During the last two decades, opponents of globalization have directed harsh protests against offshoring and foreign activities of multinational enterprises (MNEs), arguing that they produce severe deterioration in the economic fortunes of domestic employees and calling for policies that would make it more costly for firms to internationalize their operations. The opposition has exacerbated in the last few years, reaching its height at the onset of the 2004 US presidential election (Amiti and Wei, 2005; Mankiw and Swagel, 2006). It is indeed easy to find examples of firms that have fired domestic employees, or exposed them to wage cuts, after the decision to expand operations abroad. Similar experiences are definitely harsh for the workers involved and should be tackled with effective policy interventions. However, preventing firms from internationalizing their activities is not the solution. Substantial gains can in fact accrue to a country from the offshoring strategies of its firms and from the foreign activities of its MNEs; these gains can take the form of higher productivity, more incentives to innovate, faster economic growth and the like (Mann, 2003; OECD, 2003; Amiti and Wei, 2006b; Olsen, 2006). An effective policy would therefore allow the gains to be realized and spread them out more evenly over the national workforce. To this purpose, the policy makers need to know the magnitude and the nature of the labour market effects of these internationalization strategies. The aim of this paper is to draw some conclusions on these issues, by reviewing the vast empirical literature which has focused on the developed countries.
To clarify the terminology, I use the word offshoring to describe the situation in which a firm relocates some stages of production abroad, to either one of its affiliates or an unaffiliated supplier. I will call the first offshoring mode ‘production transfer within MNEs’, because the activities remain within the boundaries of the same multinational corporation; I will instead call the second offshoring mode ‘international outsourcing’, because the activities are moved outside the firm by means of a licence contract.1 It should be noted that in the business literature offshoring means relocation of activities abroad but within the same MNE, and therefore indicates only the case I define as ‘production transfer within MNEs’. In the industrial organization literature, and increasingly more often in the international trade literature, offshoring is instead used to indicate both cases jointly (UNCTAD, 2004; Helpman, 2006; Olsen, 2006; Blinder, 2007b); I therefore prefer to use the word with this broader meaning.2 I will also specialize the definition of offshoring according to the type of activities that are relocated abroad: material offshoring will define the relocation of production activities (e.g. assembly) and service offshoring the relocation of service activities (e.g. call centre operations, back office activities, accounting and the like).3 Turning to MNEs, I will often exploit the standard classification based on the horizontal or vertical nature of foreign direct investments (FDI): vertical FDI are meant to transfer stages of production abroad; horizontal FDI are instead meant to replicate abroad the same activities as those performed domestically, in order to serve local or neighbouring markets while avoiding trade barriers and transportation costs (Brainard, 1997). Clearly, offshoring and foreign activities of MNEs are linked to each other, but the relationship is not exhaustive: neither offshoring takes place only within the boundaries of MNEs, nor do MNEs exist only to pursue offshoring strategies.
As is already well known, offshoring and MNEs' activities have rapidly expanded in recent decades. Figure 1 compares the growth in world FDI outflows and in world GDP between 1975 and 2006; it also reports data on outflows from eight developed countries that accounted for over 50% of the total in 2006. The figure shows that FDI growth has by far exceeded GDP growth since the late 1980s; it also shows that FDI growth has almost entirely been driven by the developed countries, at least until 2000.4 During the same period, offshoring has become a widespread practice in the industrialized world. The solid line in Figure 2 shows the trend in material offshoring by US manufacturing industries between 1972 and 2002. Following Feenstra and Hanson (1996, 1999), material offshoring is proxied by the share of imported intermediate inputs in total non-energy input purchases.5 This share has increased from 5.1% in 1972 to 18.1% in 2002. Similar trends have occurred in almost all industrialized economies: for instance, Campa and Goldberg (1997) show that between 1974 and 1993 the above indicator has risen from 15.9% to 20.2% in the Canadian manufacturing sector, and from 13.4% to 21.6% in the UK industrial sector.6 More recently, thanks to improvements in information and communication technologies that have eased the tradability of services, the practice of offshoring has been extended to service activities (Freund and Weinhold, 2002; Lipsey, 2006). The dashed line in Figure 2 shows a proxy for service offshoring by US manufacturing industries between 1995 and 2002; the proxy is the share of imported private services in total non-energy input purchases. The figure shows that service offshoring was virtually close to zero in 1995 but has grown exponentially since then, gaining roughly 3 percentage points in less than a decade. Similar patterns have occurred in the EU, where service offshoring has increased by more than 50% between 1990 and 2004 (Crinò, 2007b).
The expansion of offshoring and foreign activities of MNEs have raised concerns in the developed countries about the effects that these phenomena may produce on the economic fortunes of domestic employees. A large body of literature has flourished with the aim of studying and quantifying these effects. In what follows, I will distinguish this literature in three segments, which collect, respectively, the studies on material offshoring, those on service offshoring and those on the foreign activities of MNEs.
I will start from material offshoring in Section 2. Numerous studies have analysed its contribution to the strong increase in wage inequality between skilled and unskilled workers experienced by most developed countries during the 1980s and the first half of the 1990s. These studies suggest that material offshoring has indeed played an important role; they also show that its effects have been qualitatively and quantitatively similar to those of skill-biased technical change (SBTC), another major culprit for the increase in wage inequality. A more limited set of contributions have analysed whether material offshoring raises the volatility of employment, by making labour demand more elastic and by increasing the risk of job losses. While a positive role for material offshoring can probably be detected also in this case, more research is needed to understand the exact magnitude of these effects.
I will turn to service offshoring in Section 3. The weak labour market dynamics experienced by the USA and other developed countries after the dot-com bust of the late 1990s have triggered oppositions to service offshoring, which was simultaneously rising at high rates. Firms have been blamed for contributing to the labour market weakness by relocating service jobs in foreign countries. Empirical evidence does not lend support to this view: the effects of service offshoring on total employment are in fact very small. More recently, service offshoring has been blamed for producing adverse effects on the process of human capital accumulation, by exposing white-collar workers with high skill levels to the risk of relocation. The few studies dealing with this issue have instead shown that service offshoring shifts the composition of white-collar employment in favour of these workers and against those with the lowest skill levels.
In Section 4, I will deal with the labour market effects of MNEs' activities. Opponents of globalization have often blamed MNEs for taking advantage of their global presence by substituting domestic and foreign labour in response to changes in relative wages across countries. While some evidence exists in favour of a substitutability relationship between domestic and foreign labour employed by MNEs, this relationship seems too weak for MNEs to pose a serious threat to national employment. In contrast with the common perception, the relationship is mainly driven by horizontal (market seeking) FDI, rather than by vertical (cost-saving) FDI.
In Section 5, I will finally draw some conclusions from the empirical evidence and suggest some possible avenues for future research.
A few other works provide reviews of the literature on the labour market effects of offshoring and foreign activities of MNEs. The most notable examples of such surveys are those by Feenstra and Hanson (2003), Feenstra (2004, chapter 4) and Hijzen (2005) on offshoring, and by Barba Navaretti and Venables (2004, chapter 9) on MNEs.7 This paper complements those studies, but differs from them in two ways. First, it discusses offshoring and MNEs jointly, rather than focusing on either of them separately: because the two phenomena are not univocally linked, and often affect the labour market independently of each other, this approach may provide a more comprehensive portrait of their effects. Second, the paper pays specific attention to service offshoring, which has started soaring only recently: due to the novelty of the topic and its expected diffusion in the future, reviewing the state of the art in the literature may offer insights for further research.