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VIDEO
Gartner Outsourcing & Strategic Partnerships Summit 2012, London, UK
Outsourcing
Since the fall of the Iron Curtain and the integration of China into the world trading system, international trade in goods and services has increased significantly. This is a consequence of the large differences in factor endowments and hence in relative prices between the earlier OECD countries and the countries that have been opened up to international trade.
Trade in intermediate products has developed particularly rapidly, due to outsourcing activities of firms that have tried to make use of the huge wage differences between the formerly separated parts of the world. Major improvements in information and communication technologies in the 1990s are a second reason for the increase in outsourcing.
The new international production patterns have caused the domestic value added per unit of output, the so-called production depth, to decline in many sectors. This trend towards a reduction in domestic production depth has been particularly strong in the manufacturing sector. Its importance has declined significantly in recent years in most Western European countries, where it now usually accounts for about one quarter of total production and one fifth of aggregate employment. Furthermore, the share of manufacturing value added in GDP has been declining in recent years.
A closer look at the input-output tables shows that this trend of de-industrialization is related to outsourcing activities of domestic firms. Parts of the production process have been moved to low-wage countries. In particular, the new members of the European Union in Eastern Europe are at the receiving end of outsourcing done by Western European firms.
Outsourcing is not limited only to manufacturing. In Germany, for example, it has been shown that the same phenomenon applies to the export sector as a whole. From 1991 to 2002, an additional unit of real exports induced, on average, a 55 percent increase in intermediate imports.
Only 45 percent of the increase in exports implied additional value added in Germany, a phenomenon that has been caricatured as the “bazaar effect”. Nevertheless, export-induced value added grew relative to GDP, which is a natural implication of increased specialization. In principle, outsourcing activities can lead to gains from trade for all countries involved.
The low-wage countries of Eastern Europe and Asia find new and profitable employment activities for their large labor forces and are able to increase their wages. The high-wage countries of the West are able to withdraw part of their endowments of labor and capital from labor-intensive sectors and use them more productively in the service and high-tech sectors, where they may have comparative advantages. Outsourcing is a special form of international trade that can be expected to boost world GDP and world welfare, because it allows countries to specialize on the basis of their comparative advantages.
However, for the gains from trade to occur, it is essential that the domestic factor markets in the West are flexible enough to allow for the necessary factor migration between shrinking and expanding sectors. While capital markets in Europe do seem largely to meet this requirement, labor markets are rather rigid. For one thing, national job protection measures prevent workers from moving easily between sectors. For another, collective wage agreements and welfare state provisions that ensure high replacement payments for the non-employed prevent the necessary wage flexibility.
Gains from trade go hand in hand with a tendency towards factor price equalization. In particular, the specialization in more capital-intensive production requires lower wages of the less-skilled workers relative to wages of skilled workers in order to prevent unemployment. If wages are rigid, this process cannot take place.
The sectors where the West has a comparative disadvantage shrink too quickly, setting more labor free than is useful, and the growing sectors where there is a comparative advantage do not create enough additional jobs. The result is a growing level of unemployment.
The EEAG sees strong signs for such a deficiency of the adjustment process in some European countries. Thus, the group advocates policies to make the labor market more flexible. The necessary measures range from more limited job protection policies via opening clauses for collective wage agreements toward policies of activating social aid that reduce labor costs and give further incentives to work, changing thereby the role of the welfare state from a competitor to a partner of private enterprises.
