nterquartle range of blue-collar employees as a rato of total employment s n the order of 20 percentage ponts. 5 Fnally, and very mportantly for our purposes, we see, stll n Table 1, that foregn workers are a rather small fracton of total employment (3.8% on average) and of total blue-collar employment (5.7% on average) but are hghly dspersed across frms. Whle more than 50% of surveyed frms report no foregn employees, we see that 25% of the observatons report at least 4.3% foregn employment (and 10% of the frms report a share hgher than 10 percent). We wll be nterested n explorng the relatonshp of these dmensons of heterogenety to each other, and to frm-specfc ndcators of actvty offshorng and labor force composton. Roughly 7.5% of the frms report that some of the producton ncluded n sales occurs n other countres; among these, 38% state that offshored producton accounts for less than 10% of sales, 43% that t accounts for between 10 and 50%, and 19% that t accounts for over half of sales. The dstrbuton of the proporton of sales produced abroad s very smlar to that of mmgrant employment share and both have szeable mass at zero. There s lttle theoretcal reason to use a dscrete specfcaton for mmgrant employment. Conversely, offshorng of producton s an ntrnscally dscrete choce, and the fact that dscreteness s only partally found n the data may reflect wthn-frm aggregaton of task-specfc offshorng decsons. Not all offshorng s alke. Usng nput-output nformaton, Daver and Jona-Lasno (2007) detect szable dfferences n the assocaton wth productvty of offshorng of ntermedates rather than servces. The survey we analyze elcts nformaton as to the motvaton and destnaton of nternatonal producton actvtes. Among frms that do offshore some actvtes, 72% state that lower labor costs as one of the two man reasons for dong so, and another 35% cte the need to avod beng prced out of the output market; only 22% vew offshorng as a way to reduce costs of foregn market penetraton. Romana s the destnaton country for 31% of the offshorng frms, Chna s the next most frequent at 21.5%, and vrtually 5 Another survey queston refers to the number of specalzed (plant managers and techncans) blue-collar employees. These are rather often reported to be absent or to concde wth total blue-collar workers, whch may spurously reflect survey respondents nablty or unwllngness to provde more precse nformaton. Indcators based on ths varable proved unnformatve when used alongsde or n place of the standard whte/blue collar dstncton n regressons such as those reported below. 6

7 all countres mentoned n the survey as offshorng destnatons are at much lower levels of development than Italy. We defne a dummy takng the value one when some offshorng actvty s observed, and refer to such observatons as offshorng frms. Among such frms, we sngle out those that ndcate both that the porton of ther sales that s produced abroad ncludes ntermedates (thus excludng those that offshore only producton of fnshed products, and may be motvated by market proxmty consderatons rather than by producton cost savngs) and that some of ther offshorng actvtes are re-mported. We refer to these as the restrcted sample of offshorng frms. As we shall see, these are slghtly more dfferent from non-offshorng frms n ways consstent wth the modelng perspectve we propose below. Table 2 dsplays the man descrptve statstcs separately for non-offshorng frms and for offshorng frms. On average, relatve to other frms, offshorng frms are about three tmes larger n terms of sales and less than three tmes larger n terms of employment. Sales per employee are some 15% hgher. Ths s to a large extent an obvous reflecton of the fact that sales nclude producton performed by the employees of foregn plants, on whch we have no nformaton. More nterestngly, the value added per employee of offshorng frms s some 2% hgher than that of non-offshorng frms, and the former employ a much smaller share of blue collar workers. 6 Offshorng frms also employ fewer extra-eu workers. All such dfferences are larger f the comparson focuses on a restrcted sample of frms that offshore only a porton of ther manufacturng process and therefore perform n ther domestc plants at least some varable-cost producton actvtes. Avalablty of both mmgrant employment and offshorng nformaton offers a rare opportunty to assess emprcally the relatonshp between the two phenomena. Our analyss wll be focused on frm-level nformaton. Market-level nteractons wll be controlled by provncal dummes, and technologcal heterogenety by ndustry dummes. Resdual heterogenety n 6 The skll composton of the domestc labor force of offshorng frms may well be a reason why offshorng of manufacturng actvtes s assocated wth hgher overall labor productvty n general, but not when offshorng regards servce actvtes (Daver and Jona-Lasno, 2007). Servces are lkely performed by hgh value-added whte-collar workers wthn manufacturng frms. The measured productvty of (not qualty adjusted) labor n domestc plants wll tend to be hgher when producton tasks are offshored, lower when servce actvtes are. 7

8 productvty and offshorng costs drves offshorng, and ts consequences for employment, n the theoretcal and emprcal models of the next two sectons. 3. Producton offshorng by heterogeneous frms The descrptve evdence of Table 2 s consstent wth a data-generatng mechansm that assocates hgher effcency and stronger skll ntensty to frm-level offshorng decson. In ths secton we formulate a model of frm-level decsons that delvers ths mplcaton on the bass of sensble assumptons. Frst, we show that sortng of hghly productve frms nto offshorng can be explaned f the reorganzaton of producton needed to take advantage of lower margnal costs n foregn locatons entals fxed costs. Second, we show that dfferent skll composton across the domestc actvtes of offshorng and non-offshorng frms s a natural consequence of heterogeneous skll requrements of actvtes that may or may not be relocated by frms that do choose to offshore some of ther producton. In the next secton we wll proceed to dscuss how ths may bear on the evdence, especally as regards employment of mmgrant workers. 3.1 Frm level heterogenety and offshorng As ponted out by Meltz (2003), a frm s ntrnsc effcency bears on ts choce across producton and sales modes wth dfferent fxed and margnal cost and benefts. In Meltz s orgnal contrbuton, more effcent frms are better able to take advantage of market access, and more nclned to bear the fxed cost of equppng themselves to export. In ths paper s context offshorng s more attractve for stronger frms f, at the same tme as t makes t possble to tap nto cheaper labor pool and decrease margnal costs, t entals hgher fxed costs. Substantal fxed costs may n fact be entaled not only by foregn drect nvestment n wholly owned plants, but also by the negotatons and know-how requred by arms-length outsourcng relatonshps. We dsregard the dstncton between nsourcng or outsourcng arrangements for producton relocaton, but allow ther costs to be heterogeneous across frms, reflectng organzatonal rather than technologcal features. Ths mples that, among heterogeneous frms wthn an ndustry, the more productve ones wll select themselves nto offshorng. To focus on nternatonal factor cost dfferences as the drvng force of the offshorng decsons we wsh to characterze, we suppose that a frm s nverse demand functon s 8

9 1 σ p ( y) = by, where σ > 1 s the elastcty of demand, b s an ndex of demand strength, and y denotes the frm s total producton ndependently of where ts plants are located. The demandstrength parameter b dffers across frms but, for a gven frm, t s ndependent of the producton process and locaton: thus, offshorng decsons are not based on product market consderatons, such as foregn market penetraton, because output s sold on an ntegrated world market or s transported back to the frm s specfc natonal market. Producton costs (net of transport costs) may nstead be affected by offshorng f factor prces or technologes are heterogeneous across locatons. We suppose that margnal cost and average varable cost are ndependent of scale, for notatonal smplcty and to clarfy the role of heterogeneous productvty and offshorng choces n the model. 7 The cost of producng an addtonal unt of output at frm s denoted k(o )/p : t s smaller f the frm-specfc productvty ndcator p s larger, and also depends on whether frm offshores part of ts producton actvtes (ndcated by o =1) or performs all of t domestcally (o =0). To choose the locaton and level of producton, a proft-maxmzng frm wth revenue functon 1 1 σ yp ( y) = ay needs to take nto account that margnal and fxed costs depend on whether producton s wholly domestc or s partly offshored. 8 For each o, maxmzaton of profts 1 1 k( o ) Π( y, o ) = b y σ [ f ( o, m ) + y ] p mples that prce and output s 1 σ y a equals margnal cost c ( o ) / p tmes the mark up factor σ /( σ 1), k ( o y = ( ) σ ) * σ σ 1 (1) p b 7 It would be straghtforward to allow for non-constant returns to scale under constant elastcty, as the parameter ndexng the elastcty of costs to scale would have the same mplcatons as a larger demand elastcty. 8 Ths functonal specfcaton represents monopolstcally compettve frms producng dfferentated goods, but can also be renterpreted n terms of decreasng returns to producton at the level of the frm. 9

10 To decde whether to offshore, the frm compares maxmzed proft levels Π( y * σ, o ) = σ 1 1 σ 1 σ σ σ 1 1 σ ( b ) ( p ) c( o ) f ( o, m ) across the wholly domestc (o =0) and partly offshored (o =1) confguratons of ts producton process, where the frm s fxed cost of producton f(o, m ) depends on the offshorng vs. domestc producton choce, as well as on other frm-specfc factors ndexed by m. 9 Offshorng s optmal for a gven frm f the unt cost dfference mples a large enough operatng proft dfference to cover the fxed cost dfference,.e. f σ σ 1 where ( ) ( ) σ σ 1 1 σ 1 σ σ 1 σ ( b ) ( p ) ( k(1) k(0) ) > σ ( σ 1) ( f (1, m ) f (0, m )) a b p s a summary ndex of frm-specfc demand and productvty condtons. Ths ndex captures heterogenety due to frm-level characterstcs that matter for varable costs, n the same way whether actvtes are offshored or not (whch of course also matters for varable as well as fxed costs, as dscussed next). We wll dscuss below whether, and to what extent, such heterogenety can be observably recovered by total-factor-productvty. whose Among frms wth smlar cost structures but heterogeneous compettveness, only those a ndex s suffcently large as to let addtonal profts from lower margnal cost cover the fxed cost dfference offshore. The crtcal level, σ 1 σ 1 σ 1 σ [ ln( σ ( σ 1) ( f (1, m ) f (0, m ))) ln( k(1) ) (0) )]/ σ ] a = exp k, (2) depends ntutvely on offshorng s mpact on varable as well as fxed costs. Varable costs dffer across frms accordng to the productvty ndcator p, and also accordng to whether producton takes place abroad. To model the relatonshp between the frm s offshorng choces and costs we suppose that producton nvolves two dstnct stages, dubbed components and assembly n what follows. Whle producton of a unt of fnal output requres components and assembly actvtes n fxed proportons, each of the two stages of producton may use dfferent types of labor n flexble proportons. For llustraton purposes, suppose two types of labor may be used n producton, dubbed S and U (these ndces may be read to mean sklled and unsklled but, as 9 If demand and productvty are so weak as to mply negatve profts for both offshorng choces, then the frm should shut down. 10

11 dscussed below, need not correspond drectly to observable characterstcs of ndvdual workers). And consder a Cobb-Douglas functonal specfcaton and let x unts of S labor and z γ γ unts of U labor produce the components of Gx z 1 unts of output. If a unt of sklled labor costs s and a unt of unsklled labor costs u, a cost-mnmzng 1 1 γ γ s frm uses x = ( ) 1 1 γ s sklled workers and z = ( ) γ γ G γ u components of a unt of output, at total cost 1 γ γ 1 1 γ s 1 γ s 1 γ 1 ( ) s + ( ) u = ()() s u, ~ G γ 1 unsklled workers to produce the 1 γ G γ u G γ u where 1 G ( 1 γ ) We smlarly suppose that the producton functon 1 s α ( ) 1 1 α A α u G γ u 1 ~ G γ γ ( γ ) 1. (3) α 1 α Ax z mples employment of x = 1 1 α s sklled workers and z = ( ) α unsklled workers to assemble a unt of α α A output. The margnal cost of assembly actvtes s therefore gven, as a functon of wages, by an expresson smlar to that of equaton (3), n terms of A and α rather than G and γ. The S and U types of labor n ths smple model may n the data correspond to dfferent observable skll levels, or to dfferent natonal orgns. In general, the sklls of mgrants dffer from the sklls of local workers along more detaled dmensons than that of the rough ndcators (whte and blue collars) avalable n standard data. Indeed, recent works on the US show that even among low sklled workers, specfc tasks requre dfferent sets of sklls and that mmgrant workers tend to specalze n manual tasks rather than n nteractve and language ntensve ones (Per and Sparber, 2007). Emprcally, offshorng s related to employment of mmgrants, over and beyond the varaton accounted for by frm-level employment blue vs whte employment shares. For the purpose of analyzng and nterpretng the evdence ntroduced above, the essental modelng ngredent s a role for mmgrant employment n determnng how offshorng affects varable costs. The model suggests that offshorng s related to mmgrant employment n that the U workers who are not employed domestcally when some producton are relocated are more lkely than others workers to be mmgrant. The mx of sklls across the pools of mgrant and domestc workers s dfferent n ways that are not captured by avalable rough measures of the skll composton of the work force. Recallng that other frm-specfc characterstcs, denoted m, are allowed to nfluence the mpact of offshorng on fxed costs, our emprcal work wll also need to dentfy emprcal varables that nfluence the largely organzatonal costs of offshorng, α u 11

12 but do not matter for the aspects that brng mmgrant employment nto play. 3.2 Observable mplcatons Some of the model s emprcal mplcatons are obvous, and consstent by constructon wth the descrptve evdence that motvates our analyss. Other aspects, especally those pertanng to the nterplay of employment composton and offshorng, are more nterestng. They deserve to be llustrated n some detal, and assessed econometrcally below. At a gven frm, the effect of offshorng on domestc employment s ambguous. Relocaton of assembly lowers the local labor nput requrement of each unt of fnal output, but also decreases the margnal cost of producton and ncreases the output level n equaton (1): thus, employment may well ncrease n the components actvty that remans domestc. The overall sze of domestc employment s ncreased by a scale effect, smlar to that nduced by productvty-enhancng fragmentaton n Grossman and Ross-Hansberg (2006), and decreased by a substtuton effect. Fgure 1 llustrates frm-level relatonshps between compettveness, employment, and offshorng. The plots report (as dashed and dotted lnes) theoretcal relatonshps condtonal on whether producton s offshored or not. The crcles refer to a sample of frms drawn from a lognormal dstrbuton of compettveness a (measured on the horzontal axs of panels A and C n the fgure; to mprove legblty, a small amount of unrelated nose s added to the varables mpled by each draw of a). The frms that offshore producton are those whose a draw s larger than the threshold defned n equaton (2). Snce offshorng entals a fxed cost and the parameters satsfy condton (4), offshorng frms have lower margnal costs and, as shown n panel A of Fgure 1, are unambguously larger n terms of producton and sales: the selecton nto offshorng of exogenously more compettve frms renforces the postve assocaton between offshorng and producton levels nduced by the lower margnal cost of offshored producton. Panel C llustrates the mplcatons of offshorng outcomes for frms domestc employment levels. Snce the lower margnal cost of an offshorng frm ncreases producton at the same tme as t decreases ts domestc labor requrements, offshorng s n general ambguously related to domestc employment. For the parameters used n plottng the Fgure, we see n panel C that at a gven level of exogenous compettveness a offshorng reduces the sze of 12

13 frms n terms of employment: t ncreases ther sze n terms of sales n panel A, but not by enough to offset the lower domestc labor requrement of offshored producton. But even after the parameters have pnned down a negatve mpact of offshorng for a gven frm s sze, the model yelds an nterestngly ambguous cross-sectonal assocaton between employment levels and the actual, endogenous offshorng choces of heterogeneous frms. Snce more compettve (and lkely larger) frms selected nto offshorng by fxed costs, n panel C the more compettve non-offshorng frms are larger n terms of employment than the least compettve offshorng frms. As to the observable mplcatons of frm heterogenety and offshorng choces, we see n panel B of Fgure 1 that offshorng frms are larger n terms of sales, but not necessarly n terms of domestc employment, and qute ntutvely dsplay hgher sales/worker ratos. In realty as n the model, only some of the frms that operate n a gven labor and product market offshore producton. The model nterprets these outcomes n terms of heterogeneous frm-level effcency or compettveness, and predcts that frms that offshore a porton of ther producton actvtes should be larger n terms of output and sales but may or may not be larger n terms of local employment. The model s mplcatons for the composton of employment are unambguous f, as s realstc, the assembly producton actvtes that may be performed offshore use more ntensely the U type of labor ( α < γ ). Fgure 2 llustrates the mplcatons of our model for the relatonshp between offshorng, frm sze, and employment composton. Its panel A agan llustrates the basc mechansm whereby the structure of fxed cost and margnal costs mples that offshorng frms produce and sell more than non-offshorng ones (the mplcatons of dfferent fxed offshorng costs are smlarly ntutve, and are not shown). The other three panels of Fgure 2 llustrate the mplcatons of the model s explct treatment not only of the cost, but also of the structure of employment. For the parameters used n plottng the fgures, the assembly actvtes canddates for offshorng are much more U-labor ntensve than the components actvtes that are always performed n the frm s domestc plant. Thus, n panel C the heterogeneous compettveness ndcator a s related to U-type employment (ndcated by crcles) n very dfferent ways across offshorng and non-offshorng frms: for gven a offshorng mples much lower U employment, but t actually mples a hgher level of S employment (ndcated by crosses), because 13

14 components producton s suffcently more S ntensve than assembly that the offshorng-related ncrease of a frm s sales (n panel A) more than offset the loss of domestc S labor entaled by delocaton of assembly. Panels B and D of Fgure 2 relate the level of sales (on ther and panel A s vertcal axs) to S and U employment levels, respectvely. In panel D, the rato of (hgher) sales to (lower) U employment levels s much larger for offshorng frms. In panel C, the rato of sales to unts of S- type domestc labor s actually smaller when producton s offshored, and s not very dfferent across offshorng and non-offshorng frms: as both of these perform domestcally the actvtes that employ most of ther sklled workers, the relatonshp between sales and sklled employment s very smlar regardless of whether less skll-ntensve actvtes are performed domestcally or abroad Emprcal evdence The structure of our theoretcal offshorng model s nspred by the descrptve statstcs of Secton 2, as well as by recent advances n modelng of related phenomena, and s therefore by constructon compatble wth some key emprcal features. In the data, offshorng frms are larger, have larger sales/employment and value added/employment ratos, and employ a larger share of sklled workers n ther domestc operatons, especally when offshored producton ncludes ntermedate products to be re-mported and assembled, rather than fnshed products only. Dscreteness of offshorng choces s explaned n ths and related models by the fxed character of cost dfferentals, whch also ratonalzes the sze dfferentals across offshorng and non-offshorng frms n terms of the role of heterogeneous frm-level compettveness n determnng how easly margnal cost savngs may offset the fxed cost of organzng foregn producton. In the model lad out n Secton 3, offshorng of low-skll actvtes s motvated by cost savngs rather than output market proxmty. It may ncrease or decrease domestc employment, but certanly alters ts skll ntensty. In what follows, we assess the statstcal sgnfcance of 10 Ths paper s model focuses on margnal labor costs and dsregards the labor content of fxed costs, whch s lkely to consst predomnantly of natve workers wth characterstcs more smlar to those of S workers than to those of U workers employed n varable actvtes. The mplcatons of offshorng for the composton of domestc headquarters employment would be qualtatvely smlar to those we analyze explctly. 14

15 these patterns, and attempt to provde more structural evdence of the model's ft, by specfyng and estmatng formal models that make t possble to control for observable heterogenety across sectors and geographcal locaton. To characterze the relatonshp between offshorng and mgraton, we estmate a system of two equatons. The frst one relates the (endogenous) offshorng outcome to other observable frm-level characterstcs, ncludng some that are not expected to be drectly relevant to employment skll composton. The second relates (nstrumented) offshorng nformaton to the structure of frms employment. 4.1 Determnants of offshorng decsons For our man purpose of detectng lnkages between nternatonalzaton of producton and domestc employment, we adopt the sem-structural approach of nstrumentng the offshorng dummy wth varables that plausbly drve offshorng but, for gven offshorng, do not drectly nfluence the composton of employment. In realty sales, employment, and offshorng depend on many more frm characterstcs than just ntrnsc effcency. Whle the theoretcal llustratons n Fgures 1 and 2 kept those constant across frms, they are lkely to vary across sectors and local labor markets n the data. To some extent ths heterogenety may be controlled by ndustry and geographcal dummes. Moreover, t s possble to use the survey s nformaton to try and control for addtonal dmensons heterogenety that may select frms nto the offshorng mode of operaton. In the theoretcal model, a chef determnant of a frm s decson to offshore s ts ntrnsc compettveness, ndexed by the frm-specfc a varable n the model. Its relevance reflects the presence of offshorng fxed costs, whch may n turn depend on frm-specfc organzatonal features. As Fgures 1 and 2 make clear, ths varable jontly determnes the volume of sales, the sze and composton of employment, and offshorng decsons. In practce, compettveness s not drectly observable. In prncple t could be estmated by standard producton functon methods. These are partcularly problematc f, as our theoretcal perspectve makes clear, the factor ntensty of producton n domestc plants s naturally dfferent across offshorng and non-offshorng frms. To account for endogenous producton functon heterogenety across offshorng and non-offshorng frms, observable varables relevant to that 15

16 choce could be used to endogenze selecton of frms nto dfferent technologes, and mprove estmaton of producton functon parameters and TFP resduals. Estmatng structural producton functons would reman problematc on cross-sectonal data, however, snce smultanety and unobserved heterogenety would stll be worrsome sources of bas for the resultng productvty ndcators. In lght of these problems, we choose to report results based on an admttedly smple mnded approach to TFP estmaton, controllng only for captal ntensty on all data pooled n cross-secton. We compute an emprcal counterpart to the theoretcal factors captured by the model s a ndex as the resdual from the cross-sectonal estmaton of a two-factor Cobb-Douglas augmented wth provnce and (2-dgt NACE) ndustry dummes, to control for producton-functon and wage-drven relatonshps between frms producton and sales. At the frm level, for gven compettveness and gven market condtons, the choce between offshored and domestc mmgrant-ntensve producton may also be drven by heterogenety of the fxed costs of offshorng (as ndexed by m n the model of Secton 3). Some of the relevant varaton may be observable, at least n prncple: frms located near arports, or frms whose managers prevous career ncludes overseas postngs, mght well fnd t easer to set up and control offshore producton facltes. These and other organzatonal features, however, can hardly be vewed as completely exogenous, snce a frm that fnds the offshorng opton attractve for unobservable reasons mght well choose ts locaton or managers so as to make that convenent. Moreover, our data do not nclude locaton nformaton beyond the provncal dummes that we nclude n our specfcatons to control for a myrad of phenomena, nor do the data offer nformaton about the prevous career or lngustc sklls of managers. The data do nclude survey questons meant to sngle out famly frms: we know whether members of the owner s famly are senor managers, and whether frms employ managers who are not members of the famly. Ths nformaton can arguably provde nstruments for the purpose of detectng the mplcatons of offshorng decsons. It s hard to see how explotng nternatonal producton opportuntes could have causal effects on the aspects of manager selecton that reflect famly hstores and demographc developments (n our data, non-famly managers are sgnfcantly and ncreasngly lkely to be employed by older frms). But the presence of famly and non-famly managers arguably can affect a frm s propensty to offshore producton, because less dversfed famly owners may well be more reluctant to rsk and nnovate than the managers 16

17 of publc frms, 11 and wll affect offshorng costs f external managers are more lkely than the entrepreneurs offsprng to have relevant sklls. The substantve mplcatons are smlar whether famly matters for the dfferental mpact of offshorng on varable or fxed costs. Lke all nstrumental varables, the ones we propose may fal to be approprate. Specfcally, IV regressons may detect relatonshps that are spurously drven by technologcal dfferences across frms wthn an ndustry, rather than by the mpact of frm productvty and management on ther propensty to offshore. For example, famly frms may be less nnovatve, hence employ lower-skll (and more lkely mmgrant) workers when not offshorng. Indeed famly frms n our sample are found to have lower productvty levels and a lower propensty to nnovate. Atttudes towards mmgrants as such (rather than towards offshorng as a cost-savng strategy) may also dffer systematcally across famly-managed and other frms. As dscussed below, we wll seek support for our results robustness n the comparson of results obtaned from specfcatons that are arguably more or less strongly affected by spurous unobservable heterogenety: comfortngly, the results are very smlar when ether nstrument set s used, when mmgrant employment s measured as a share of total or blue-collar employment, and when technologcally advanced sectors are ncluded n or excluded from the sample. Formally, let the offshorng OS = 1 outcome be observed f a latent varable OS 0, whle OS = 0 otherwse. We consder specfcatons for the latent varable n the form OS ( ) = α g X + ε where g X ) s a sutable functon of a set of frm-level varables. (, (4) The frst and thrd columns of Table 3 report the results of the estmaton of reduced form probt models for offshorng outcomes that specfy g ( Y ) as a lnear functon of the TFP proxy for productvty. These regressons ndcate that offshorng s rather tghtly related to productvty proxes n our data. The other two columns of Table 3 specfy g X ) as a lnear functon of the arguably relevant determnants of offshorng decsons ntroduced above, namely the presence of famly members and of others n the frms top management. The explanatory power of these organzatonal ndcators s also very hgh: the sgnfcantly negatve coeffcent of the FF dummy ndcates that the presence of a famly member reduces the management s 11 Tucc, Barba Navarett and Fan (2006) dscuss how rsk averson n famly frms may ncrease the perceved cost of carryng out rsky foregn operatons. ( 17

18 propensty to offshore producton, whle the presence of external managers has the opposte effect. The two ndcators are mperfectly correlated n our data: about a ffth of frms report employment of a sngle manager (and about one out of eght reports zero managers), but whle the number and the share of external managers s postvely related to the sze of the frm, frms of all szes may or may not employ non-famly managers: among the frms that employ a sngle manager, for example, about a ffth report that the person s not a member of the owner s famly (or the owner herself). 4.2 Offshorng and mmgrant employment Ths evdence reported n the prevous subsecton s consstent wth our theoretcal model s focus on offshorng decsons drven by frm-level compettveness and/or by determnants of offshorng costs. In the model, offshorng n turn affects the skll composton of employment, n that the actvtes whch reman n the domestc country have hgher skll requrements than those that may be performed abroad. To assess the extent to whch offshorng and the resultng skll ntensty of domestc actvtes account for the natonal orgn of each frm s employees, we estmate regressons relatng the share of mgrant workers on total workers to off-shorng. To assess the realsm of ths mplcaton we run regresson n the form L j L = βos + v (5) where the dependent varable s the rato of foregn employees to total or blue collar employment n the domestc operatons of surveyed frms. On the rght hand sde, the coeffcent β measures the relevance of offshorng n those respects. If a sngle exogenous compettveness characterstc determned all aspects of frm heterogenety, the offshorng ndcator OS would be unquely determned by frm-level effcency. As mentoned, however, more than one dmenson of relevant heterogenety determnes offshorng and employment n realty. The parameter of nterest β can be estmated consstently by OLS only f the unobservable determnants relegated to the error terms of (4) and (5) are not correlated, E ε ν ) = 0. Ths however rules out the plausble possblty that ( unobserved frm characterstcs may jontly affect the skll structure and natonalty of the 18

19 workforce and management s nclnaton to offshore. If, for example, entrepreneurs who dscrmnate aganst mmgrant workers also lke to nternatonalze ther actvtes, then E( ε ) < 0 and the OLS estmates of β wll be based downwards. More generally, the bas v wll depend on the correlaton between the unobservables n (4) and (5). To try and dsentangle structural mechansms from such spurous relatonshps, we estmate (5) by nstrumental varables (IV), usng the predcted propensty to offshore * OS from the reduced-form relatonshp (4) to nstrument the observed offshorng outcome. 12 Table 4 reports the results of OLS and IV regressons of the share of mmgrants on total workers on observed offshorng (OLS) and on nstrumented offshorng (IV), usng provnce and two-dgt ndustry dummes to control for the effects of technologcal dfferences n the skll ntensty of producton actvtes and of locally determned wages. 13 As predcted by the model the estmated coeffcent of the offshorng predcton s negatve n all specfcatons, and the effect s stronger when estmated on the restrcted sample of frms that we expect to conform more closely to our theoretcal perspectve. The coeffcents are larger n absolute value when estmated by IV. Ths may reflect attenuaton bas, or t may ndcate that the unobservable (and unrelated to TFP and organzatonal nstruments) component of what determnes decsons to offshorng choces s postvely related, at the frm level, to the unpredctable nclnaton to hre mmgrants: entrepreneurs who for some reason prefer to outsource ther actvtes abroad also, for unexplaned reasons, prefer to hre foregn workers. As mentoned above, nether estmated TFP productvty and famly-management ndcators are beyond suspcon n the role of nstrumental varables. Snce all IV models are exactly dentfed, we do not offer evdence on the valdty of the assumed orthogonalty condtons. Snce the nstruments may be problematc for dfferent reasons, however, t s therefore comfortng to fnd that IV results are broadly smlar when ether set s used. Standard errors are smaller when our bnary proxes for famly frm are used as regressors n the reduced form for offshorng. Also, 12 Whle the data do not deny the relevance of our productvty-based explanaton to ndvdual frms offshorng decsons, t s of course mpossble to rule out uncontrolled endogenety bas. Egger and Egger (2003) use a formally smlar approach to ndustry-level data, and model heterogenety n terms of offshorng costs and ncentves proxed by varables excluded from the determnants of employment s skll ntensty. 13 We report results of lnear regressons. Specfcatons that account for the lmted range of the dependent varable yeld essentally dentcal results. 19

20 these nstruments are stronger, as documented by the weak nstrument test statstcs reported n the table. In Table 5 and 6 we perform two mportant robustness checks. In partcular, Table 5 summarzes the regresson results obtaned by restrctng the sample only to those frms whch operate n low-tech ndustres. Ths s mportant to control for the possblty that some of our fndngs may be spurously drven by the fact that famly frms are less lkely to nnovate wthn a gven ndustry, and do not adopt new technologes that affect both the skll composton of the work force and offshorng costs. Ths element of the data generatng process, whch would nvaldate use of famly frm dummes as nstruments, s lkely to mportant (relatvely to costsavng-orented decsons to produce abroad) n sectors wth smaller opportuntes for process nnovaton. Comfortngly, all our results are vrtually unaltered f the sample s restrcted to low.- tech ndustres: f anythng, we even fnd a stronger, albet less precsely estmated, negatve relatonshp. The negatve coeffcent estmates reported n Table 4 mght reflect another omtted varable problem. The share of mgrants on total workers mght depend on addtonal frm technologcal characterstcs that are not fully captured by the set of two dgt ndustry dummes, for nstance the share of blue-collar workers on total workers. Ths would bas not only the OLS estmates, snce blue-collar worker ntensty s lkely to be correlated wth both the share of mgrants on total workers and the offshorng decson, but also bas the IV estmates f the share of blue-collar workers on total workers s not orthogonal to our set of nstruments: the skll composton of a frm s labor force may well be emprcally related to ts productvty, and t s also possble (as just mentoned) that famly frms are less nclned to adopt skll-ntensve technologes. Under the reasonable, albet untestable, assumpton the all mgrant workers n our sample are blue-collar, ths problem can be crcumvented usng the share of mgrants on total blue-collar workers as dependent varable. As shown n Table 6, all our prevous fndngs are confrmed n ths specfcaton Alternatvely we could nclude the blue collar workers to total workers rato drectly n the specfcatons reported n Table 4. Unreported regresson results show that the ncluson of ths addtonal varable does not alter any of our fndngs. Ths approach of course s not robust to the plausble endogenety of skll ntensty. 20

21 5 Concludng comments Ths paper has explored the relatonshp between offshorng of producton and employment of local, possbly mmgrant workers. Amng to characterze how frm-level mechansms may nduce postve or negatve covaraton between the two phenomena, we have focused on heterogeneous frms proft-maxmzng dscrete choce of whether to offshore producton. Our theoretcal framework, nspred by recently developed modelng approaches, delvers ntutve mplcatons for the amount and composton of domestc employment. In a large sample of Italan frms we estmate economcally szable and statstcally sgnfcant relatonshps between offshorng decsons, whch n turn bear on ther propensty to employ foregn-born workers, and such frms characterstcs as ndcators of productvty and of manageral structure: frms that are less productve and/or are managed by the owner famly s members are less lkely to offshore producton, and more lkely to demand mmgrant labor. These results are nterestng n the context of more general ssues facng manufacturng ndustres n Italy and other hgh-wage countres. In our theoretcal framework, frms choose whether to outsource producton to countres where labor s cheaper, or hre smlar mmgrant workers locally. Both choces preserve (to some extent) the country s manufacturng compettveness. Immgraton can provde a sutable local supply of labor, and fragmentaton of producton and relocaton to cheap labor countres can gve frms suffcent compettve leeway to mantan part of ther local actvtes. The mplcatons of offshorng for factor-ncome dstrbuton and for effcency are smlar to those of other forms of economc ntegraton drven by wage and factor endowment heterogenety. Offshorng depresses domestc employment opportuntes for some types of workers but, as suggested by Grossman and Ross-Hansberg (2006), t can however foster overall employment creaton through ts productvty-enhancng effects. Allowng easer mmgraton can reduce ncentves to offshore producton to cheap labor countres, whle mmgraton pressure can be ncreased by polcy actons meant to reduce the ncdence of offshorng. Less ntutvely, polces that mprove domestc frms compettveness can ncrease the ncdence of offshorng, snce a stronger market poston makes t easer for frms to overcome fxed organzatonal costs and explot foregn locatons lower margnal costs. In order to flesh out these and other polcy mplcatons, further research should proceed to brng our theoretcal and emprcal results to bear on market-level evdence. Embeddng our frm-level theoretcal relatonshps n structural models of local labor markets, focusng n 21