Offshoring, Inshoring and Labor Market Volatility

• DOI: http://doi.org/10.1111/asej.12052
• Author: Neil Foster‐McGregor,Johannes Pöschl
• Published date: 01 June 2015
• Date: 01 June 2015

Offshoring, Inshoring and Labor Market

Volatility*

Neil Foster-McGregor and Johannes Pöschl

Received 16 October 2013; accepted 26 February 2015

Using sectoral data from the World Input-Output Database, this paper considers the

impact of offshoring and inshoring on the volatility of employment and wage

growth. Our results indicate that inshoring has a positive impact on sectoral

employment volatility, while offshoring has a negative impact. Additional results

indicate that much of the positive volatility effect of inshoring is found to occur in

countries in East Asia and the EU12, regions that are important destinations for

offshoring activities. Conversely, the negative volatility effect of offshoring is

found to occur mainly in EU15 and ‘Other’ countries, which consists of developed

countries that are relatively intensive offshorers. We also present results to suggest

that firms smooth employment fluctuations by offshoring, and that such smoothing

tends to be concentrated on low-educated and medium-educated workers.

Keywords: employment, inshoring, offshoring, volatility, wages.

JEL classification codes: F1, F4.

doi: 10.1111/asej.12052

I. Introduction

Several studies have linked trade openness to the volatility of output (e.g. Haddad

et al., 2013), with di Giovanni and Levchenko (2009) finding that openness has a

positive and economically significant impact on the volatility of output per

worker growth in a large cross-section of countries.1The presence of such a

relationship is important because studies have found that increased volatility is

associated with lower long-run growth (Ramey and Ramey, 1995) and welfare

(Pallage and Robe, 2003), and affects inequality and poverty (Laursen and

Mahajan, 2005). Theoretically, the argument for a role of openness in affecting

volatility is weak, with little understanding of the channels through which the

effect works. Di Giovanni and Levchenko (2009) discuss a number of channels,

* Foster-McGregor (corresponding author): UNU-MERIT, Keizer-Karelplein 19, 6211TC, Maas-

tricht, the Netherlands. Email: foster@merit.unu.edu. Pöschl: Vienna Institute for International Eco-

nomic Studies (wiiw), Rahlgasse 3, 1060, Vienna, Austria. The authors gratefully acknowledge

financial support from the Jubiläumsfonds of the Austrian National Bank (OeNB). Comments from

participants at the joint CESSA-wiiw workshop held in Vienna in June 2013 and an anonymous

referee are gratefully acknowledged.

1 Recent work also considers the relationship between openness and volatility at the firm level, with

Buch et al. (2006) finding that German firms that export are less volatile than non-exporters, for

example.

bs_bs_banner

Asian Economic Journal 2015, Vol. 29 No. 2, 145–163 145

© 2015 The Authors

Asian Economic Journal © 2015 East Asian Economic Association and Wiley Publishing Pty Ltd

including the argument that trade exposes a country or industry to external

shocks, changes the degree of co-movement between the trading industries and

the rest of the economy, and impacts upon the diversification of production across

sectors. In this paper, we consider the impact of offshoring and inshoring on

volatility, and in particular the impact of offshoring and inshoring on the volatility

of employment and wage growth.

The ongoing globalization process has seen the increasing frequency of inter-

national outsourcing, or offshoring, of production, involving the contracting out

of activities that were previously performed within a production unit to foreign

subcontractors. Discussion of the impacts of offshoring tends to be focused on

labor markets, in terms of its links to changes in employment, wage levels and

relative wages (see e.g. Feenstra and Hanson, 1999; Foster-McGregor et al.,

2013).

In this paper we move away from this focus on the impact of offshoring on

absolute and relative wages and employment, to consider its impact on labor

market volatility. The expansion in offshoring helps tie industries in different

countries to each other, and this can lead to increased volatility at the sector and

macro level. Such increased volatility may be linked to a number of labor market

phenomena that have been noticed in recent years. For example, increased vola-

tility in labor markets may be an explanation for the increased vulnerability felt by

workers (Alibert et al., 2006), the reduced bargaining power of workers (IMF,

2007), and the reduced opportunities for risk-sharing arrangements between

workers and firms (Bertrand, 2004).

Empirically, a small number of papers have presented evidence to suggest that

offshoring may be a determinant of sectoral volatility. Bergin et al. (2009), for

example, note that employment fluctuations in Mexican maquiladora industries

are twice as volatile as those in their US counterparts, while Comin et al. (2009)

show that although the recent recession in Mexico started later than that in the

USA, it was much more severe. Bergin et al. (2011) develop a model of global

production sharing in which the decisions of firms respond to macroeconomic

shocks. An important feature of the model is that the decision to offshore by firms

in the home market is endogenously determined by comparing home and foreign

unit labor costs. Because home wages are pro-cyclical a boom in demand will

tend to increase the extent of offshoring, with the higher wages in the home

country making it profitable for more firms to offshore production. The reverse

will occur in the case of a negative demand shock. The implication of this is that

shocks in the offshoring country will tend to be amplified in their transmission

abroad. Bergin et al. (2011) identify two main reasons for this amplification

effect. First, in their example of the Mexican maquiladora sector, the foreign

offshoring sector has smaller total employment than in the home country. There-

fore, any given shift in employment from the home to the foreign country (or vice

versa) will have a bigger impact on volatility in the foreign countries. Second, the

direct effect of a demand increase on employment in the home country will be

offset by the indirect decrease in demand due to greater offshoring. In the case of

ASIAN ECONOMIC JOURNAL 146

© 2015 The Authors

Asian Economic Journal © 2015 East Asian Economic Association and Wiley Publishing Pty Ltd