Manisha Goel on Offshoring

by Reihan Salam

Speaking of labor market protections, the specter of offshoring has been a source of considerable anxiety among U.S. scholars. Among others, Alan Blinder and Michael Spence and Sandile Hlatshwayo have described offshoring as a potential threat to U.S. employment levels, and not just for less-skilled workers. Eli Dourado’s “technologies of control” thesis offers insight into the underlying dynamic: when the U.S. labor market is tightly regulated, there is an incentive to substitute technology for labor and to substitute foreign (unregulated or less onerously regulated) labor for domestic labor. 

Recently, Manisha Goel, a newly-minted Ohio State Ph.D., released a job market paper on the impact of offshoring on wages and employment levels in the U.S. Goel’s findings certainly don’t settle the long-term question of how offshoring will impact employment levels going forward, but the paper nevertheless offers a series of counterintuitive and encouraging findings. The abstract of the paper reads as follows:

This paper develops and evaluates a novel mechanism through which imports of unskilled intermediates (o shoring) indirectly aff ect the labor market by inducing skill-biased technology adoption and innovation in developed countries. Data for a panel of manufacturing industries in the United States over 1974-2005, strongly support the indirect channel with a doubling of o ffshoring increasing technology adoption by 13% and innovation intensity by 40%. This is the primary channel through which off shoring increases the skill premium, but also increases the employment and wage-bills of both skilled and unskilled workers. The labor market eff ects through the direct substitution of unskilled workers are small. Predictions from a formal two-country trade model are consistent with these empirical results. A model with only the direct channel yields smaller gains for both groups of workers and higher inequality between them.

Goel elaborates on this indirect channel:

The indirect channel that I propose is motivated by the observation that the growth in o ffshoring to developing countries is accompanied by capital deepening and increasing innovation, with all three accelerating after the mid-1990s. Figure 1(a) shows that imported intermediates, as a share of total imports, fluctuated with a declining trend from 1974 until the mid-1990s, but then turned sharply upwards to reach nearly 80% by 2005. However, o shoring to developing countries consistently grew between 1974 and 2005. Simultaneously, the average equipment-labor ratio rose from about 24 points to 98 points and the average product R&D-sales ratio grew from 1.5% to 2.4% (corresponding to a growth in average real product R&D expenditure from 95 million dollars to 2,800 million dollars, as shown in Figure 1(b)). The timing suggests that these trends may be causally related. My work below demonstrates that the growth in o shoring to developing countries induces investments in R&D and equipment, indirectly bene ting all U.S. workers, although magnifying the skill premium and skill upgrading.

The direct substitution of domestic unskilled labor by imported unskilled intermediates, as predicted by the Heckscher-Ohlin theory, can trigger two eff ects, that constitute the indirect channel. First, the cost reduction from o ffshoring induces rms to expand their output, leading to an increase in the skill-intensive tasks required in the production process. This increases the demand for skilled labor and skill-complementary equipment capital (technology adoption). The complementarity between skilled labor and capital also magni fies the relative marginal product of skilled labor, and hence the skill premium. Second, lower costs of production make new products profi table, inducing product innovations. Innovation creates greater demand for skilled workers as well as capital equipment that is complementary to these workers, once again putting an upward pressure on the skill premium. However, o ffshoring-induced technology adoption and innovation increase productivity, leading to an expansion in output that generates demand for both skilled and unskilled workers, thereby creating wage and employment bene fits for all. [Emphasis added]

Those who are primarily concerned about increasing employment levels and wages will find Goel’s findings encouraging. Those who are primarily concerned about mitigating market inequality will, in contrast, see their worst fears confirmed in the way that offshoring puts upward pressure on the skill premium. 

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.