Services offshoring increases wage inequality

Holger Görg, Ingo Geishecker, Christiane Krieger-Boden, 24 December 2011

a

A

Offshoring from industrialised countries always evokes hot debate in public and academic circles. Worries concern a loss of employment opportunities in unskilled jobs at one point, and in high-skilled jobs at another. Other worries concern the suspected devaluation of unskilled labour.

Particularly with regard to manufacturing activities, offshoring has already been explored quite extensively in economic research. The theory tells us that effects are clearly ambiguous (Baldwin 2010). Empirical results show that materials offshoring has increased the demand for skilled labour (e.g. Feenstra and Hanson 1999, Hijzen et al. 2005). It has also been shown to impact the wages of unskilled labour negatively (Geishecker and Görg 2008, Munch and Skaksen 2009, Ebenstein et al. 2009, Baumgarten, Geishecker, Görg 2010).

Offshoring of service activities has been studied much less so far, the attention has turned towards this aspect only recently. While services offshoring is still at a relatively low level compared to materials offshoring (Amiti and Wei 2005), its growth rates are much higher. Again, studies do not find any strong negative effects on employment (Amiti and Wei 2005, Hijzen et al. 2011). Rather, they find that services offshoring makes employment in offshoring firms grow faster than otherwise. As to wage effects, the existing studies are ambiguous. While Liu and Trefler (2011) find wage inequality to rise with service offshoring, Munch and Skaksen (2009) argue there are specialisation gains from an improved division of labour and find that productivity and wages rise both for unskilled and skilled labour. A recent paper by Geishecker and Görg (2011) now adds to the existing evidence and supports the finding of increasing wage inequality as a result of services offshoring.

The ambiguity of empirical findings may well be rooted in the subject itself. Grossman and Rossi-Hansberg’s (2008) theoretical framework allows distinguishing between the offshoring of a low-skill activity and the offshoring of a high-skill activity, and evaluates the wage effects on both low-skilled and high-skilled workers, to come up with three different types of wage effects from offshoring. First, by offshoring those activities that are least productive with regard to a respective labour skill, the productivity of the remaining workers of the same skill will increase, and this will tend to increase their wages. Second, offshoring will release workers of the respective skills, and the excess labour supply will tend to decrease the real wages of such workers, in contrast to those of the opposite skills. Third, as the relative price of the final good using the offshoring may decline, this can negatively affect the wages of the workers with the related skills (the Stolper-Samuelson effect). Combining the three types of effects from both kinds of offshoring, one gets the resulting wage trends for low- and high-skilled workers as presented in Table 1. Accordingly, offshoring of low-skill activities benefits high-skilled workers, while the effect on low-skilled workers is ambiguous. Offshoring of high-skill activities benefits low-skilled workers while the effect on high-skilled workers is ambiguous. On balance, the outcome of offshoring for wages depends on the relative strength of the diverting effects, and on whether offshored activities are low-skill or high-skill intensive.

Table 1. Theoretical wage effects of offshoring

  Low-skilled workers High-skilled workers
 Offshoring of low-skill production
Productivity increase of low-skilled workers  Wage↑  -
Labour supply effect  Wage↓  Wage↑
Relative price effect on final goods  Wage↓  Wage↑
 Offshoring of high-skill production
Productivity increase of high-skilled workers    Wage↑
Labour supply effect  Wage↑  Wage↓
Relative price effect on final goods  Wage↑  Wage↓

 Source: Grossman and Rossi-Hansberg 2008.

On the base of this theoretical framework, we analyse the dimensions of these different effects (Geishecker and Görg 2011). This, as a start, requires defining a measure for offshoring, which is far from a trivial effort. Since direct coherent and comparable data on offshoring is lacking, economists revert to adopting appropriate proxies. A basic idea is that trade in intermediates will indicate the extent of offshoring in an industry. Moreover, to encircle the unknown actual value, a narrow and a broad definition are provided for each industry. In the case of services offshoring, the proxies refer to the general trade intensity in services (broad definition) and to the trade intensity in telecommunication, computer and other business services (narrow definition, first conceptualised by Amiti and Wei 2005, upper part of Figure 1). In the case of materials offshoring, the proxies refer to total intermediate trade intensity (broad definition) and to intra-industry trade intensity (narrow definition, first conceptualised by Feenstra and Hanson 1999, upper part of Figure 1).

Figure 1. Evolution of offshoring and hourly wages in UK, 1992-2004

Source: Geishecker, Görg (2011) based on UK National Statistics and BHP Survey.

Data on skills and on wages are drawn on an individual-level basis from the British Household Panel Survey. A first glance, these data already suggest a divergence in wages of high-skilled and low-skilled workers while offshoring increases (Figure 1). To explore this relation more precisely, the wage effects of offshoring are estimated with a Mincerian wage equation. The explanatory offshoring measures are also interacted with three different skill groups of high-, medium- and low-skilled workers, according to education levels, to account for the different effects on these groups of workers. The individual-level data even allow estimating the effect of increasing offshoring on individual wages of workers in an affected industry. Two strategies are used to identify a link between offshoring and wages. The first is the standard strategy in the literature, which looks at the impact of within-industry changes in offshoring intensities on wage changes of individuals in the same industry. The second strategy is based on the idea that offshoring may not only affect wages of workers with a given skill level in the industry in which the offshoring takes place, but also in industries that use workers with the same skill levels. This approach implicitly allows for movement of workers of a given skill level across industries. All estimations also include control variables to factor out any wage effects from firm sizes, locations, business cycles and industry-specific technological progress.

The results show that services offshoring affects the real wage of low- and medium-skilled individuals in the same industry negatively. By contrast, skilled workers benefit from services offshoring in their industry in terms of higher real wages. When allowing for movement of workers across industries, we find statistically significant evidence that offshoring of services in industries that use the same skills reduces wages for low- and medium-skilled workers. We cannot identify with sufficient precision any wage effect for high-skilled workers, however. To give an impression of the values that are at stake according to these estimations, we calculate the cumulated wage effects for the median worker of the different education levels over the period 1992-2004 (Table 2).

Table 2. Cumulated wage effects of increased offshoring 1992-2004 (£)a

  High-skilled Medium-skilled Low-skilled
Within-industries changes only
Narrow definitionb      
     Services offshoring 1999.74 - -310.86
     Materials offshoring - - -308.36
Broad definitionc      
     Services offshoring 1278.70 -256.02 -191.83
     Materials offshoring - - -393.73
Including between-industries changes
Narrow definitiond      
     All offshoring - -4893.08 -4323.73
Broad definitione      
     All offshoring 5282.85 - -1872.82

 Notes: a) Assumed 1732 work hours per year and a median hourly wage in 1992 of £18.37 (high-skilled), £8.19 (medium-skilled) and £4.92 (low-skilled). b) based on an estimated overall change of offshoring of 0.12 (services) and 2.23 materials) percentage points. c) Based on an estimated overall change of offshoring of 1.57 (services) and 4.81 (materials)percentage points. d) Based on an estimated overall change of offshoring of 2.35 percentage points. – e) Based on an estimated overall change of offshoring of 6.83 percentage points.

Source: Geishecker and Görg (2011).

Accordingly, British high-skilled workers could have gained some extra £1300-£2000 over the whole period due to services offshoring, when recognising within-industry changes only, and up to £5300 when taking between-industry changes into account. British medium-skilled workers are more likely to have lost income, up to as much as £4900. And finally, low-skilled workers are likely to have suffered most, from a loss of about £190-£310 from services offshoring and about £310-£390 from materials offshoring (only within-industry changes) to a loss of about £1900-£4300 when including between-industry changes. Given that these cumulative changes refer to a 12-year period, the amounts are small but not so small to be neglected, particularly as the variation around these median changes may be considerable.

Finding a negative effect of services offshoring in an industry on the real wage of low- and medium-skilled workers, and a positive effect on the real wage of skilled workers, is consistent with the partial equilibrium view in Grossman and Rossi-Hansberg (2008), if one assumes that mainly low- and medium-skilled services activities are offshored. Going beyond the Grossman-Rossi-Hansberg model and recognising that offshoring in one particular industry may also affect labour demand in other industries, the effects of services and materials offshoring cannot be identified separately. However, taken together, services and materials offshoring still seem to impact positively on wages of high-skilled workers and negatively on wages of low- and medium-skilled workers, thus contributing to a rising wage inequality. Hence, high-skilled workers can be seen as winners and medium- and low-skilled workers as losers from offshoring. The relevant questions are whether the losers should be compensated, and if this is answered in the affirmative, what form such compensation should take. Another policy implication is that skill upgrading needs to be continued in order to allow unskilled workers to move into the winning category of skilled work.

References

Amiti, M. and Wei, S.J. (2005) "Fear of service outsourcing: Is it justified?", Economic Policy, 20, 308-347.
Baldwin, Richard (2010), “Thinking about offshoring and trade: An integrating framework” VoxEU.org, 23 April.
Baumgarten D., Geishecker, I., and Görg, H. (2010) "Offshoring, tasks, and the skill-wage pattern", CEPR Discussion Paper 7756
Ebenstein, A., Harrison, A., McMillan, S., and Phillips, S. (2009) "Estimating the Impact of Trade and Offshoring on American Workers Using the Current Population surveys", NBER Working Paper 15107.
Feenstra, R.C. and Hanson, G.H. (1999) "The impact of outsourcing and high-technology capital on wages: Estimates for the US, 1979-1990", Quarterly Journal of Economics, 114, 907-941.
Geishecker, I. and Görg, H. (2011) "Services offshoring and wages: Evidence from micro data", Oxford Economic Papers, forthcoming.
Geishecker, I. and Görg, H. (2008)" Winners and losers: A micro-level analysis of international outsourcing and wages", Canadian Journal of Economics, 41, 243-270.
Grossman, G.M. and Rossi-Hansberg, E. (2008) "Trading Tasks: A Simple Theory of Offshoring", American Economic Review, 98, 1978-1997.
Hijzen, A., Görg, H., and Hine, R.C. (2005) "International outsourcing and the skill structure of labour demand in the United Kingdom", Economic Journal, 115, 860-878.
Hijzen, A., Pisu, M., Upward, R., and Wright, P. (2011) "Employment, job turnover, and the trade in producer services: firm-level evidence", Canadian Journal of Economics, 44 (3), 1020–1043.
Liu, R. and Trefler, D. (2011) "A Sorted Tale of Globalisation: White Collar Jobs and the Rise of Service Offshoring", Working Paper 17559, NBER, Boston M.A.
Munch, J.R. and Skaksen, J.R. (2009) "Specialization, Outsourcing and Wages", Review of World Economics, 145, 57-73.

 

Topics: International trade
Tags: offshoring, UK, wages

Junior Professor at the University of Göttingen

Professor of International Economics, Kiel Institute for the World Economy

Christiane Krieger-Boden

Researcher, Kiel Institute for the World Economy