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Outsourcing occurs as firms reorganize production processes. Buying, rather than producing, their own inputs is done by a firm to take advantage of cost savings. Trends in doing this presage major changes in the importance of large integrated firms, as opposed to decentralized supply networks with each participant doing only a small part of the work.
Firms constantly adjust their make-or-buy decisions at the margin. While examples can always be found of particular instances where the firm's margin is either expanding or contracting, the issue that we address here is whether there has been any major change on average in the degree of outsourcing across a wide range of Canadian industries. The data show that that there has been little, if any, change in the overall outsourcing of materials since 1960.
This is not the case for service inputs. The outsourcing of service inputs has been taking place for a considerable period. Service outsourcing has been greatest in the service sector. This tendency reflects several forces. First, service industries have matured from single-establishment entities to large multi-establishment firms that offer critical business services at lower costs, due to the exploitation of economies of scale. The provision of computerized payrolls is one example. The evolution of large general-accounting firms is another. In each of these cases, movement of some services that used to be provided in-house has occurred as firms in both manufacturing and services moved some production processes outside.
Those interested in outsourcing often also discuss offshoring—the tendency of inputs to be increasingly sourced abroad. Offshoring, of course, can result from increased outsourcing, or be completely separate from it. For example, material outsourcing has not increased, but material offshoring has. This is probably the result of the general move to trade liberalization that Canada has experienced over the last four and a half decades. But service offshoring has increased at the same time as service outsourcing. Service offshoring, in the case of business services, is primarily related to outsourcing, since the import intensity of business service inputs has remained relative constant over time. But in the case of other services—real estate, finance, insurance—the import ratio has gone up at the same time as service outsourcing in these areas has increased. The advantages in these areas that come from sourcing foreign services have led to a gradual increase in the share of services that are accounted for by imports.
Two factors were found to be related to the increase in offshoring—globalization and technological change related to information and communications technologies (ICTs). The share of ICT intermediate inputs is positively related to growth in offshoring in both materials and services. Industries that increased ICT inputs were more likely to increase their offshoring of services. Information-input use probably served to reduce the distance barriers for trade in services generally.
The 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.
But it is the impact of offshoring that is of most interest. Offshoring is related to productivity growth, shifts to higher value-added activities and changes in labour markets.
Outsourcing of products to sources outside of Canada can potentially affect the type of production that is done in Canada and also affect labour markets. Offshoring production potentially moves producers up (or down) the value chain and may affect productivity if it allows for the substitution of inefficient internally produced goods with less expensive and superior inputs from abroad.
Over the last 40 years, material offshoring was positively related to multifactor productivity (MFP) growth. In contrast, service offshoring was not related to MFP growth.
Just the opposite occurs with the relationship between offshoring and changes in the value-added chain. 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.
Service offshoring has been 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 in 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 in high-tech capital deepening. It is negatively related to the share of university-educated workers in total employment.
Finally, 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.
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