Executive summary

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Outsourcing involves moving production outside of a firm. Offshoring entails sourcing part of the purchased inputs outside of the country.

Outsourcing decisions affect the boundaries of the firm—what production takes place within the firm and what is purchased from outside the firm.

Changes in offshoring may be, but are not necessarily, related to changes in outsourcing. They involve decisions both to purchase outside the firm and to do so from abroad. Considerations to do the latter are at the heart of the study of international trade.

Interest in outsourcing arises because it may presage changes in industrial structure. Interest in offshoring arises because it may signify changes in international trading patterns.

The paper focuses on three areas.

First, the paper presents data on long-term trends in outsourcing and offshoring across Canadian industries, using detailed industry data derived from Statistics Canada's input– output tables. It asks whether there is evidence of changes in outsourcing or offshoring patterns. It finds:

  1. While concern about material outsourcing has been expressed, there has been little change in the ratio of material inputs to gross output over the period from 1961 to 2003. There is little evidence that changes in the boundary of the average firm is occurring when it comes to materials purchases.
  2. But there has been a trend to service outsourcing. Service outsourcing has increased in almost all industries. The rate of growth was highest in service industries.
  3. With post-Second World War trade liberalization, there has been a steady growth in the offshoring of material and service inputs. Canadian industries have purchased an increasing share of material and service inputs from abroad. Increases in the import share of material and service inputs have been pervasive across industries. The share of imports in material inputs almost doubled while the share of imports in service inputs almost tripled from 1961 to 2003. Most of service offshoring has taken place in the service sector.
  4. Business services represent the largest category of service inputs being offshored by the Canadian industries, followed by financial services and insurance services.
  5. The increase in the share of imported service inputs in total material and service inputs is a result of both an increase in import intensity and an increase in the share of services inputs in total material and service inputs for all main categories of service inputs, except for business services. The import intensity of business services was virtually unchanged over time.
  6. Most of the offshoring that occurs is with the United States, though there has been some increase over the last decade with developing countries.

Second, the paper examines the relationship between offshoring and changes in trade patterns using detailed industry data derived from the Capital, Labour, Energy, Materials and Services (KLEMS) database maintained by the Productivity Accounts. It focuses on two major drivers that some have suggested are behind the recent trends toward offshoring: globalization and technological change related to the use of information and communications technologies (ICTs). It finds:

  1. The share of ICT intermediate inputs is positively related to growth in offshoring of both materials and services.
  2. The results suggest that growth in both services and material offshoring reflects the continuing trend in globalization and integration of world economies. Material offshoring reflects the two forces of globalization: gains from exploiting comparative advantage; and, gains from the exploitation of scale economies in differentiated product lines. Service offshoring reflects the force of scale economies and product differentiation.

Third, the paper examines the economic impact of offshoring by investigating the relationship between the extent of offshoring and productivity growth, shifts to higher value- added activities and changes in labour markets. It finds:

  1. Material offshoring is positively related to multifactor productivity (MFP) growth. In contrast, service offshoring is not related to MFP growth. The effect of material offshoring on productivity growth has changed little over time.
  2. Service offshoring is positively related to increases in the ratio of value added to intermediate input. Material offshoring is not related to changes in the ratio of value added to intermediate inputs.
  3. Service offshoring is positively related to an increase in ICT capital deepening. Material offshoring is not.
  4. Service offshoring is not related to changes in the share of university-educated workers, material offshoring is associated with a decline in the share of university-educated workers.
  5. Together these findings indicate that service offshoring is associated with a shift to higher value-added activities in Canadian industries. The growth in service offshoring is positively related to an increase in the ratio of valued added to intermediate inputs, and high-tech capital deepening. In contrast, we find that material offshoring is not associated with shifts to higher value-added activities. The growth in material offshoring is not related to the changes in the ratio of value added to intermediate input, and high-tech capital deepening. It is negatively related to the share of university-educated workers in total employment.
  6. Material and services offshoring has no effect on employment in Canadian industries. The effect of offshoring on wage growth differs between material offshoring and service offshoring. Material offshoring is not related to wage growth. Service offshoring has a negative relationship with wage growth in the service sector, and it has little effect on wage growth in the goods-producing sector.