Labor Market Effects of Offshoring ... - Stanford University · West Coast Trade Workshop -...

Labor Market Effects of Offshoring Within andAcross Firm Boundaries

Lindsay Oldenski Brian Kovak Nicholas Sly

Georgetown University and Peterson Institute

Carnegie Mellon University and NBER

University of Oregon and CESifo

West Coast Trade Workshop - Stanford - February 2015

Kovak, Oldenski & Sly Employment & Offshoring

Disclaimer

The statistical analysis of firm-level data on U.S. multinationalcompanies was conducted at the Bureau of Economic Analysis,U.S. Department of Commerce under arrangements that maintainlegal confidentiality requirements. The views expressed are those ofthe authors and do not reflect official positions of the U.S.Department of Commerce.


Introduction

Popular Question:

How does offshore employment affect local hiring?

Research Question:

How does the secular decline in offshoring costs affect localemployment


Introduction

Several difficulties in answering this question:

Economic Difficulties

1 Offshoring is a loosely defined economic activity2 Many effects of offshoring - positive and negative

Empirical Difficulties

1 Endogenous choice to offshore activities via any mode2 Simultaneous choice about volume of production activities

within offshore establishments3 Long secular trend towards globalized economy


Our Contributions

We use a model of endogenous offshore activities in order to

1 Characterize the margins on which we expect positive(i.e.,productivity/scale) and negative (i.e., substitution)effects of offshoring activity for local employment

2 Characterize the exclusion restriction necessary to identify theeffects of offshore employment on local hiring

3 Derive a multi-tier 2SLS empirical strategy to estimate theeffects of offshore activity on local employment


Our Contributions

On the empirical side we introduce a novel (policy) instrument forchanges in offshoring costs: Bilateral Tax Treaties (BTT)

The impact of BTTs vary by

1 destination country2 time3 industry4 firm offshoring mode*


Introduction

Second-Stage:

1 Estimate effect of offshoring on local employment withinexisting US multinational firms (US BEA data)

2 Estimate effect of offshoring on local employment within USmultinational firms that open new affiliates (US BEA data)

3 Estimate effect of offshoring on local employment within USindustries (CPS; two-sample IV)

4 Estimate effect of offshoring on local employment withinregions (MSA; Bartik-style analysis)


Preview of Results

In line with expectations we findFor a 10% increase in offshore employment

a 1.3% increase in employment within MNE operating anaffiliate in a treaty country

a more modest 0.9% increase in employment within MNEsthat open a new affiliate in a treaty country.

a small net increase of 0.27% increase in industry-levelemployment

We also find important heterogeneity in these effects acrossindustries and geographic locations that is in line withtheoretical predictions


The Model

We adopt the Global Sourcing setting developed by Antras &Helpman (JPE 2004), in which firms choose their domestic/foreignsourcing behavior, facing incomplete contracts with suppliers

Two countries: Home & Foreign

Wages are higher at Home

Consumers have identical quasi-linear preferences

U = x0 +1

µ

I∑i=1

Xµi 0 < µ < 1 (1)

so that monopolistically competitive suppliers of varieties (h) ofthe composite X face an inverse demand function given by

pi (h) = Xµ−αxi (h)α−1 (2)


Production

Production requires labor services for activities that cannot beoffshored, s, and labor services to generate inputs m.

Workers are identical in terms of productivity across bothlabor services, and across countries

Specifically, a worker in either country produces a single unitof m, and domestic workers can supply a single unit of s.

The firm-level production schedule follows

xi (h) = θh

[s(h)

ηi

]ηi[

m(h)

1− ηi

]1−ηi

(3)

where θ is a firm-level productivity parameter (i.e., TFP).


Sourcing

Domestic firms can source components, m, from the foreigncountry, albeit facing two frictions

1 MNEs face the incidence of double-taxation, leading to ahigher effective tax rate only for those activities that takeplace abroad

2 Domestic firms face an incomplete contracting problem withpotential suppliers, generating a hold-up problem in themanufacture of components


Sourcing: double-taxation

Let τi indicate the relatively higher tax rate paid by firms thatsource components from integrated suppliers

Even though the statutory tax rate is identical acrossindustries, the incidence of double taxation varies acrossindustries due to institutional constraints in enforcing rules.(Blonigen, Oldenski, Sly 2014)We model τi > 1 such that the hiring of τi foreign workersyields one unit of components m for production.


Sourcing: incomplete contracts

Firms cannot contract completely with suppliers. As a result,they face a hold-up problem when choosing how much laborto hire.

Integrating with a supplier occurs as the parent MNE buys theresidual rights over component manufactures.The domestic parent company cannot use the inputs suppliedby a foreign affiliate as effectively without its cooperation.Specifically, if the parent exercises its residual rights and seizesinputs it loses (1− δ) of final goods during production

The parent and supplier engage in ex post negotiation overthe surplus generated during production.


Local Labor Demand: Equilibrium

The problem the parent company solves is to maximize its share oftotal surplus, given its outside option of seizing componentsfabricated by the supplier, is given by

maxs(h)

[δα + β(1− δα)] R(h)− w Ns(h) , (4)

where the revenue earned during production in equilibrium is givenby

R(h) = θαh Xµ−α[

s(h)

ηi

]αηi[

m(h)

1− ηi

]α(1−ηi )

. (5)

The corresponding problem for the component supplier is

maxm(h)

(1− β)R(i)− w Sτi m(h) . (6)


Towards an empirical strategy...

Solving the problem of the foreign affiliate, we obtain optimalforeign hiring decisions[

m(i)

1− ηi

]α(1−ηi )

= w S (1−β′)−1(α)−1θ−αh Xα−µ[

h(i)

ηi

]1−αηi

τα(ηi−1)i ,

(7)which after taking logs and simplifying becomes

ln m(i) =α− µ

(αηi − 1)ln θh −

1

(1− αηi )ln w S

(αηi − 1)

α(ηi − 1)ln ηi + ln(1− ηi ) +

α− µα(ηi − 1)

ln X +1

α(1− ηi )ln(1− β)

+(αηi − 1)

α(ηi − 1)ln s∗(i)− (1− αηi ) ln τi . (8)



For exposition purposes we can rewrite this FOC as

ln m(h) = ϕhdi + γ1 ln s∗(h) + γ2 ln τi . (9)

The asterisk on s reflects the fact that is is an endogenous choicesmade by the parent company, which is simultaneously determinedwith foreign affiliate labor hiring decisions.

Thus, one should only consider changes in exogenous taxincidence to identify foreign labor demand, consistent with ourempirical strategy using BTTs below.

A similar exercise yields the optimal labor demand for theparent company in the North:

ln s(h) = ϕhdi + γ′1 ln m∗(h) (10)



ln s(h) = ϕhdi + γ′1 ln m∗(h) (11)

Note that γ′1 = 1−αiηiαi (1−ηi )

> 0

Thus, offshore employment within MNEs complements localemployments activities.

Moreover, the effect of offshore employment should have a largereffect on local employment within multinational firms in industrieswith high price markups (low elasticities)


Local Labor Demand: Offshoring Arm’s lentgh

The problem the parent company solves is to maximize its share oftotal surplus, without its outside option of seizing componentsfabricated by the supplier, is given by

maxs(h)

[β(1− δα)] R(h)− w Ns(h) , (12)

where the revenue earned during production in equilibrium is givenby

R(h) = θαh Xµ−α[

s(h)

ηi

]αηi[

m(h)

1− ηi

]α(1−ηi )

. (13)

The corresponding problem for the component supplier, not facingpotential double taxation, is

maxm(h)

(1− β)R(i)− w S m(h) . (14)


No empirical strategy!!!

Again solving for the FOC and then simplifying we obtain

ln m(h) = ϕhdi + γ1 ln s∗(h) . (15)

A similar exercise yields the optimal labor demand for the parentcompany in the North:

ln s(h) = ϕhdi + γ′1 ln m∗(h) (16)

There is no exogenous variation for offshoring activity, EVEN whenthat activity takes place outside the boundaries of multinationalfirms.!



At the industry level there may be some firms that engage in a discreteshift in their global organization strategy when offshoring costs fall:

1 Greater offshoring within integrated MNEs leads to anunambiguous increase in local hiring for general labor services, s.

2 Greater offshoring within integrated MNEs may substitute foreignlabor for activities that took place locally**

3 Greater offshoring within integrated MNEs may substitute foreignlabor for activities that took place abroad within arms-lengthsuppliers (unobserved!)

Within the set of MNEs that open a new affiliate when offshoringcosts fall, the within-firm observed gains in local employment aresmaller (no greater) than for the set of MNEs with existing affiliates inthe treaty country.



Now, across firm boundaries to local industry-level employment.

LNi =

∫h∈Oi⊂Hi

s(h)Pr(h ∈ Oi )dh +

∫h∈Ai⊂Hi

s(h)Pr(h ∈ Ai )dh

+

∫h∈Ii⊂Hi

[m(h)+s(h)]Pr(h ∈ Ii )dh+

∫h∈Ui⊂Hi

[m(h)+s(h)]Pr(h ∈ Ui )dh .

(17)

Oi is the set of firms in industry i that choose to offshorecomponent production to an affiliate in the in the SouthAi is the set of firms that offshore component production to anarms-length supplier in the SouthIi is the set of non-multinational firms that hire local workers inthe North to manufacture components in houseUi is the set of firms that source production of components fromlocal arms-length suppliers in the North.



Now, across firm boundaries to local industry-level employment.

∂LNi

∂τi=

∫h∈Oi⊂Hi

∂s(h)

∂τiPr(h ∈ Oi )dh

+

∫h∈Ii⊂Hi

m(h)∂ Pr(h ∈ Ii )

∂τidh +

∫h∈Ui⊂Hi

m(h)∂ Pr(h ∈ Ui )

∂τidh . (18)

Slaughter (2009) documents that upwards of 20% of US totalprivate sector employment is in MNEs, so that benefits ofoffshoring may be substantial.However, Blonigen, Oldenski & Sly (2014) and Davies, Norback& Tekin-Koru (2009) show that BTTs raise the propensity forfirms to enter foreign employment, substituting foreign foreignlabor for domestic workersAlso, Monarch, Park, and Sivadasan (2014) show that domesticplant closures within MNEs lead to substantial employment losses


Empirical Specification

Consider a multi-tiered two-stage least squares strategy with threealternative second stages:

Stage 1 uses BEA firm-level data to estimate the effects ofbilateral tax treaties on foreign affiliate employment.

Stage 2a uses these first stage estimates to identify the impactof offshoring on firm-level employment within existing MNEs

Stage 2b examines the relationship between offshoring shocksand employment outcomes at the industry level, where thesecond stage looks at US employment at both MNCs andpurely domestic firms (CPS; two-sample IV).

Stage 2c examines the effects of offshoring on local labormarkets within the US, based on each market’s initial industrymix of employment (see Topalova 2007).



The IV: Bilateral Tax Treaties

OffshoreEmphdit = βTdt + ϕhid + αit + ΦXhdit + εhdt .

Tax treaties are bilateral (i.e., country-specific) and varysubstantially in the dates they enter into force

The stated intended purpose is the alleviation ofdouble-taxation on cross-border activities.

OffshoreEmphdit = β1Tdt + β2Di Tdt + ϕhid + αit + ΦXhdit + εhdt .

The impact of BTTs differs according to the intensity withwhich production relies on ‘differentiated inputs’

Finally, they reduce double taxation only for integratedmultinational firms


Data

Table: Countries with New Treaties in Effect

Country Date Country Date

Bangladesh 2007 Russia 1993Estonia 1999 Slovenia 2001India 1990 Spain 1990Indonesia 1990 Sri Lanka 2004Israel 1994 Thailand 1997Latvia 1994 Tunisia 1990Lithuania 1994 Turkey 1997Mexico 1993 Ukraine 2000Portugal 1995 Venezuela 1999


Data

BEA data provide firm- & affiliate-level information aboutemployment

CPS data provide information about industry-levelemployment by MSA

International Fiscal Database and IRS Publications providesinformation about treaty enforcement dates

Nunn (2007) provides industry-level information on requireduse of differentiated inputs a la Rauch (1999)



Identifying assumption

Changes in employment within affiliates of US multinationalsovertime across countries are uncorrelated with employmentprior to (counterfactual) the implementation of BTTs acrosscountries.


First-Stage

Potential Concerns:

1 Confounding pre-trends

2 SUTVA

See Antras, Fort and Tintelot (2014)

3 Omitted Motives for FDI



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Figure: Relative Foreign Affiliate Activities Across Treaty Status, Time &Sectors


Results: Stage 1

Table: Stage 1: The Relationship between BTTs and Offshoring: Dif-in-difwith Affiliate Fixed effects

Model : 1 2 3 4 5 6Sample: Abv Med Blw Med Abv Med Blw Med Abv Med Blw MedDepvar: ln(emp) ln(emp) ln(emp) ln(emp) ln(emp) ln(emp)

BTT 0.157*** -0.029 0.158*** -0.023 0.157*** -0.022(0.043) (0.055) (0.044) (0.054) (0.044) (0.053)

Sibling BTT 0.011 0.018*** 0.011 0.018***(0.008) (0.005) (0.008) (0.005)

Sib-Sib BTT 0.020 0.023**(0.016) (0.011)

Affiliate FE YES YES YES YES YES YESYear FE YES YES YES YES YES YESN: 52041 46224 52041 46224 52041 46224R-sq 0.008 0.005 0.008 0.006 0.008 0.007

Notes: *,** and *** indicate significance at the 10, 5 and 1 percentlevels, respectively. Standard errors clustered by country are in

parentheses.


Results: Stage 1

Table: Stage 1: The Relationship between BTTs and Offshoring: Dif-in-difwith Affiliate Fixed effects

Model : 1 2 3 4 5 6Sample: Abv Med Blw Med Abv Med Blw Med Abv Med Blw MedDepvar: ln(emp) ln(emp) ln(emp) ln(emp) ln(emp) ln(emp)

BTT 0.146*** -0.009 0.145*** -0.007 0.145*** -0.006(0.048) (0.053) (0.047) (0.053) (0.047) (0.052)

Sibling BTT 0.010 0.016*** 0.010 0.015***(0.009) (0.004) (0.009) (0.004)

Sib-Sib BTT 0.012 0.020**(0.013) (0.010)

GDP 4.048*** 2.797** 3.960*** 2.681** 3.939*** 2.617**(0.964) (1.410) (0.933) (1.381) (0.922) (1.374)

GDP2 0.122 0.040 0.114 0.029 0.113 0.023(0.086) (0.120) (0.083) (0.118) (0.082) (0.118)

Skill Diff -0.076** -0.033 -0.076** -0.032 -0.076** -0.031(0.029) (0.026) (0.029) (0.025) (0.029) (0.025)

Trade Cost -0.020* -0.003 -0.020* -0.003 -0.020* -0.003(0.010) (0.010) (0.011) (0.010) (0.011) (0.010)

BIT -0.062 -0.061 -0.081 -0.073 -0.080 -0.072(0.121) (0.045) (0.120) (0.045) (0.121) (0.045)

FTA -0.021 -0.109*** -0.015 -0.097*** -0.016 -0.098***(0.058) (0.038) (0.058) (0.036) (0.058) (0.036)

$Ex Rate 0.000 0.000 0.000 0.000 0.000 0.000(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

Affiliate FE YES YES YES YES YES YESYear FE YES YES YES YES YES YESN: 51103 45173 51103 45173 51103 45173R-sq 0.015 0.009 0.015 0.010 0.015 0.010


parentheses.


Results: Stage 1

Table: Stage 1: The Relationship between BTTs and Offshoring: Parent xYear Fixed Effects

Model : 1 3 4 2 5 6

Sample: All Abv Med Blw Med All Abv Med Blw MedDepvar: ln(emp) ln(emp) ln(emp) ln(emp) ln(emp) ln(emp)

btt 0.060 0.187*** -0.034 0.061 0.181*** -0.028(0.040) (0.062) (0.048) (0.041) (0.063) (0.050)

lsgdp 2.373** 2.144* 3.196**(1.003) (1.299) (1.538)

lgdfsq -0.052 -0.022 -0.068(0.097) (0.130) (0.143)

lskldf -0.075*** -0.094*** -0.042(0.027) (0.037) (0.040)

ltcost -0.012 -0.025* 0.005(0.009) (0.014) (0.012)

bit -0.073 -0.070 -0.119(0.083) (0.183) (0.089)

fta -0.047 -0.033 -0.075(0.035) (0.049) (0.048)

exrate 0.000 0.000 -0.00004*(0.000) (0.000) (0.000)

Par x yr FE YES YES YES YES YES YESIndustry FE YES YES YES YES YES YESCountry FE YES YES YES YES YES YESN: 96606 51298 45308 94617 50360 44257R-sq 0.171 0.180 0.209 0.170 0.177 0.209

Notes: *,** and *** indicate significance at the 10, 5 and 1 percentlevels, respectively. Standard errors clustered by affiliate are in

parentheses.


Results: Stage 2a

First tier: Prediction

Greater offshore employment raises employment withinexisting multinational firms


Results: Stage 2a

Table: Second Stage: Affiliate Level

Model : 1 2Depvar: ln(par emp) ln(par emp)

ln(OffsoreEmp) 0.156*** 0.194***(0.044) (0.046)

ln(SibOffshoreEmp) 0.106***(0.002)

Affiliate FE YES YESYear FE YES YESControls YES YESN: 97010 82284R-sq 0.023 0.058


parentheses.


Results: Stage 2a

First tier: Predictions

Greater offshore employment raises employment withinexisting multinational firms more in industries that haverelatively high markups (low elasticities)

Greater offshore employment raises employment withinexisting multinational firms less within multinational firmsthat open new affiliates within treaty countries


Results: Stage 2a - heterogeneity

Table: Second Stage: Parent Level

Model 1 2 3 4Sample All Sigma Blw Med Sigma Abv Med New Aff Post-BTTDepvar: ln(par emp) ln(par emp) ln(par emp) ln(par emp)

ln∑ (offshoring) 0.134*** 0.156*** 0.112*** 0.092***

(0.006) (0.009) (0.009) (0.014)

Parent FE YES YES YES YESYear FE YES YES YES YESN: 22976 10028 9785 3901R-sq 0.022 0.025 0.024 0.006

Notes: *,** and *** indicate significance at the 10, 5 and 1 percentlevels, respectively. Robust standard errors are in parentheses.


Results: Stage 2a

Second-tier: Prediction

Greater offshore employment may have positive or negativenet effect on industry-level employment

But, the effect is relatively smaller then the estimated effectwithin existing multinational firms

Greater offshore employment raises employment withinexisting multinational firms more in geographic regions thathave relatively higher concentrations of activity withinindustries


Results: Stage 2b

Table: Second Stage: Industry and MSA Level

1 2Depvar: ln(industry emp) ln(msa emp)

ln∑ (offshoring) 0.027** 0.050***

(0.013) (.010)

Industry FE YES -MSA FE - YESYear FE YES YESN: 2527 6384R-sq 0.349 0.724

Notes: *,** and *** indicate significance at the 10, 5 and 1 percent levels, respectively.Robust standard errors are in parentheses.


Conclusion

We show theoretically how failing to properly account for theendogeneity of offshoring and labor markets can bias theestimated effects of offshoring on US workers.

We then estimate the impact of offshoring by US firms on USworkers both within and across firms using a new instrumentalvariable: BTTs

The results show that offshoring has positive aggregateimpact on domestic US employment at MNCs

We estimate that there is modest, but robust, net positiveimpact of offshore employment on local hiring at the industrylevel.


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