Offshoring

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Offshoring/Outsourcing

Offshoring/Outsourcing
• Firms (MNEs) choose not to do certain production stages in-house but
to outsource to other firms (e.g. Pharma, sotware)
• Questions:
• What stages are likely to be outsourced under what conditions?
• What is impact of outsourcing on wage inequality in both sending and
receiving countries?
• How do predictions compare with Heckscher Ohlin Model?
A simple production process

Production
Assembly of Sales and
R&D of
Components Mktg
Components
Production Process as per Skill Intensity

Skill Intensivity= Skilled workers/Less skilled Workers=


S/L

Production
Assembly of Sales and
of R&D
Components Mktg
Components
Assumptions
•  Home (sending) and away (receiving) countries
• Ws>Ws*, WL>WL*
• > OR <
• Assume cost of outsourcing any activity is same
• Home country would have economic incentive to outsource least skill
intensive stages of production
• This is “Slicing the Value Chain”
Slicing the Value Chain As costs of offshoring↓ , more
profitable for firms to offshore more
skill-intensive stages of value chain

The Value Chain is Sliced here

Production
Assembly of Sales and
of R&D
Components Mktg
Components
Situation during basic offshoring of least skill
intensive stage
Home Assume so far
Ws/WL S
only assembly
(Ws/WL )0 activity is
outsourced
D

S/L
(S/L)0

S* Foreign
Ws */WL *
(Ws */WL *)0

D*

S*/L*
(S*/L*)0
Situation Wdue
/W
to increase in offshoring
s L As offshoring cost ↓, component prod’n
is also outsourced
Home
S
Relative factor dd in home country shifts
(Ws/WL )0 to right.
D1
Wage inequality in home country ↑
D

S/L From Foreign Country’s


(S/L)0 perspective, components
prod’n may be most high-
S* Foreign skilled activity
Ws */WL *
(Ws */WL *)0 So offshoring causes ↑ dd for
high skilled workers in foreign
D1* country
Hence contrary to intuition,
D* S*/L* and HO Model, wage
(S*/L*)0 inequality may ↑ even in
foreign country!
Offshoring and Trade
• Use a simplified model where R&D (skilled activity) and component
prod’n(Less skilled) are only considered.
• R&D and Component Prod’n are intermediate goods used in prod’n of
final goods by producers.
• So in the PPF diagram we show the optimal point as one of tangency
between PPF and Isoquant.
• Offshoring enables the home country to specialize in R&D and export
the same and import components.
• Whether relative prices can be influenced depends on whether country
is “large” or “small”
Features of offshoring
• IT extends the reach of managers-enables them to reach out to
people from a distance.
• Manager thus becomes more productive-earns more
• However unskilled workers in rich country face more competition
• Now we view trade as “trade in tasks” rather than commodities-
wealthier countries tend to specialize in “difficult tasks”-higher
rewards to skilled labour.
• Poor countries specialize in tasks which require relatively less
expertise.
Can offshoring explain this?

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