Outsourcing, Productivity, and Input Outsourcing, Productivity, and Input Composition at the Plant LevelComposition at the Plant Level

Catherine J. Morrison Paul and Mahmut YaCatherine J. Morrison Paul and Mahmut Yaşşar ar

World Congress, Washington D.C., World Congress, Washington D.C., May 2008May 2008

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Make-or-BuyMake-or-Buy

““It is the maxim of every prudent master of a family, It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him never to attempt to make at home what it will cost him more to make than to buy.” more to make than to buy.” Smith (1776, pp.485-486)Smith (1776, pp.485-486)

“… “… quite apart from the question of diminishing quite apart from the question of diminishing returns the costs of organizing certain transactions returns the costs of organizing certain transactions within the firm may be greater than the costs of within the firm may be greater than the costs of carrying out the exchange transactions in the open carrying out the exchange transactions in the open market.” market.” Coase (1937, pp. 7-8)Coase (1937, pp. 7-8)

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Productivity driversProductivity drivers

Firms’ productivity depends on their potential to minimize Firms’ productivity depends on their potential to minimize production costs by substituting among a variety of inputsproduction costs by substituting among a variety of inputs

Studies used to focus on “value added” capital and labor inputs Studies used to focus on “value added” capital and labor inputs but now recognize substitution of processed (materials) for but now recognize substitution of processed (materials) for processing (capital and labor) inputsprocessing (capital and labor) inputs

More generally, input choices include purchasing rather than More generally, input choices include purchasing rather than producing goods and services (implies outsourcing or producing goods and services (implies outsourcing or subcontracting)subcontracting)

Affects the productivity & competitiveness of outsourcing firmsAffects the productivity & competitiveness of outsourcing firms

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Outsourcing driversOutsourcing drivers

Firms would be expected to use their own inputs for activities they Firms would be expected to use their own inputs for activities they have a have a comparative advantagecomparative advantage for and outsource others for and outsource others

Roodhooft and Warlop (1999)Roodhooft and Warlop (1999)

A firm’s comparative advantage depends on A firm’s comparative advantage depends on trade, price, and trade, price, and technical conditionstechnical conditions

E.g.,E.g., import competition import competition from from lower wagelower wage countries encourages countries encourages foreign outsourcing, reducing the wages of less skilled laborers foreign outsourcing, reducing the wages of less skilled laborers

Feenstra and Hanson (1999, 2003), Hanson et al. (2005)Feenstra and Hanson (1999, 2003), Hanson et al. (2005)

In reverse, lower wage countries may subcontract outputIn reverse, lower wage countries may subcontract output

Both specialized tasks and lower productivity/skill processes may be Both specialized tasks and lower productivity/skill processes may be outsourced to other domestic or foreign firmsoutsourced to other domestic or foreign firms

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Our goalOur goal

We explore how We explore how outsourcing or subcontractingoutsourcing or subcontracting is related to is related to plant productivity plant productivity andand input composition/substitution input composition/substitution

from the perspective of a developing countryfrom the perspective of a developing country

We consider the productivity effects of:We consider the productivity effects of:domestic outsourcing,domestic outsourcing, through the share of inputs that are subcontracted through the share of inputs that are subcontracted receiving contracts,receiving contracts, through the share of output that is subcontracted through the share of output that is subcontractedforeign outsourcing,foreign outsourcing, through the share of imported intermediate inputs through the share of imported intermediate inputs

represented as production frontier represented as production frontier shifts and twistsshifts and twistsfrom diff shares of subcontracted inputs/outputs or imported materialsfrom diff shares of subcontracted inputs/outputs or imported materials

and find this aspect of input choice important to recognizeand find this aspect of input choice important to recognize

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LiteratureLiterature

Outsourcing/subcontracting has not been a focus of the production literatureOutsourcing/subcontracting has not been a focus of the production literature

But some studies suggest (domestic or foreign) outsourcing results if producing But some studies suggest (domestic or foreign) outsourcing results if producing inputs or services in-house is at least as costly as subcontracting theminputs or services in-house is at least as costly as subcontracting them

Involves two types of Involves two types of costs costs production costsproduction costs: labor costs, scale economies, clustering of special skills or : labor costs, scale economies, clustering of special skills or expertise, or production smoothing expertise, or production smoothing transactions coststransactions costs: negotiating, monitoring, and enforcing contracts, or searching : negotiating, monitoring, and enforcing contracts, or searching for outside suppliersfor outside suppliers

Also may be Also may be benefitsbenefits from from foreign technologyforeign technology transfertransfer through outsourcing through outsourcingimportingimporting: R&D embodied in materials/capital imports and learning from their : R&D embodied in materials/capital imports and learning from their use (input subcontracting through input imports) use (input subcontracting through input imports) FDI/exportsFDI/exports: increased demand for exports from host country suppliers (output : increased demand for exports from host country suppliers (output subcontracting)subcontracting)

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Data: output and inputsData: output and inputs

Plant data collected by the Plant data collected by the State of Statistics in TurkeyState of Statistics in Turkey for the for the Annual Surveys of Manufacturing IndustriesAnnual Surveys of Manufacturing Industries

International Standard Industrial Classification,International Standard Industrial Classification, Apparel & Textiles Apparel & Textiles

Output (Y):Output (Y): total value of shipments plus changes in inventories of total value of shipments plus changes in inventories of finished goods and work-in-progressfinished goods and work-in-progressMaterial (M):Material (M): expenditures, allowing for changes in stocks expenditures, allowing for changes in stocks

Energy (E):Energy (E): value of fuel+electricity value of fuel+electricity Y,M and E nominal values are divided by corresponding price deflators Y,M and E nominal values are divided by corresponding price deflators

to get constant value quantities at 1987 pricesto get constant value quantities at 1987 pricesLabor input (LLabor input (LTT and L and LNN):): technical and administrative workers, technical and administrative workers,

production workers production workers Capital (K):Capital (K): perpetual inventory method using gross investment perpetual inventory method using gross investment

data data Seven Seven regionsregions distinguished distinguished

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Data: outsourcing and technology transferData: outsourcing and technology transfer

Our domestic outsourcing variables are:Our domestic outsourcing variables are:

subcontracted inputsubcontracted input (the share of a plant’s inputs (the share of a plant’s inputs subcontracted to supplier plants, in total inputs)subcontracted to supplier plants, in total inputs)

subcontracted outputsubcontracted output (the share of output subcontracted by (the share of output subcontracted by other plants, in total output)other plants, in total output)

Klicaslan and Taymaz (2005) Klicaslan and Taymaz (2005)

Our foreign outsourcing variable is:Our foreign outsourcing variable is:

the share of the share of imported materialsimported materials in total materials use in total materials use

Our foreign technology transferOur foreign technology transfer variables include:variables include:

the share of the share of exportsexports in total sales in total sales

the share of foreign firm ownership (the share of foreign firm ownership (FDIFDI))

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Table 1. Shares of SUBI, SUBO, and IMPM for Different Group of Plants (%)

SUBI SUBO IMPM Overall A&T Industries 13.49 17.45 1.48 By Size Small 11.96 22.40 0.77 Medium 15.10 14.45 1.42 Large 15.11 10.44 2.90 By Export Status Non-Exporters 11.63 30.64 0.32 Exporters 14.69 8.92 2.22 By Ownership Domestic 13.32 17.19 1.39 Foreign 19.64 26.56 4.50

By Region

South-East Anatolian and East Anatolian

1.58 6.02 0.00

Agean Sea 12.18 21.80 0.88 Black Sea 4.16 12.95 3.22 C. Anatolian 3.75 12.45 0.52 Marmara 14.99 16.36 1.66 Mediterranean 9.12 34.37 3.23

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Empirical frameworkEmpirical framework

First look at premia/correlationsFirst look at premia/correlations

for Pfor Pitit = performance indicators = performance indicators (t=time and i=plant)(t=time and i=plant)

labor productivity (LProd), wage, employment, skilled labor productivity (LProd), wage, employment, skilled labor, and capital intensitylabor, and capital intensity

O/SO/Sjitjit (j=(j=SUBSUBII, SUB, SUBOO, , IMPIMPMM))

D=regional (r) and time (t) dummies and EMP=sizeD=regional (r) and time (t) dummies and EMP=size

Estimate:Estimate:6 1 1

01 1 1

ln

R T

it j jit r r t t EMP it itj r t

P OS D D EMP u

1111

Table 2. Percentage Differences between Groups, A&T Industries Dependent variable

SUBI-DUM SUBO-DUM IMP-DUM SUBI & SUBO

SUBI & IMP SUBO&IMP

ln LProd 0.643

(0.039)*** -0.852

(0.046)*** 0.632

(0.119)*** 0.079

(0.040)** 1.036

(0.064)*** 0.656

(0.065)***

ln WAGE 0.146

(0.019)*** -0.084

(0.022)*** 0.24

(0.058)*** 0.088

(0.019)*** 0.413

(0.031)*** 0.295

(0.032)***

ln EMP 0.349

(0.037)*** -0.042 (0.043)

0.605 (0.112)***

0.535 (0.037)***

0.834 (0.060)***

1.258 (0.061)***

ln LADM 0.664

(0.047)*** -0.368

(0.055)*** 0.831

(0.141)*** 0.544

(0.047)*** 1.286

(0.076)*** 1.544

(0.077)***

ln LTECH 0.094

(0.056)* -0.019 (0.069)

0.210 (0.144)

0.170 (0.056)***

0.444 (0.082)***

0.62 (0.080)***

ln K/EMP 0.323

(0.070)*** -0.294

(0.081)*** 0.932

(0.208)*** 0.465

(0.071)*** 0.813

(0.113)*** 1.023

(0.115)***

ln INV/EMP 0.108

(0.096) -0.552

(0.118)*** 0.632

(0.273)** 0.108

(0.096) 0.588

(0.139)*** 0.299

(0.136)** Percentage of plants

27.2 15.2 2.1 23.0 4.8 3.9

Notes: (1) Robust standard errors are in parentheses. *Significant at the 10% level. ** Significant at the 5% level. ***Significant at the 1% level. (2) The independent variables for the different regressions include time, size, and region dummies. (3) The base group is the plants that do not engage in any of these activities.

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Econometric FrameworkEconometric Framework

We assume that the plant production function Y = f(X,r,t) can be represented by a translog approximation:

where Xj ( j = K,LT,LN,E,M) is the jth input, the rm include the O/S, technology transfer, characteristics and dummy variables distinguishing the plants, and is a error term

Use Olley and Pakes (OP) method to estimateUse Olley and Pakes (OP) method to estimate

ln Yit = 0 + j j ln Xjit + t t + m m rmit + j jt ln Xjit t + mj mj rmit ln Xjit

+ .5 (jk jk ln Xjit ln Xkit + tt t2) + it ,

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Table 4. Elasticities at the Mean Values Calculated by the Delta Method

Variables Elasticity Standard Error

T-Statistic P-Values

SUBI 0.086 0.052 1.66 0.097 SUBO -0.092 0.051 -1.80 0.072 IMPM 0.593 0.241 2.46 0.014 M 0.716 0.010 73.21 0.000 LT 0.071 0.011 6.37 0.000 LN 0.198 0.016 12.05 0.000 K 0.040 0.018 2.24 0.025 E 0.033 0.009 3.58 0.000 EXP 0.626 0.134 4.67 0.014 FDI 0.851 0.378 2.250 0.024 RTS 1.059 0.042 25.54 0.000

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SUBSUBII Results Results

ββSUBISUBI is positive and significant (at 10%) is positive and significant (at 10%)

positive first order productivity effect of SUBpositive first order productivity effect of SUBII

ββLT,SUBI LT,SUBI is positive and significant (at 1%)is positive and significant (at 1%)

a strong positive a strong positive LLTT bias bias

a higher share of subcontracted inputs implies greater a higher share of subcontracted inputs implies greater administrative and technical (skilled) labor intensityadministrative and technical (skilled) labor intensity

ββLN,SUBILN,SUBI is significantly negative (at 5%) is significantly negative (at 5%)

more more SUBSUBII is associated with less use of unskilled labor is associated with less use of unskilled labor

SUBSUBII substantively affects only the labor shares substantively affects only the labor sharesall other cross-effects are insignificantall other cross-effects are insignificant

The positive The positive SUBSUBII output elasticity is driven entirely by the output elasticity is driven entirely by the positive first-order and positive first-order and LLTT effects effects

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InterpretationInterpretation

SUBSUBII--LLTT complementarity and complementarity and SUBSUBII--LLNN substitutability substitutability

implies that subcontracting inputs reduces in-house implies that subcontracting inputs reduces in-house “production” of lower-productivity and -skill activities or “production” of lower-productivity and -skill activities or processes or servicesprocesses or services

e.g., those provided by unskilled production line e.g., those provided by unskilled production line workers or janitorial workersworkers or janitorial workers

rather than services of skilled workers rather than services of skilled workers

e.g., legal or accounting servicese.g., legal or accounting services

Perhaps because input subcontracting requires Perhaps because input subcontracting requires administrative and technical expertise due to greater administrative and technical expertise due to greater required supervision or support of contractors. required supervision or support of contractors.

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SUBSUBOO Results Results

By contrast, more By contrast, more SUBSUBOO implies significantly less reliance implies significantly less reliance

on skilled labor (on skilled labor (LLTT))

implies subcontract-receiving plants are more “low-tech”implies subcontract-receiving plants are more “low-tech”

SUBSUBOO is also associated with lower is also associated with lower MM levels levels

suggests more use of lower value primary rather than suggests more use of lower value primary rather than processed materialsprocessed materials

but a greater energy share but a greater energy share perhaps required for the additional processingperhaps required for the additional processing

The lower The lower MM and and LLTT levels for subcontract-receiving plants levels for subcontract-receiving plants

underlie the negative underlie the negative SUBSUBOO output elasticity. output elasticity.

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IMPIMPMM Results Results

More More IMPIMPMM also implies lower (but not sig) also implies lower (but not sig)

domestic materials and skilled labor usedomestic materials and skilled labor use

The only sig The only sig IMPIMPMM bias is a positive bias is a positive EE effect effect

The dominant effect of The dominant effect of IMPIMPMM is therefore from the is therefore from the

first order coefficient first order coefficient IMPMIMPM

imports have little effect on input compositionimports have little effect on input composition

the primarily negative input biases are too small to the primarily negative input biases are too small to

counteract the strong positive overall effectcounteract the strong positive overall effect

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Tech Trans Results,Tech Trans Results,

Linkages of trade factors with O/S vary by mechanismLinkages of trade factors with O/S vary by mechanism

no significant productive relationships between no significant productive relationships between SUBSUBII

and and EXPEXP, , FDIFDI, , IMPIMPMM

but effects between but effects between SUBSUBOO and trade variables are sig and trade variables are sig

with with EXPEXP is negative, and with is negative, and with FDIFDI and and IMPIMPMM positive positive

IMP or FDI firms do not have as low productivity as other IMP or FDI firms do not have as low productivity as other SUBSUBOO

plants, but EXP firms actually have worse productivityplants, but EXP firms actually have worse productivity

conversely, the productive contributions of trade factors are conversely, the productive contributions of trade factors are smaller for EXP and larger for IMP or smaller for EXP and larger for IMP or FDIFDI plants with plants with SUBSUBOO

a higher a higher EXPEXP share is associated with a lower share is associated with a lower LLNN share share

supports that internationally best practice production requires supports that internationally best practice production requires more skilled and less unskilled workersmore skilled and less unskilled workers