Employment effects

Employment goals and unemployment reduction policies are at the top of government political agendas. Unemployment is one of the most important challenges an individual has to face. a per- son without a job is stripped of the skills that define him or her as a useful member of society. We believe that studying the channel through which employment is impacted by business decisions is well worth our while.

The 2007 oECd report describes offshoring as the result of the interactions between direct investment, subcontracting with nonaffiliated firms, and international trade. Furthermore, it lists all the known short-term employment effects, which can be nega- tive or neutral, direct or indirect. Negative effects occur when a company stops any of its activities in the home country, only to create or subcontract them abroad. Neutral effects cover cases in which direct investment or subcontracting takes place independ- ently of the company’s operations at home. direct effects, such as outright layoffs, are easy to identify, whereas indirect effects are more subtle. For instance, some local subcontractors might be compelled to follow their client abroad, thus potentially aggra- vating the downturn in domestic employment. another important indirect effect is that generated by intrafirm trade between com- panies and their foreign branches. Cheaper intermediate inputs are now available and have come to replace the production previ- ously carried out within national borders. as we will see later, this rationale is embedded in all indirect measures that try to estimate offshoring effects.

If we set a timeline the following premise holds true: the short- er the term considered, the greater the risk of job losses. as a result, this would likely have a negative impact on people’s opin- ion about offshoring. The challenge, then, is to realize the full benefits of offshoring and to be explicit about them, since many of these benefits usually go unnoticed and are not necessarily related to people whose jobs have been lost. This is part of the current heated debate in politics, the big business arena, and the

media. However, we might yet discover that offshoring has more to do with plain economics than with business strategies or politi- cal conundrums.

In fact, it is possible to conceive offshoring as the utmost mod- ern expression of economic trade (Mankiw and Swagel 2006), and even in this light it still has a long way to go in order to grow to full maturity. There are, to date, a vast amount of services that would fall under the category of potentially offshoreable. It is indeed reasonable to think that a wider range of tradable goods and services means increased welfare one way or the other. Presumably then, there will be more social benefits to seize when offshoring really takes off. But this welfare improvement comes at the expense of short- run unemployment due to friction in the labor markets. In the immediate term, these social costs might even be greater than the benefits that stem from wage savings and a higher productivity rate.

So, the assumption that offshoring may increase welfare is a reasonable one as it makes previously nontraded services into tradable ones. This also provides opportunities for cheaper im- ported products and services to flood the economy, that is, the same products and services previously produced locally. The harmful effects of an expanding world supply of information tech- nology for the terms of trade of the source country have often been argued. Bhagwati et al. (2004), for example, assert contrarily that this hardly describes the reality of offshoring. Countries like China and India are most likely to remain focused on low-end informa- tion technologies already exported to more developed countries.

additionally, we can see how services are becoming a determi- nant player in this second-generation offshoring (which took over after a first generation chiefly centered on production), since they naturally represent a higher added value. Service activities also imply a considerable dynamic not seen with materials, and this might translate into employment opportunities being fulfilled more rapidly. But let us be clear, not all services can be offshored nor is every service bound to move abroad immediately.

on the other hand, we must not forget that the dynamics of glo- balization and offshoring is a two-way street or, rather, a multiple- lane highway linking far-off economies. Indeed, inshoring can

occur at the same time with the expected positive employment effects. relative comparative advantages lead us to believe that provided the country is (relatively) more developed, jobs cre- ated domestically would be higher-value and better paid jobs. as mentioned previously, this transition is not without a temporary adjustment, and if imperfect information or other imperfections should arise, frictional unemployment would follow. But, alas, structural unemployment would also sneak in as an uninvited guest. Not only might unemployment occur because of the move- ment of people between jobs, but also because of the mismatch between the types of jobs available and the skills of the people looking for them. It is then the structure of the economy that decides the extent and nature of the benefits of offshoring (see Bhagwati et al. 2004; and Samuelson 2004, for somewhat oppos- ing views).

Would more flexible markets adjust more easily to exogenous shocks brought about by offshoring? Under this perspective we might presume that anglo-Saxon labor markets with their flex- ible institutions and lenient employment laws ought to enjoy the benefits of offshoring more rapidly. on the other hand, continen- tal European countries have more powerful institutions, such as larger labor unions and strict employment laws, both of which would deter the full potential of productivity gains.⁸ Seemingly, labor institutions might affect comparative advantages and trade flows among countries (Helpman and Itskhoki 2009). Empirical evidence on this regard, however, is far from definitive.⁹

Therefore, we may ask ourselves if there is any role for the gov- ernment, aside from unemployment insurance, to cope with the problem of unemployment in a more efficient and sophisticated way. In other words, how can we figure out the existing mismatch while easing the hardships faced by those workers displaced as a result of offshoring? We will discuss this in chapter 5.

8 See for instance the different measures of labor market flexibility developed by Botero et al. (2004).

9 See, for example, the study by Jensen et al. (2006). a more formal approach is the one by Helpman and Itskhoki (2009), which builds on previous studies on trade and unemployment.