MASTER THESIS AUTHOR

MSC FIB ZEESHAN ABBASI

ADVISOR

Tor Eriksson

Foreign Outsourcing – A Myth or Menace?

Impact of outsourcing on Employment, productivity and Growth

Evidence from Danish and UK manufacturing

Aarhus School of Business

1

Abstract

In the changing global market place role of outsourcing is increasingly crucial for

firms to remain competitive. The media hype that surrounds outsourcing is often based

on stereo types and myths that are far from hard facts. The purpose of this paper is to

provide an inside into the recent upsurge in the foreign outsourcing in United Kingdom

and Denmark. Paper identifies the UK & DK industries that have experience high

intensity of outsourcing in last two decades and possible job losses that may have

resulted from it. Paper attempts to understand the outsourcing in the changing

international trade environment and provide post outsourcing analysis on productivity

growth on outsourcing industry and impact of outsourcing on foreign country where

outsourcing take place.

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TABLE OF CONTENTS

1. INTRODUCTION 4

1.1 Problem Statement 7

1.2 Delimitation: 9

1.3 Data 9

1.4 LITERATURE REVIEW 10

2. WHAT IS FOREIGN OUTSOURCING AND HOW CAN WE MEASURE IT?

12

2.1 Foreign outsourcing: 12

2.2 Measure of Foreign outsourcing - Discussion 14

2.3 What Industries are affected by Outsourcing? – Data Analysis 17

3. OUTSOURCING AND EMPLOYMENT 22

3.1 Theoretical Framework 22

3.2 Labor Market Rigidities: 23

3.3 Empirical Analysis – Does Outsourcing Destroy Jobs? 26

3.4 Regression Results 28

4. DRIVERS OF FOREIGN OUTSOURCING: 35

4.1 Globalization & International Transaction Cost 36

4.1.1 Cost of trade barriers 37

4.1.2 Transportation cost 38

4.1.3 Information Costs 39

4.1.4 Capital Transfer Cost 40

4.2 Outsourcing and Competition: 42

3

5. OUTSOURCING & PRODUCTIVITY – IMPACT ON LOCAL PLANT 44

6. EFFECT OF OUTSOURCING ON HOST COUNTRY 48

7. Outsourcing Impact on the local Firms 52

7.1 Outsourcing & Economic Performance 55

8. SYNERGIES FROM OUTSOURCING INTERACTION 57

9. CONCLUSION: 58

REFERENCE LIST: 61

Appendix = 1 Industry classification 67

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1. Introduction

“All fixed fast-frozen relations, with their train of ancient venerable prejudices

and opinions are swept away, all newly formed ones become antiquated before they

can ossify. All that is solid melts into air, all that is holy is profaned, and man is at last

compelled to face with sober senses, his real conditions of life, and his relations with

his kind. The need of constantly expanding market for its products chases the

bourgeoisie over the whole surface of the globe. It must nestle everywhere, settle

everywhere, and establish connections everywhere.

Marx and Engels (1973, p. 83)

The famous words of Marx might be a source of inspiration and hope for the preachers

of free trade and globalization. Though it was a hard sell for the former U.S.

presidential hopeful, who was fighting a close contested presidential Election amidst of

popular public discontent and fear of job losses resulting from foreign outsourcing in

United States. Senator John Kerry managed to put a political spin on the issue of

foreign outsourcing. Awkwardly admitting that foreign outsourcing was a reality,

though, at the same time he managed to blame outsourcing as a bad policy, he was

quoted saying "Because of George Bush's wrong choices, this country is continuing to

ship good jobs overseas - jobs with good wages and good benefits," "My value is good,

old-fashioned four words: 'Made in the USA."1

The opposing views of Senator John Kerry show the significance of the recent debate

on the foreign outsourcing. Confusion and fear over businesses moving part of their

production abroad at the cost of domestic employment are debated far beyond U.S.

borders. According to the IMF working paper (WP/04/186) “there were 2,634 reports

in US newspapers on foreign outsourcing between January and May 2004, mostly

focusing on the fear of job losses. Similar report appeared in the news publications in

United Kingdom, France, Germany and other industrialized countries00

1 The Washington Times (http://washingtontimes.com/national/20040920-123916-5429r.htm)

5

“This is the law of the jungle turned into a constitution. I do not want a constitution

that imposes a principle – free and unfettered competition – with which I do not

agree.” asserted socialist French Senator, Jean-Luc Melenchon campaigning for no

vote in EU referendum on European constitution. The strong sentiment from French

senator is not a rarity these days. A recent survey conducted by the French polling

institute SOFRES2 following up to the French referendum on European constitution

conclude that 46 percent of those who voted no in French referendum listed fear of

unemployment as the main reason for their decision. Worries about outsourcing and

the arrival of lower-paid workers from new EU member countries played a large

part in the debate preceding the referendum. Similarly French public opinion has been

echoed in other Western European countries with varied enthusiasm.

However, there is something very ironic about the recent debate on foreign

outsourcing. Foreign Outsourcing is not a trend or innovative concept of 90’s. The

roots of foreign outsourcing could be traced back to decades. Outsourcing strategies

have been used by the companies/countries for long period of time. In early years of

US History, America's covered wagon covers and clipper ships' sails was a job

outsourced to workers in Scotland. Similarly with raw material imported from India,

England's textile industry became so efficient in the 1830s that eventually Indian

manufacturers couldn't compete, and that work was outsourced to England.3 Similarly

the manufacturing or Textile jobs in U.S. that are outsourced to developing countries

today were originally outsourced from Massachusetts to South Carolina because

companies encountered an economic benefit in moving to south. Sirohi (2004). More

recently, Multinational companies like Nike and Toyota have used outsourcing

2 KWR Special Report Waiting for the French – The May 29th Referendum, By Scott B. MacDonald

(KWR international)

3Globalvision-ABriefHistoryofOutsourcing

An essential part of today's global economy, outsourcing has been occurring for decades

Terri Kelly, a freelance journalist, community college instructor, and intercultural conflict mediator in

Portland, Oregon.

6

strategies to create more specialized knowledge, to gain from economies of scale and

cheap labour costs for considerable amount of time.

So outsourcing is not something new, similar to the concept of outsourcing, the stereo-

types attached to the foreign outsourcing and global-trade are not new either. Abraham

Lincon was quoted saying “I don’t know much about tariff. But I know this much,

when we buy manufacture good abroad, we get the goods and foreigner gets the

money. When we buy the manufactured goods at home, we get both the goods and

money.”4 Responding to the loss of employment in India following the outsourcing of

textile industry to United Kingdom India's governor general, William Bentinck, wrote

to his superiors in London in 1834 "The misery hardly finds parallel in the history

of commerce,"

The sentiment expressed in statements by Senator John Kerry, Abraham Lincon and

French senator Jean-Luc are very is very similar in substance. The all seemed to echo

the popular political stereo types that we have learned to live with in last few decades.

We hear them now and again, the evil of globalization and international trade,

globalization and how it relates to job losses and trade. Punch lines with various spins

like "exports equal jobs," "imports kill jobs” and "offshore R&D” is not good.

At the same time we have witnessed an era of unprecedented globalization driven by

free movement of goods, services, investment, capital flows and technological

advancements. Emergence of economic blocs in North America, Europe and Asia

Pacific has caused greater integration of world economy. We have seen how a cool and

steel community (ECSC) can transform itself into powerful Economic

union/community (EEC) that accounts for the 7% of world population and one third of

global trade in goods and services. Gradual removal of trade barriers and expansion of

intra-European trade has helped Europe to embark on a unique project in the form of

monetary union. Removal of exchange rate risk, single interest and reduced transaction

4 Dani Rodrick-journal of Economic perspective-volume 12, fall 1998-page 3-8

7

cost has helped European companies to expand their products and production in other

European countries to maximize their potential and to be competitive on global

market.

So, if we accept that Stereo types about globalization/international trade/outsourcing

have been around forever, as it seems, and still the people and courtiers have

committed themselves to the course of globalization and further integration of trade,

then where lies the problem?, Is current debate about outsourcing is just a media hype?

Or is it due to information bias about what outsourcing really is? Could the current fear

of outsourcing be an irrational response to the other micro-economic problems in

respective countries? Or is it rational fear? Is outsourcing really causing

unemployment and loss of trade? Is it as bad as it made out to be? In order to properly

understand the precise meaning of all this, one should take account of a whole series of

factors weighing on the internationalization of employment, such as the positive and

negative effects of trade.

1.1 Problem Statement

The core objective of this paper is to Enhance Our Knowledge and Better Understands

the Concept Of foreign Outsourcing in order to establish what are the facts and what

are the hypes about international outsourcing are. More precisely thesis intends to

answer the following question:

1. Has there been a significant increase in outsourcing in UK and Danish

manufacturing industries, what industries are affected?

2. Is there a relationship between foreign outsourcing and job losses in UK

and Danish manufacturing industries? If yes

3. What has caused the sudden increase in the outsourcing intensity?

4. Does outsourcing boost the productivity growth of home industries?

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5. What impact foreign outsourcing has on the host country (china)?

Before we can identify and assess industries affected by outsourcing, one has to

properly define and measures the effect of outsourcing. There is no universally

accepted method of measuring outsourcing in economic literature. Measures of

Outsourcing vary from Outward processing estimates to FDI as a proxy of foreign

outsourcing. Each of these methods has their strength and flaws. The choice of method

is generally driven by research design and convenience. In this paper I have decided to

use FH (Feenstar Hanson) broad measure for outsourcing, the measure uses foreign

imported inputs to capture the outsourcing intensity. Measure is one of most efficient

in the sense that it captures the modern need of the firm to disintegrate the production

process and replace it with foreign input. I supplement this method with the Net import

penetration index to rank the industries in terms of import competition. Idea is that

firm with the high excessive import may be more vulnerable to foreign competition

and outsourcing.

The Outsourcing measurement will help us to identify the industry that is affected by

foreign outsourcing. Once we have identified the industry that is being affected by the

foreign outsourcing, we will be able to measure there is relationship with job losses

and outsourcing through regression analysis. In presence of low price foreign

competition one would expect domestic companies to respond by looking for low

cost solution through relocation in low cost country or by substituting the domestic

operation with foreign inputs. In both case we could expect a significant decrease in

employment in domestic UK and Danish manufacturing industries.

If there are indeed job losses in the UK and Danish Manufacturing industries, how

could we possibly explain them, what has cause sudden increase in the outsourcing

intensity. A host of the factors such low domestic productivity, poor quality suppliers,

focus on foreign export market and ease of international trade could be responsible for

that. I will look at what are the drivers of the foreign outsourcing, changes in the

international environment and globalization may be a good point to start, since trade

liberalization in last 30 years has changed the panorama of international trade.

9

In post outsourcing era it may be beneficial to explore the effect of productivity growth

in the UK & Danish manufacturing industries by using the value added. It will help us

assess the direct benefit of outsourcing.

Finally it is crucial to understand the effect of outsourcing in the host country. I will

use foreign direct investment as proxy to the foreign trade to understand the

outsourcing impact. Although FDI might not capture the full effect of foreign

outsourcing, it will give us a good sense. FDI are important to the growth for

developing and they result in the knowledge and technological spillover which are

crucial for sustainable economic growth.

1.2 Delimitation:

The thesis solely focuses on United Kingdom and Denmark. Primarily choice of DK

and UK as a country of origin was driven by the fact the most of the recent literature

focuses on Untied States where effect of outsourcing is somewhat different that one

would expect in EU. It is widely accepted that United States labor market is much

more "flexible" than those in Europe. Secondly the choice is interesting by the mere

fact that two economies differ considerably in terms of size which will be interesting to

see since higher UK trade will infer its relative propensity to be more competitive to

international trade.

Paper does not deal with skill biased technology change which might also have

significant impact on the employment reduction. In addition effect of the wage

adjustment is not at eh center of this paper given very reason than we work the labor

market that may be rigid. Statistics to identify the relationship used in this paper is by

the choice of the design to analyze the effect on individual industries. In addition paper

is economic scientific, means statistics or regression is used as a supplement.

1.3 Data

Basic data used in this paper is obtained from OECD Stand industry database, which

covers based on ISIC rev 3. 29 Danish UK manufacturing industries have used in the

10

analysis. Complete list of the industries could be seen in Appendix One. Period

covered is from 1980-2003.

1.4 Literature Review

Literature regarding international trade and its impact on the different stake holders of

the economy has long-standing tradition in economic research and often used as

starting point for foreign outsourcing research. Though foreign outsourcing has never

been the canter of it, as result, literature on foreign outsourcing is somewhat less

profound and restricted to certain geographical and subject areas, even though its

growing with an impressive rate in recent years.

Lawrence (1994) analyzes the relationship between low-wage international

competition and wage performance in the Developed Countries in the 1980s. He

argues that poor average US wage performance reflects slow domestic productivity

growth rather than international competition. He goes on to assert that employment

and wage behaviour in US multinational has much to do with technological change

rather than trade and increased international sourcing. He concludes that Imports by

U.S. multinationals are too small to effect the domestic employment and wage change.

Fenestrate and Hanson (1995) used import of intermediate inputs by domestic firms to

measure the impact of foreign outsourcing on labour demand, the affirmed that If firms

respond to import competition from low-wage countries by moving non- skill-

intensive activities abroad then trade will shift employment towards skilled workers,

thus import of intermediate inputs has directly contributed to an increase in the relative

demand for skilled labour in united states.

Fenestrate and Hanson (1996) further consolidated there research following year by

using four digit SIC import data from NBER trade database with disaggregated data on

input purchases from the Census of Manufactures. They constructed industry-by-

industry estimates of outsourcing for the period 1972-1990, they results further

validate their initial finding that outsourcing has contributed to an increase in relative

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demand for skilled labour. They asserted that outsourcing can account for 31-51% of

the increase in the relative demand for skilled labour that occurred in United States.

Campa and Gold (1997) measured outsourcing using data from imported inputs in

various industries for Japan, united states and united Kingdom. Input output tables they

used did not classify the imported input so proximate the imported inputs by using the

import penetration data. the concluded that there was a doubling of the share of the

intermediate good in all countries except Japan.

Bazen and Cardbeat (2001) used sectoral data for the period 1985-92 to evaluate the

impact of trade in France. They concluded that lower relative import prices have

impact both on employment and their wages. Their research found that international

trade reduced the relative employment of low skill workers in the first half of the

period and reduce their relative wages in the second half. They found that effect is

more pronounced in sectors where the skill intensity of production is initially low.

Egger and Egger (2001) find that there is a negative effect of international material

outsourcing on the productivity of low-skilled workers in the short run, but a positive

effect in the long run. They found that international outsourcing of materials

contributed to 3.3 percent of real value added per low skilled worker in the EU from

1993 to 1997. They attribute the negative short-run effect to imperfections in the EU

labor and goods markets.

Olsen, Ibsen and Nielsen (2004) analyzed the Danish textile and clothing industry

using the detail industry employment data. They reported that although there is decline

of employment in Danish textile industry by more than 80 percent from 1975 to 2000

as consequence of foreign outsourcing, though majority is rehired in the same industry

by mid 1990s.

Baily and Lawrence (2005) explored the link between foreign outsourcing and job

losses in manufacturing industry and service sector. They discovered that from 2000 to

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2003 only about 11 percent of the jobs were lost in the manufacturing sector as a result

of outsourcing, they further implied that the job loses in the service sector were even

lower.

2. What is foreign Outsourcing and How Can we measure it?

Before we can start discussion what is the appropriate measure for the foreign

outsourcing and how it could be justified, we clearly need to define and understand

what foreign outsourcing is. To define Outsourcing in a single sentence is not easy

task, definition of what constitutes outsourcing, offshoring or foreign/offshore

outsourcing is variable and terminologies are interchangeably used for the same

concept and are often misleading. According to the working paper by “Danmarks

Nationalbank” there is no official definition of what constitute outsourcing, offshoring

or offshore/foreign outsourcing5, thus it is very important that we clearly foreign

outsourcing.

2.1 Foreign outsourcing:

Outsourcing refers to the fragmentation of a production process in sequential stages

through development of new input-output relations with other firms, or through

production displacement to other locations. In addition firm outsourcing decision could

include production activity (intermediate inputs, raw material or recycling) or service

activity (customer support, logistics or maintenance).

However general definition is somewhat vague since term outsourcing could be local

or regional displacement as was in the case of Citibank several years ago when they

decided to move their credit card processing unit in New York area to South Dakota to

benefit from low cost and less rigid financial regulations.6 Or outsourcing could also

be across borders where multinationals own subsidiary in a foreign country or it could

5 Urik Bie, offshore outsourcing, Danmarks nationalbank workign paper 2005-22

6 Robert W. Mcgee, Outsourcing – An ethical anlysis of an internacional trade issue, 2005

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be a new relationship with the domestic or foreign supplier at the cost of internal

production. Figure one clarify all possible mode that are available to a firm that is on

the verge of indulging in the foreign outsourcing.

Figure 1 presents possible modes in which outsourcing and offshoring could occur.

There are three separate trajectories towards outsourcing or off shoring. Figure depicts

Figure 1 Possible Outsourcing Modes

Source: constructed by the author

situation of company having 100 percent production in house and considering

outsourcing: Our hypothetical company could outsource in three ways. First,

companies may outsource within the region or country, that would be referred as

domestic outsourcing. Second, companies may also decide to source from overseas

locations by establishing foreign affiliates or fully own subsidiary, categorized as

offshoring. Third, firm may opt to outsource from foreign supplier, in which case firm

will be opting for foreign outsourcing.

Keep in-house

Domestic division

Domestic Outsourcing

Third Party

Domestic Suppliers

Off shoring

Foreign affiliates

(FD I & international trade)

Offshore outsourcing

Third party

Foreign suppliers

Domestic Overseas

Location Decision

Outsourcing Off shoring

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In this paper international outsourcing, defined as the procuring of service or material

inputs by a firm from a source in a foreign country. This includes both intra-firm

international outsourcing (which the foreign provider of the input is still owned by the

firm) and arm’s-length international outsourcing (by which the foreign provider of the

input is independent from the firm using the input).7

2.2 Measure of Foreign outsourcing - Discussion

As of today a single direct and reliable measure of international outsourcing does not

exit. And there is no universally accepted method to capture the effect of foreign

outsourcing. International trade and economic statistics provides little help since most

of the statistics (e.g. OECD Variables and Computations) is focused on intra industry

trade and broad measure of international trade, which fail to capture the different

modes from which outsourcing could occur.

One of the reasons why measuring outsourcing activity has been challenging using

basic economic data is nature of foreign outsourcing, as World Trade Organization

(2005: 267) argues that one of the root causes for this is outsourcing refers to

management decisions made at the micro-level that cannot be easily linked to trade

statistics that are collected on the national and sector levels. The foreign outsourcing

could occur through different channels and it effect could be embodied in varies

different economic variables.

Outsourcing could take place through outward processing trade, where an organization

export of intermediate inputs for further processing abroad, and the re-export of these

products back home. First, OPT has been a popular mode of outsourcing in textile and

clothing sector, some up-stream value chain function were performed abroad and

7 Terms Foreign outsourcing, outsourcing or offshoring might be used interchangeably in this paper,

though all three refer to the same definition.

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goods were re-imported. Second, Outsourcing could be embodied in imported parts or

intermediate inputs (from same or different industry abroad) if firm decide to substitute

domestic supplier with foreign entity or Outsourcing numbers could simply be

reflected in import of final product if firm decide to move production abroad.

.

The different modes of outsourcing pose a challenging dilemma for the effective

measurement of foreign outsourcing. Researchers have used various different methods

to compute the extent of outsourcing, theses method range from using foreign direct

investment (FDI) to imported Intermediate inputs as proxy of outsourcing, though

none of the methodology used is complete, each of the method has its strength and

flaws.

FDI methodology consists of measuring the scale of relocation abroad through foreign

direct investment. FDI method takes into account a capital flow to the destination

country where a new affiliate is established or the capacity of an existing affiliate is

expanded. In general FDI method assumes that financing abroad of an activity is

identical to stopping the same activity in the country of origin. However FDI method

has some limitation. It does not take account of relocation in the form of foreign

supplier. It also operates on the faulty assumption that all direct investment in a foreign

country is necessarily the result of relocation, because FDI outflow does not have to

mean the cessation of the same activity in the compiling country.

Outward processing trade is an interesting measure of outsourcing because it

systematically record the international transaction at export and re-import stage, it

clearly isolate outsourcing from rest of the international trade. Though problem with

OPT is that it only represent small proportion of international outsourcing. OPT fails to

represent outsourcing intensities or change that might be due to increasing amount of

imported inputs used in the final production or increase in the import of final product,

in addition OPT is used by a relatively small number of industries.

Increase in Import penetration has also been used as proxy to the Foreign outsourcing.

It provides good general overview, though it has similar limitation as FDI method,

closure or reduction in domestic plant will result in increase imports to meet the

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domestic demand, though its difficult to isolate the outsourcing effect since increase in

import could also be due increase in domestic demand or increase in OPT trade. The

strong point of this method is depth of data, detailed industry level and countrywide

import data allow us to really pin down the origin and destination of the trade. Thus,

import data could be a good supplement to the other outsourcing measure to do an in-

depth analysis.

Finally, one of the most popular proxy or measure for foreign outsourcing in academic

literature is use of imported intermediate input. This method focuses on the foreign

content of domestic production by taking into account the share of imported

intermediate inputs in production. The logic behind this measure is the fact that

increased outsourcing activity is expected to increase the import of intermediate goods

as outsourcing firms replace intermediate stages of their domestic production with

foreign production, or shift their purchases of inputs from domestic to foreign

suppliers in order to save costs. The method that was originally introduced by Feenstra

and Hanson (1996) considered as a measurable indicator that can be tied directly to

outsourcing activity and it’s been widely use in Foreign outsourcing literature.

Data for fenestrate imported intermediate data is derived from input output (I/O) table.

These tables generally break down the inputs received by each industry according to

the industry of origin and their source and state the value added by the industry itself –

the sum of which is an industry’s total output. Starting from this index Feenstra and

Hanson (1996) get a narrow measure of outsourcing by considering only those inputs

that are purchased from the same industry as the good being produced. Then they

loosen their definition and include input purchased from all industries and term this

measure as Broad outsourcing. Finally they calculate what they call differential

outsourcing as the difference between their broad and narrow outsourcing measures.

The Feenstra approach is the best outsourcing estimate that we have so far though it’s

not without flaws, though one should note that Feenstra method will not include the

outsourcing of the final production stage (as in the case of outward processing trade or

import of finished goods) will not be captured by input-output tables.

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2.3 What Industries are affected by Outsourcing? – Data Analysis

In this paper I measure foreign outsourcing by using to two step approach. First i will

use NET Index of international competition (ICNET) form OECD to classify the

industries by the intensity of international competition. Index is based on net

penetration ration and calculates the excess of imports over export. I believe it’s a

good starting point to get an overview since outsourcing should have effect both on

import and export of an industry. Index is calculated as:

Second i will use the Feenstra-Hannson broad measure for foreign outsourcing to look

more specifically if there has been a sharp rise in the use of the imported intermediate

inputs. Choice of broad measure is based on data availability and research design.

OECD stan database or Eurostat input out tables do not distinguish between imported

and domestic intermediate inputs, thus I have used import penetration data for each

industry to proximate the amount of imported intermediate goods. Campa and

Goldberg (1997) used similar method in their four-country study of manufacturing

industries. The input-output tables used by them do not differentiate between domestic

and imported inputs; so Campa and Goldberg combine them with data on import

penetration to derive a similar measure.

The more obvious reason to use broad measure of outsourcing is capture bigger

picture. Like in most studies outsourcing is consider as simple BUY or MAKE

decision. Narrow outsourcing would capture most of the outsourcing if that was the

case, since most trade will occur in the same industry.

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However the choice is no that simple, a complex manufacturing of cars or airplanes

does not provide with the luxury to manufacture everything in house. Firm rather have

to outsource process or buy product like tires and metal to domestic or foreign supplier

in different industries. Thus replacement of domestic supplier with foreign agent will

not be captured in the narrow outsourcing which focuses on the same industry. So the

FH (Feenstra & hanson) wide measure would be the most appropriate. The measure is

calculate as

Outitwide

= IMPit * Sit

Yit

Where IMPit denoting imported intermediate inputs, and Yit8 the production value of

industry i at timet, Sit denotes the share of imports from industry i abroad that is

consumed by the domestic industry i.

Figue shows the calculation for net import penetration and growth rates of intermediate

inputs for 29 manufacturing industries in Denmark from 1980 to 2003. Industries are

divided into three groups by the level import intensity. High import competition refers

to the industry where net import penetration are more than 30 percent, Medium import

intensity refers to the industry where import penetration is o-30 percent and low import

penetration refers to the industries where net import ratios are negative refers to the.

The determination of import competition is arbitry and differs in the case of United

Kingdom.

The Table provide with some interesting results. Looking at high competition industry

we can see very high net import penetration ratios, which would indicate that

industries overall dependency on imports, though some these industries might be

depended on the import by their nature, thus effect of outsourcing on this industry

8 Yit =(total production of industri+imports by industry with Impit denoting imported intermediate

inputs and Yit the production value of industry

i at time t. Sit denotes the share of imports from industry i abroad that is consumed

by the domestic industry ii-exports)

19

would not be significant. We can see exactly that happing from calculation of

outsourcing in case Basic Metal, Non ferrous metal and pulp and paper product

industries. On the other hand Office accounting and machinery and leather industry

reflect different pattern, both net import penetration and outsourcing intensity has

increase significantly in the industry

Table 1 Outsourcing Measure for Denmark

Looking at the medium competition industries, we see more progressive trend in terms

net import penetration in wearing and apparel, textile and radio television and

communication equipments. Though increase in outsourcing industry is impressive. In

wearing apparel outsourcing has increase by three fold and in textile it has double from

in last 23 years. Majority of industries that find in this could be classified as moderate

to low technology industries or relatively more labor intensive. Low growth rates in

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import penetration also tell us that outsourcing intensity in these industries has been

accompanied by the export growth. Looking at low import competition we could see a

more stable picture, except of Shipping and boats, and transport equipment and Food

products, where outsourcing is notable, outsourcing in most of the industries has

grown over time, though it is weak. Most industries that have not experienced

substantial growth in this group belong to the high-technology group

The table shows the outsourcing measure for the United Kingdom. High import

competition industries are classified as those that have average net import ratio of

more 15 percent during 1980-2003. Medium competition are those with net import

penetration less than 15 percent and Low import industries classified as those having

negative net import ratios.

Table 2 Outsourcing measure for UK

Source: Created by author, Basic data fro OECD

21

In general thesis provides strong evidence of increasing outsourcing intensity in United

Kingdom. 12 out 29 industries have experienced substantial increase in the outsourcing

intensity. Amount of imported intermediate input used in the leather, textile and

apparel industries have tripled from 1980 to 2003, the average growth rate in net

import penetration gives the similar picture. Data depicts slightly different picture than

that of Denmark, in the UK data set some Low Import competition industries have

experienced smart increase in outsourcing intensity. Amount of intermediate inputs

used in the pharmaceutical and chemical industries have doubled in last 23 years. Most

of these industries are considered to be high technology industries, which provides

with the interesting mix of labor or low technology (textile and apparel) industries and

high technology (chemical and pharmaceuticals) industries. This could also be

evidence of the fragmentation of production process theory presented by (feenstra

1998) and has been actively discussed by the academic researchers. Since most these

industries have also experienced substantial export growth and import of input could

indicate firms decision to exploit the productivity gains by obtaining cheap inputs.

Table 3 – Industry ranked by outsourcing intensity

Source: Created by Author

Table shows the top fives industries by their outsourcing intensity in Denmark and

United Kingdom. One should not be surprised with the presence of the apparel and

leather industries in both groups, labor intensive nature of the textile and leather

industry makes it ideal choice for outsourcing to the low cost nations where these

products may be performed for cheaper labor cost. However presence of

pharmaceutical industry and electrical machinery in UK dataset and radio and

communication equipment in Denmark is interesting and it might indicate that

outsourcing is not only limited to the labor intensive industries and trend is extending

to the other industries.

3. Outsourcing and Employment

3.1 Theoretical Framework

In order to measure the effect of outsourcing on employment I will use Stopler-

Samuelson (SM) theorem as a theoretical base. SM theorem analyzes an economy with

two factor of production Skilled/low skilled and unskilled labor and they are fixed in

supply. Good Y and X are classified as skill intensive and labor intensive/less skill

intensive. The SM theorem is based on the assumption that production take place

under constant returns and prices of skill and low-skill Labor intensive goods are

determined by the world market and wage rates of skilled an unskilled labor are

determined by reactions in domestic market.

According to the SM theorem labor is perfectly mobile between two sectors thus

change in price due to import competition will push price of good X low skill (labor

intensive) down, prompting a production shift from product X to product Y as

production of product X is not profitable anymore. The result of the shift will be

excess supply of labor toward firm Y which produces relatively high skilled product

using skilled labor, the flow of excess supply will cause reduction in wage of low

skilled labor and both sectors will become more intensive in unskilled labor.

Putting it into international trade perspective, under perfect competition, the relatively

abundant factor (skill-capital intensive product in case of Denmark & UK) will gain

while the scarce factor will loose when the economy is opened to the world market.

This is because, due to trade, the relative price of the exported good (that mainly

employs the abundant factor and is therefore relatively cheap) will rise with the

additional demand from abroad whereas the relative price of the imported good (Labor

intensive product like textile and clothing) will fall. The increase in demand for the

export good also causes an increase in demand for its production factors (skilled labor

in case of Denmark and UK). However, because the export good uses more of the

abundant factor, the demand for this factor will rise more than proportionally. On the

other hand, the falling price in the sector that is competing against the imported goods

will mainly decrease demand for the scarce factor. This will make its price (wage) go

down. However, Full employment outcome with different allocation of labor between

23

sector – and more inequality in relative wage is possible only if factor of production

completely mobile between sectors. In the absence of labor market flexibility in terms

of wage adjustment and mobility between sectors, the impact of the change in the

production factors will be on the employment of the production factors. Thus it is vital

analyze the labor market structure in Denmark and UK.

3.2 Labor Market Rigidities:

Labor market legislations normally put in to place to protect employees from Unfair or

discriminatory actions on the part of employers. In doing so it also raises the effective

cost to firms of employing workers and raise the effective cost of adjusting levels of

employment. In Stopler Samuelson the main source of inflexibility is cause by the

labor market rigidities. Rigidities in the labor market artificially created by the

government rules regarding hiring and firing of the employment, collective bargaining

and high Union involvement.

Figure 2: Labor Market Rigidities 2000

United States

Un ited Kingdom

Switzerland

Sweden

Spain

Slo v ak Repub lic

Po rtu gal

Po land

No rway

New Zealand

Neth erlan ds

Luxembou rg

Ko rea

Jap an

Italy

Hungary

Germany

Fran ce

Fin land

Denmark

Czech Repub lic

Can ad a

Belg ium

A us tria

A u s tra lia

0,0

10,0

20,0

30,0

40,0

50,0

60,0

70,0

80,0

90,0

100,0

0,0 10,0 20,0 30,0 40,0 50,0 60,0 70,0 80,0 90,0 100,0Trade union density (% )

Collective bargaining coverage (%)

Source: OECD Employment Outlook 2004

24

Figure 2 show summarizes the structure of wage determination systems and the extent

of coordination in wage bargaining, both variables are important to see the full picture

of union involvement in labor market. Trade union density refers to number of persons

actively participating in union activity. While collecting bargaining coverage refers to

the unions ability represent the percentage of the employees in bargaining process.

Denmark seems to have a very high union density and bargain coverage, 70 percent of

the employees are represented in data which infers a very high bargaining power of

trade union in setting minimum and standard wage setting/adjustment. On the other

hand data from United Kingdom depicts a quite different picture, only 30 percent of

the employees are represented by the unions and coverage of collective bargaining

seems to be quite low, which would infer a relatively less rigid labor market. However

drawing a conclusion on just two variables would be too little.

Figure 3 represents the OECD index of employment protection Labor standard.

Employment index measures the strength of the legal framework governing hiring and

firing. The countries are ranked from 1–20, with 20 being the most strictly regulated.

Figure 3: Index of Employment Protection

Source: OECD Employment Outlook

Surprisingly Hiring and firing cost in United Kingdom is relatively higher neither than

Denmark, which suggest that the U.K. economy might not be as flexible, Denmark

seems to have lower hiring and firing costs. Hiring and firing cost are important

employment adjustment mechanism during economic expansion contraction. Oecd

25

index of Labor standard index refers to the strength of the legislation governing a

number of labor market of the labor market. The index being scored from 0 (lax or no

legislation) to 2 (strict legislation) on each of the five dimensions that is working time,

fixed-term contracts, employment protection, minimum wages and employees

representation rights. The picture is somewhat mix United Kingdom seem to have very

weak legislation in this area, whereas case of Denmark is not far away, which is

ranked 2 on the scale.

Looking through three indexes we could safely say that both countries seems to have

serious problem fulfilling the assumptions of Stopler Samuelson theorem. Denmark

has relatively more rigid market than United Kingdom, Trade union bargaining power

in Denmark could have serious effect on the employment of unskilled labor since

wages are determined though collective bargaining between employers and trade

unions and minimum wage is guaranteed. Thus in reduction in the wages would not be

possible in the face of price decrease of low-skill (labor intensive) goods and

adjustment will take place through employment reduction. Though both countries

seem to have problems in terms of labor protection policies and could not consider at

par with the United States which consider being a flexible labor market.

In case of UK, rigidities arise through protection of employment, high hiring and firing

cost will reduce the perfect mobility in the sectors as mentioned by SM theorem, when

sector are not fully mobile reallocation of resources that allow product mix (from labor

intensive to skill intensive goods in case of DK and UK which will effect the wages of

low skill worker) to take place will not happen, as a result firm that keep in the

business of producing the skill intensive goods will suffer from negative economic

profit as adjustment in the wages is not possible and price of good have fallen, as

consequence firm will have to no option but opt for the redundancy or look for the

cheap imported input, which in turn has negative effect since it will effect the domestic

production of intermediate goods, thus employment of low skilled labor will be

effected.

26

3.3 Empirical Analysis – Does Outsourcing Destroy Jobs?

Figure 4 shows the employment development in the Danish and UK manufacturing

industries over last 22 years. Change in the employment is calculated as change in the

number of employees in the corresponding industries. The numbers of job losses over

the entire period are starling and widespread in the case of united Kingdom. Picture in

the case of Denmark is slightly less grim and some industries e.g. Pharmaceutical and

Aircraft industries have actually avoided the downward spiral. Case Pharmaceutical

industry is interesting since it is ranked in terms of import competition and has not

experienced growth in the net import penetration ration, which relatively high across

the time period studied in this paper. Same goes for the iron and basic metal

industries.

Figure 4: Employment development in DK & UK 1980-2003

-100,00%

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Source: Created by the author, data from Oecd

Losses in textile sectors in both countries are significant, 82 percent of the workers in

UK textile countries have lost their jobs compare to 60 percent in Denmark. Similar

trend appears in wearing apparel and leather industries, which would indicate possible

27

effect of outsourcing according to Samuelson theorem as both sectors are consider

labor intensive. Figure 4 also provide some conflicting numbers, UK has also

experience sharp decline in the Electric machinery and Radio, TV and communication

industries which are relatively more skill intensive, while Denmark has managed to

avoid any possible employment loss in theses sectors, which could attributed be to the

existing high outsourcing intensity in theses sector or that restructuring in this sector

has taken place before 1980s or there may be no link to outsourcing and there might be

other variables that may have cause this effect.

In order to examine whether outsourcing indeed have impact on employment and

increasing outsourcing intensity is to blame for the high employment losses in the

manufacturing sector we will use econometric estimation of demand for labor (L) by

ordinary least squares estimation (OLS) for selected 26 manufacturing industries.

ln Lit = a0 + a1 lnW it + β ln IMPit + δ ln Yit

Where:

W = Change in the wage rate

IMP = Change in outsource intensity

Y =Change in total production

it = Particular Industry in time t

Choice of methodology is important to calculate the effect of outsourcing on

employment, Academic literature on outsourcing refers to the series of measure that

have been utilized with different level of effectiveness. The choice of the demand of

labor was driven by the availability of relevant data and precedent in international

research literature. The method has been widely used to study the effect on

international trade and outsourcing. The factor demand approach is based on the theory

of the representative firm. The idea of the representative firm implies that all firms

share the same technology and produce on the same scale. The labor demand approach

thus represents a partial equilibrium framework, as it is implicitly embedded in a single

sector setting. For the representative firm, labor supply can be considered perfectly

elastic so that firms decide on labor demand, for given wages. The focus is on

28

analyzing labor demand rather than wages. Given wages, firms minimize costs by

determining the profit-maximizing set of inputs.9

So in order to maximize the profit firm will replace the costly domestic production

with foreign output or outsourcing. In this context we would expect positive

relationship between change in employment demand and total output (production).

While an increase in the wage rate will have negative effect on the employment, and

will lead firms to substitute away from the more expensive domestic inputs from their

own production or supplier to a more cost competitive supplier abroad where wage

cost are low, thus we also expect a negative relationship between outsourcing intensity

and employment growth.

Magnitude of direct outsourcing effect in regression coefficient would be somewhat

more moderate. First, in our analysis we have used the value of imported intermediate

input rather than the quantity, since intermediate is of cheaper cost the real

replacement impact on domestic production may not be captured. Second replacement

of domestic production may not be fully captured by the intermediate output as firm

may import the product at the final stage of production.

3.4 Regression Results

Regression results of Danish manufacturing industries have been summarized in the

table4. Danish Electric Machinery and Equipment industry was emitted from the

analysis due to technical data problem. The results have divided in three parts; Red

letters show the industries that have experience the highest outsourcing intensity over

the period, blue letters represent the industries with highest net import penetration and

bold Black letters show other industries where regression results are significant. In

general Results show that 14 out 25 manufacturing industries are statistically

9 Alexander Hijzen, 2005 - A BIRD’S EYE VIEW OF INTERNATIONAL OUTSOURCING: DATA, MEASUREMENT AND LABOUR DEMAND EFFECTS

29

significant, the employment in these could be explained by the reduction in Output,

increase in wage rate and outsourcing intensity.

Looking more closely in sector that have experienced high level of outsourcing

intensity we could say model explains the 59, 30 and 26 percent variation in the

dependent variable in the textile, Leather industry and other transport equipment

which is relatively high.

Table 4: Regression results Denmark 1981-2002

Source: Authors calculation (basic data obtained from OECD STAN Database)

In Hi import competing/import dependent industries Railroad equipment, office

accounting and iron steel industries seem to suffer most form the high wages,

Outsourcing is also an important source of unemployment in Iron and Transport

vehicle industries. Coefficient of wages is very high in the all the industry except

pharmaceutical, ships and boats, which demonstrate the wage sensitivity of these

industries, similar conclusion could be drawn about output, firms decision of

30

relocation abroad seem has negative effect on domestic production. Outsourcing

coefficient is relatively high for the low skill labor intensive industries like textile,

wood product, pulp and paper, non metallic, which indicate that outsourcing plays

sever role in employment reduction in this industries. However changes in

employment in chemical industry, which is classified as relatively hi-skill industry,

could also is blamed at outsourcing.

To conclude we could say that Industries failure to absorb import price competition

through downward wage adjustment result in the reduction of domestic production and

jobless. Fact that outsourcing industry is could be present in some Danish

manufacturing industries, a good example in our data is wearing apparel sector which

has experience significant job loss and high outsourcing intensity, though our method

may not capture it due to the fact many apparel product are important as final goods.

UK regression results presented in table 5 are more upbeat than those of Denmark,

Statistical results for 24 out 26 industries have are significant. About 75 percent of

variation in employment could be explained in 5 high outsourcing intensity industries

Table 5 Regression result for UK 1981-2002

31

Source: Own calculation (Basic data from OECD Stan database)

marked in red. Outsourcing coefficient in three industries are extremely high, that

might explain the 80 percent employment reduction in UK textile industries. In general

Labor intensive industries are the one hardest hit, though there no special exception,

only pharmaceutical, printing and office accounting and computing machinery have

managed to escape the full blow of restructuring, increasing outsourcing intensity ratio

inn pharmaceutical firm from 1980 to 2003 might have hinder the job growth in this

Sector.

The appalling regression results of United Kingdom could partly be explained by

going back to net import competition data that we have calculated. It seems apparent

that in the case of United Kingdom net import penetration ratios were more favorable.

Net import penetration measures the intensity of competition based on import and

export and point to the fact that UK industries were more active in the international

market. Thus change in the international prices due to increasing import competition

might have more serious consequences for them, since home production may not serve

export market abroad due to obvious competitive disadvantage and home producer will

also to incoming producer from abroad.

To conclude we could say that outsourcing has cause a significant amount of job losses

in labor intensive sectors in both Denmark and United Kingdom. In the case of United

Kingdom evidence is widespread in the majority of the industries, while In the case of

Denmark relatively high skill intensive industries like chemical and pharmaceutical

industries are not affected.

In order to further strengthen out hypothesis that it is actually outsourcing that has

cause widespread job losses across manufacturing industries we could decompose the

imported intermediate input to see their origin. If the share of imported intermediate

input from low cost or developing countries is on the rise than we could say that trend

of outsourcing is the culprit. However Stan bilateral industry database doesn’t not

provide with luxury to decompose the import data for three reasons (a) Data is covered

for selected countries and does include grouping from developing countries, (b) Time

period is somewhat limited and (c) the most importantly it uses slightly different

32

classification system and is no compatible with classification system that we have in

this paper. Nevertheless I have tried to construct some graphs from Stan bilateral

database in order give us overview of general trend in these imported intermediate

inputs form their origin for the industries that have experience the highest outsourcing

intensity and job losses

Figure 5: Outsourcing by Origin (% of total imported input by DK)

Source: Constructed by Author (Data from Stan Bilateral database)

First graph in the figure 5 represent the three textile industries that have worst job

losses in Danish manufacturing. The trend in the graph could not have more clearly;

there is a rise of 40 percent in non OECD trade, which indicates the share of

developing countries. If that share to be doubtful due to the vast number countries that

are sampled together, we could just look at the china, a classic developing country with

33

abandoned of cheap labor and basic infrastructure. The share of China over laset15

year has risen nearly nonexistent to the 20 percent of total intermediate input in three

textile sectors. At the same time we could see that trade from OECD and EU 15

countries has declined systematically, which would vindicate that due to import

competition imported intermediaries from these countries are not competitive

anymore. Picture for the other transport is also similar. There was 46 percent job loss

in other transport industry, graph sows that trade with non oecd countries has doubled

in last 15 yaers and there is decline in trade form OECD countries. Other two

industries show somewhat more stable picture though there is slight tendency of

increasing trade with non-OECD compare to OECD.

Figure 6: Outsoaring by Origin - (% of total imported inputs by UK)

Source: Constructed by Author (Data from Stan Bilateral database)

Increase in the imported inputs form Non OECD countries for Untied in three textile

sectors is impressive and China captures the good part of changing trade share

imported input from haven to 20 percent alone during last 15 years. Figure 6 depicts

the similar story across the panel. There was 40 and 50 percent job loss over the

studied period in electric and TV, Radio and communication industry respectively.

34

From the graph we could say where its coming form, share of developing countries in

both sector has almost tripled, similar trend observed for the electric machinery. Once

again it´s validate the regression output that in the Case of United Kingdom

outsourcing is not limited to the low skill labor intensive goods, though tendency of

job losses in these industries is less sever than those of labor intensive industries.

So if there widespread job loses in the low skill labor intensive industries in Denmark

and United Kingdom due to outsourcing and trend is moving toward more skill

intensive industries (pharmaceutical) in Denmark and already persistent in UK, how

could we possible explain?, Is it pure evil? Should the countries move back to the

protection era and cut international trade ties to protect their labor?

To draw conclusion like this based on just one side of the story, i.e. job loses in

domestic market would not be appropriate and unscientific. In order to properly

understand the phenomenon we must look at the broader picture by looking at what

drives the outsourcing in order to determine the impressive increase in the outsourcing

intensity over last 23 years. W should also look at the impacts of outsourcing on

industry productivity in post outsourcing era. Most importantly one must not turn a

blind eye to the receiving country i.e. where production is shifted.

35

4. Drivers of Foreign Outsourcing:

Impressive growth in outsourcing intensity over last 23 years demonstrates its

importance in national manufacturing industries for Denmark and United Kingdom.

However in order to fully understand what has caused this tremendous growth and it’s

present and future consequences, one must look outsourcing though global perspective.

Appendix 2 provide a framework to understand the changing pace of outsourcing

through global integration and it’s impact on the firm.

When firms decide on where to outsource their business needs and processes based on

a rational business assessment of economic efficiencies and comparative advantages, a

number of positive outcomes could happen. The cost to consumers of the products and

services these companies provide could go down. The quality and the range of

products and services go up, as companies pour more resources into research,

development and innovation.

Fundamentally changes in global environment facilitated by the technological advance

and reduced trade barriers could affect the firm in two specific ways. First, it creates a

even playing field between domestic and foreign producer, In this open market

domestic producer will have to compete with low cost producer from developing

countries. Second, it provides motivation for domestic firm benefit from outsourcing

productivities, and may cause dominal effect. Before looking at each of the effect in

detail we must first look through how international trade integration (globalization) has

changed the global economic environment. More precisely

(a) We should look at how globalization has changed economics of international trade

(outsourcing) over the years.

(B) What impact these changes have on domestic competition.

36

4.1 Globalization & International Transaction Cost

One of the pioneers on outsourcing research Robert C Feenstra (1998) describe “The

decades leading up to 1913 as a golden age of trade and investment worldwide, an

era that was ended by World War I”. Table 6 shows the level of merchandise trade

relative to GDP. The level of merchandise trade that was experienced during the

golden era in 1913 was not reached by Denmark until 1980 and in the case of United

Kingdom barely reached the level by 1990. Of course one should be careful when

taking into account such general trade statistics because many OECD countries in the

post world war era have moved to the service industry, thus true GDP composition

may and growth may not be capture by total merchandise trade. Even though they

Table 6: Ratios of Merchandise Trade to Industry Value-Added (Percent)

Provide some very interesting insight into the trade integration. Just like feenstra´s

golden age of trade, we could also call the post 1913 period as Dark Age of trade, at

least until 1970, which is generally marked by the era of protectionist policies. Most of

the countries experienced stagnant and declining trade growth in this period. However

post seventy era has once again has seen amazing growth, in case of Denmark

Merchandise trade rose from 65 percent to 90 percent of industry value added. Though

change in the case UK was more moderate in 80´s and more pronounce in 1990s. The

trend in the growth is compatible to my calculation of outsource intensity, Outsourcing

growth seems to replicate the trade in the merchandise. In order to better understand

37

how changes in global environment drive growth I will Amelung (1190) Transaction

cost model.

Appendix 2 shows the graphic version of transaction cost theory. According to the

Amelung transaction cost theory there are three kind of kind of costs that are

associated to the international transaction. The costs are classified as Information

costs, which include cost of searching for information and communication cost, Cost

of good transfer, which include actual transportation cost and costs of trade barrier and

transport insurance cost and Capital transfer costs which include transfer fees and costs

of capital controls and financial insurance cost. Amueling transaction model place

increasing importance on development of the transaction cost factor. Model is

particularly interesting to measure the recent technological breakthrough in

information and communication technologies, development of efficient transportation

network at relatively lower cost and lower tariff, all three factors have severe impact

on international trade.

4.1.1 Cost of trade barriers

Reduction in trade barrier is fundamental to international trade growth, non-artificial

trade barriers like tariff, import, excise duties, inefficient good handling at port and

vague clearing and forwarding procedure have negative impact on the international

trade growth. Last two decades have seen a dramatic reduction in the international

trade barriers.

Figure 7: Trend in the International Tariff rate from 1980-2000

38

Figure 7 show the trend in the international tariff rates from 1980 to 2000. It clearly

splits the tariff reduction two stages. Period between 1980-1991 is marked by

relatively moderate decline in the of both developed and developing countries, the

percent decline from 1980 to 1991 is about 5 percent in both groups. The second stage

presents a more dramatic decline high income countries, reduction in tariff is about 15

percent in developing, while 5 percent in developing countries

4.1.2 Transportation cost

A country’s effective export competitiveness is determined by its productive capacities

as well as its ability to bring goods to foreign markets at the lowest possible cost and

under conditions required by importers and consumers. The efficient transportation is a

major element of supply capacity and is largely determined by the availability, quality

and cost of transport and logistics services. Innovation of containers in 1980s has

clearly emerged as the technological concept governing the transport of trade in

manufactured goods. The majority of international trade is containerized, irrespective

of the mode of transport used. The growth of containerization has resulted in changes

in transport patterns and practices. It has both and quality effect in terms and safety

and storage.

Figure 8: Freight Ration by Country Group Of Import Value

39

Source: UNCTAD – Globalization and facts 2004

Figure 8 shows the trend in ocean freights and air transportation costs. Ocean freights

have declined significantly since 1940, however their downward progression 1960 to

1980 has been moderate and steady. Significant decline of international ocean freight

in 90´s is significant for the cross border trade growth and may be link to the increase

in international trade.

4.1.3 Information Costs

The last two decades of 20th centaury have been characterized by the major

technological advances. Specially 1980s and 1990s have seen major breakthrough in

the information and communication technological. The internet revolution has changed

the way we live every day life, it has the way we get information, the way we do

business an spend leisure time. There is hardly any part of the economy which is not

affected by the internet revolution. At the same time cost of these services has declined

significantly.

Improved and low cost information and communication technologies (PC, fax machine

and modems etc) are crucial for the outsourcing intensity. Figure 9 shows reduction in

the telephone and satellite charges. Satellite charges have taken a free fall in 80 an

telephone charges (cost of telephone is measured as three minute call form new York

to London) have hit the rock bottom in 80s and 90s.

40

Figure 9: Cost information ICT

The reduction these cost are very important as provide firms to efficiently control the

activities affiliates in the host countries and help them keep in constant contact with

their supplier. In addition, Internet revolution has substantially reduced the cost

information searching, ready made database of foreign supplier on internet are

constantly update and provide a very useful too at extremely low cost In addition it

also provides additional information about the potential supplier’s quality of products,

customer relation and on time delivery traits for the experience of other buyers.

Constant communication through email at fraction of cost and sharing of

organizational database across border through networking has enormous productivity

potential.

4.1.4 Capital Transfer Cost

Capital cost are characterize as the costs that come up due to financial transactions

from, e.g. payment of imported good. The cost of capital transfer barriers is made of

two factor direct and indirect control. Direct control put a strict limitation on foreign

monetary transaction. These are similar to that of quantitative restrictions on imports

of various goods and services. They also include foreign ownership and investment

restriction in particular sectors.

Figure 10 : Evolution of financial opennesss

41

Source: The Impact of International Financial Integration on Industry - Ellen

Vanassche1, Katholieke Universiteit Leuven – Belgium 2004

Indirect capita control raises the cost by discouraging capital transfer through

discriminatory or double taxation of cross border capital flows. By taxing foreign

money required to purchase foreign goods and services, capital controls cut the

quantity imported and/or raise the domestic relative price of imports. Capital control

costs are closely related to the development of international trade and growth. Figure

10 presents the evidence of capital control OECD and developing countries, Zero

referents a regime of strict capital control, while one represent no capital account

restriction. We can see that there is clear trend in OECD countries to move towards

more liberal capital regime in order reduce cost and boost trade. In case of developing

countries is somewhat unclear, though there hesitance towards more liberal capital

regime may linked to the development in their respective economies. Conclusion is

based on the fact the shift towards more liberal regime in Developing countries has

taken moment in late 80s when, role of state was redefined through deregulation,

privatization and de-monopolization on unprecedented scale to stimulate the economic

growth. Reduction capital and foreign exchange control was part of the drive, from

experience of the OECD countries we may infer that economies may tend to move free

capital control regime at certain stage of economic maturity.

42

There is another important source of capital transfer cost raised by the (Matthias

Busse). He points out that international trade of commodities deliberately includes

risks due to the lack of enforceable property rights and contracts. Foreign governments

or contracting parties may abuse this lack of enforcement and may default on a

contract. In order to protect firms against these risks, they may seek special insurances

against default, such as letters of credit or export guarantees by governments and

banks.

4.2 Outsourcing and Competition:

Global economic integration through the reduction of trade barrier, technological

advances, reduced cost of capital and transportation efficiencies have altered the

environment in which firms operate. While globalization offers unprecedented growth

and development opportunities for firm, it also increases competitive pressures on

them. Globalization removes the traditional protection and amnesties that firm enjoy in

domestic markets, and force the national producers to compete in the international

market with the producer from low wage countries. In essence it increases the

predetermined costs for firms that lag behind; those lagging firms thus risk becoming

marginalized.

An open and liberalized world changes the rules of the game and raises the stakes. The

only viable way for firm to prosper in this market is to focus on its competitiveness,

thus increasing firm competitiveness has become a major challenge in the globalize

economy. Competitiveness is defined as the ability to provide products and services as

or more effectively and efficiently than the relevant competitors. In the traded sector,

this means sustained success in international markets without protection or

subsidies.10Competitiveness of an enterprise could be attributed to numerous variables

like investment intensity, technological know how, quality of inputs and managerial

capabilities. Though in manufacturing industries labor productivity or better said total

labor cost is important. Thus companies and industries that are involved in labor

intensive and low skill products like apparel, clothing, footwear and office and

10 The competetive institiute

43

accounting machinery will be faced with the severe import price completion from the

countries that abandoned in labor and have comparatively low cost.

Table 7 Average Annual wages ($)

Source: OECD Data

Table 7 shows the Average annual wages in the Denmark, United Kingdom and

developing countries. In general difference between developing and developed

countries is astonishing, average annual income of a Danish worker is 4872 U.S.

dollars, while an Indian worker receives a astonishing 39 dollars per year and Chinese

worker make 125 dollar over the year. The difference between DK/UK and China is of

particular interest.

The divide between two countries is huge and hard to comprehend. Even though the

cheap labor cost will be crucial element for the competitive advantage for the Chinese

or Indian manufacturers it has to be coupled with other operational efficiencies in

order to gain the upper hand. Once these companies reach the minimal technological

know how, operational efficiencies and skill, they will tend to challenge their

competitors on the side of the globe. That has been the case in many Danish and UK

manufacturing industries. Import competition from low wage countries has pushed

western manufacturer to look for the ways to cut their production cost in order to

44

survive. According to the survey11 conducted by the International labor organization

Cost reduction was the prime reason for the companies to indulge in the outsourcing.

5. Outsourcing & productivity – impact on local plant

Continuous improvement in the productivity is crucial for the growth and survival of

an efficient organization. Productivity also plays important role in the Income growth

of a country and it’s competitiveness in international market. Productivity refers

developing techniques which enable existing goods and services to be produced more

efficiently, or which expand the range or quality of goods and services which can be

produced.

Figure 11: Productivity Framework

11 Peter Auer, Geneviève Besse and Dominique Méda (eds.) 2004 -Offshoring and the Internationalization of Employment

-A challenge for a fair globalization? – International labor statistics.

Capital Intensity Outsourced inputs Quality of Labor Quality of Capital

Total Factor Productivity

Improved

Competitiveness

Skill

Development

Higher

INDUTRY

GDP

Qualitative Inputs Quantitative Inputs

45

Source: Created by Author

Figure 11 provides a framework to understand the way productivity affects the

manufacturing firm on the plant level, which in turn contribute to the industry GDP.

Qualitative and quantitative inputs are equally important and inter dependent to reach

the overall productivity goal. The best way to look at the framework is as a chain,

which ultimately leads to higher growth and provider further impetus to re-invest in

qualitative measure to boost the knowledge in skill level. Outsource inputs in the

framework could be a lifeline for the productivity of the manufacturing industries

suffering from import competition from low wage countries.

International outsourcing effects productivity of a manufacturing plant in number of

Ways. First, firms could benefit form outsourcing by slicing up the value chain, when

goods are produced in a multistage production process each good involves different

stages from basic upstream production to the eventual completion of the final good in

the downstream stages. By moving some of these processes abroad or replacing them

by cheap foreign inputs a firm can inject a massive dose of productivity in that

particular process and overall productivity of the good.

Second, by indulging in the business of foreign outsourcing firm could have access to

the higher quality of goods than those available domestically due to specialization of

foreign trader in that particular process. Therefore increasing use of internationally

traded inputs could result in a direct boost in productivity for the manufacturing firm.

Table 8: Productivity in UK manufacturing (Value added per employee –million of DKK)

46

Source: constructed by Author, Data from OECD Stan database

Thirdly, by Outsourcing the whole upstream production process firm can benefit form

moving its focus on more specialize or high skilled part of the production process

which could in turn result in higher productivity gain.

Table provides the change in the productivity for UK manufacturing industries from

1980 to 2003. Productivity is calculated as value added divided by the number of

employees in the corresponding sectors; measure is often used as labor productivity.

Though variable of labor productivity does not provide us detailed picture of the

productivity gains in terms of production factor, it does give us sense of direction. We

have to be careful when drawing a connection between productivity numbers and

outsourcing, productivity gains in figure may also represent a good chunk of

productivity gains by using the other factors like technological breakthrough in

production process or radical change in design of production process. Even though we

could assume that a good deal of productivity gains in these industries may have come

from outsourcing.

Looking at the table we could see most the industries have experience smart growth

over the last 23 years. We could also infer that pharmaceutical and textile sector has

47

significantly benefited by the outsourcing strategies, its share of proclivity growth is

higher than that of average UK industry. we could see that textile industry has

experienced higher productivity during the period between 1990-2002, this the period

where relatively large layoffs have taken place in textile industries and numbers might

reflect the efficiency gains through the replacement of domestic production by foreign

inputs. Similar pattern is repeated in the UK pharmaceutical industry that has

experienced outstanding productivity growth during the 1990-2002, this is the period

where outsourcing intensity has actually doubled. Radio television and office

accounting industry show similar trend.

In the case of Denmark productivity growth is somewhat more moderate, though its

not a surprise given the outsourcing intensity in Danish manufacturing industries was

weaker than that of United Kingdom. If we look at the table 9 in the next page we

could see that productivity growth is visible both in the five sectors marked with red

color, these are the sectors that have experience highest increase in outsourcing

intensity, however its difficult to isolate the effect of outsourcing due to the high

average productivity growth most of the Danish manufacturing sector.

Table 9 Productivity growth in Danish manufacturing (value add per employee in million Dkk)

Source: Constructed by author using OECD data

48

Even though pattern in the productivity growth in textile sector does coincide with the

increasing outsourcing intensity in the sector and increasing job losses in three textile

sectors. The productivity growth in Pharmaceutical industry is outstanding, sector is

not listed as one with the highest increase in the outsourcing intensity, though its worth

noticing that it has high dependence on the foreign inputs in our sample and that could

be a reason for the spectacular among other things.

To conclude we could say that outsourcing does have positive effect on the

productivity growth of Danish and UK manufacturing industry. Industries that have

experience high growth in the manufacturing or one with high dependency on foreign

inputs seem to have relatively higher productivity growth. Intensity of productivity

growth is higher in United Kingdom that that of Denmark, which is compatible with

the fact that UK companies tend to invest more in outsourcing strategies.

6. Effect of Outsourcing on Host country

Host country effect of outsourcing is crucial to assess the overall impact of

outsourcing; the host country effect of outsourcing is not the usual one that is

mentioned in the newspaper or TV and still relatively uncharted territory in the general

public domain. Outsourcing is important for providing countries with capital and, more

importantly, technologies for production and for gaining access to export markets. In

reality outsourcing could be force of transformation and key for developing countries

for the long term sustainable economic growth. In general economic literature

measures the effect of outsourcing on host country through Inward Foreign Direct

Investment. FDI is usually defined as ownership of foreign capital or stake in the

capital of foreign entity; it includes corporate activities such as building plants or

subsidiaries in foreign countries.

The impact outsourcing on the local economy could vary depending on the mode of

outsourcing strategy. In primary mode Multinational Company’s decision to involve in

FDI is usually considered as a trade-off between supplying a market by exports or by

local production. In classic Multinational FDI model basic consideration is given to the

costs of supply and decision are made on strategic level, perceived future benefits

49

drive the strategy and focus is kept on the possible efficiency gains that may lead to

increase in the competitive level of the Firm.

Choice to move production abroad is made because marginal cost, transport costs, and

delivery time might be high or it could be driven by Multinationals failure to tailor the

product to local circumstances. Investment based on this kind of rationality is

described as horizontal FDI, Companies like Nike have been using this kind of FDI

made to outsource the downstream production functions and trend has been replicated

by the large number of firm looking though vertical integration efficiencies.

In the second mode Vertical FDI or Outsourcing investment is rather driven by need.

The motivation is to take advantage of cheap labor to shift the labor-intensive parts of

the production in low wage countries. Major difference between two modes of FDI is

the change in the intensity of domestic competition and productivity gains by local

firm through knowledge and technology spillovers. Horizontal FDI are relatively more

oriented towards local market and often used as export base, their effect on the

domestic competition might be significant. Whereas vertical FDI or outsourcing by

need is rather more outward oriented and ignore the domestic market, partially

spearing the domestic competitions.

In this paper we do not distinguish between two modes of FDI, Changing nature of

international competition has caused firms to adapt to changing business environment

by locating in the low cost countries. In the case of United Kingdom international

trader intensity in pre outsourcing era was quite high many firms were active in the

International market before international trade boom, many of these companies were

serving foreign countries by export mode. Change in the international

prices/competition will force them to move abroad not by choice but to remain

competitive and hold on to the market share. In this case a firm which relocates major

part of his production abroad through subsidiary or joint venture may serve local

market through subsidiary. Thus firm will have focus on local market and will serve as

an export base for the parent economy.

Figure 12 - FDI Sock Denmark, UK and China

50

FD I stock- M illions $

-

200 000

400 000

600 000

800 000

1 000 000

1 200 000

1 400 000

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Outw

ard FdI -DK & UK

-

50 000

100 000

150 000

200 000

250 000

300 000

350 000

Inward FDI- China

United K ingdom Denm arkChina

Source: Created by author, data from unctad

Figure shows the change in the change in the outward FDI for Denmark and UK stock

from 1980-2005 and inward FdI for china. The growth in the last 10 years is

exceptional and show that its one of the favorite spot for foreign outsourcing or FDI

investment. The growth in the outward FDI stocks replicate the growth in the

outsourcing intensity and the size of the stock is staggering that would explain the

exposure of the UK companies in international trade. For Denmark the trend is similar,

increasing outward investment has increased substantially.

I have chosen china as host country due to the mere fact that china’s Trade with United

Kingdom and Denmark has increased substantially in last 23 years as send from

decapitation of outsourcing by origin in the earlier chapter. China fits the perfect

profile of outsourcing country, a outcry with abundant cheap labor and basic

infrastructure that is prerequisite for foreign outsourcing. Not to mention China’s

economic integration in the world economy is, already, one of the major events of the

past decades. In 2003, it was already the sixth largest economy in the world, at market

exchange rate 4, the fourth-largest global trader and the major recipient of foreign

direct investment in the world.12

12 Jorge Blazquez-Lidoy, Javier Rodriguez and Javier Santiso – Chinese trade impact on latin american market -2004

51

Figure 13: Organizational Framework for FDI

Organizational framework for FDI from (Mayer 2003) is a very useful tool to

understand the effect of outsourcing through FDI. Framework takes the holistic

approach where firms decision to decide investment mode depends on the set of many

external and internal factors. Many of these external factors like Capital restriction and

artificial competition law (protection laws) have been considered deterrent to

international trade and the removal of these barriers is partially responsible for the

boom in outsourcing and international trade in general. According to the Mayers

(2003) a firm could further influence this variable by the investment presence in the

foreign country, which could result in the further increase in the international trade or

more favorable business conditions. Nevertheless, most important part the framework

focuses interaction between foreign outsourcer and local firm and its impact on over

all economy. In this paper we will focus on two aspects organizational framework:

First we will look how local company may benefits from the presence of foreign

producer in the domestic market through knowledge and technology spillover, We

will also investigate if there is general evidence of skill upgrading in the local market

52

We will look at the welfare effect on the economy, knowledge spill and skill upgrading

may be source productivity in the industries and increasing FDI and trade should be

positively related to the general economic growth.

7. Outsourcing Impact on the local Firms

The most import asset for any organization is the firm-specific advantages, which are a

set of knowledge-based assets such as technological and organizational capabilities.

These capabilities could be technical knowledge of the production process or

organizational efficiencies that range form data mining to customer intelligence. Most

developing countries lack technology capability and FDI can serve to facilitate

technology transfer and reduce the technology gap between developing countries and

industrial countries. In fact, it is suggested that spillovers or the external effects from

FDI are the most significant channels for the dissemination of modern technology

(Blomstrom, 1989)

Technology and knowledge spillover could occur in many different situations. In very

basic scenario transfer of knowledge will occur when a foreign outsourcer transfer

knowledge to its subsidiary in foreign country. Tendency of transfer is variable and

evolves overtime with firm maturity and local market sophistication. Transfer of

Knowledge depends to extent that it serves the subsidiary to achieve it objectives and

its role in the local competitive environment. Moreover, subsidiaries facing

competition from technologically by advanced local firms may meet that challenge by

upgrading technology with additional support from the parent company hence, the

technology transfer within a parent company and subsidiary can be expected to

increase with the technological sophistication of the local environment

Second, knowledge transfer could also take place in arms length transaction where

firm gives licenses or franchise to foreign supplier. In this case foreign operator will be

obliged to transfer the product or process knowledge to local producer to achieve the

standard quality. In turn the local supplier might improve on that process or technique

53

to achieve higher productivity and will technological upgrade in the industry as other

competitors will try to reduce the productivity gap with their own innovations.

Third, Knowledge transfer occurs when outsourcing firm contract foreign supplier to

replace the domestic process of production in home country. In this case the foreign

firm has to provide certain standard specification of the product, thus giving away

valuable knowledge that has been accumulated over the years. In some cases foreign

contractors constantly work with the local producer to improve the products, thus there

is constant transfer of ideas and knowledge.

The spill over on to the local firms of the foreign technology could be explained by

demonstration effect and labor turnover in first two cases. Demonstration effect refers

to the fact that local firms may adopt technologies introduced by foreign firms through

imitation or reverse engineering. While In labor turnover scenario Staff and workers

trained or previously employed by the foreign companies are may be the source of the

knowledge transfer. They may transfer important information to local firms by

switching employers or may contribute to technology diffusion by starting their own

firms. In third case of spillover, the very supplier could be the source of the knowledge

spill over as it shares the improvement in the production process and technology

through the supply of inputs to local producers.

Figure 14: Value Added in Chemical, textile and total Mnf 1980-2005 (% GDP)

54

Source: World Bank – constructed using WDI Online

The direct effect of knowledge spillover will be on the productivity of the local

producer through improvement in the product and process design and technological

advancement in the process. Figure 14 provides the value added for Chinese total

manufacturing, textile and chemical industry. The graph does not any significant

changes in the pattern. Though there is slight improvement in the value added by the

chemical industry, which is consider to be relatively more skill intensive. Absence

impact of value added is not so strange since productivity is dependent many different

variables, improvement in technology and process knowledge is just one part of it and

development in value added could be shadowed by other factor.

In the run the Outsourcing decision of the foreign company coupled with the

knowledge diffusion could cause skill up grading in the Chinese manufacturing. The

process that are considered low skill intensive in Denmark and united Kingdom may

be considered high skilled in the Chinese economy, thus providing motivation for the

local labor and population update their skill in order the rap the higher economic

benefit. This skill upgrading in the long run coupled with knowledge diffusion

technology spill over will result in the development more skill intensive manufacturing

55

products in China, and we would expect a relative decline in the more labor intensive

sectors.

Figure 15: Chinese export to rest of the world 1980-2005

Total exports of China to the rest of the world, in US$1,000, 1980-2005

0

100,000,000

200,000,000

300,000,000

400,000,000

500,000,000

600,000,000

700,000,000

800,000,000

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Primary agricultural products Primary mineral products

Machinery & equipment Office machines, telecomm. equipment & electrical machinery

Clothing & apparel accessories, textiles, footwear Other manufactures

Source: Linda Y. Yueh (Chinese statistical year book)

The figure 15 shows changing pattern of Chinese manufacturing, from virtual non

existence in 1980s machinery & equipment has emerged as one the main exporting

sectors of the Chinese economy. Development in the telecommunication equipment

and electric machinery is even more prominent; the sector has emerged as a leader in

the Chinese manufacturing and taken over the more labor intensive textile sectors.

Emergence of these two sectors as leader would vindicate of theory of knowledge

spillover and skill upgrading as both of these sectors are considered relative more skill

intensive.

7.1 Outsourcing & Economic Performance

Generally outsourcing has positive effect on the overall economy of the host country

through direct and indirect effects. Firm decision to relocate in the foreign country has

direct effect on the employments as it creates demand for labor. It also help country

56

improves its trade balance as local production replaces imports and country is used as

an export base. It also provide impetus for the local and central government to redefine

the laws and rules relating to foreign trade, capital restriction, labor laws and

competition laws that will have positive effect and long term impact on the overall

performance of the economy.

Dollar Kraay (2001a) shows the developing countries that had the largest increase in

the trade share between late 1970s and mid 1990s (called “globalizes”) experienced on

average a much larger increase in income per capita during the 1990s than did not

globalizes. They further concluded that trade volumes are important determinant of

changes even after taking account of variety of other determinants of growth and of

possibility that growth could cause the increase in the trade.

Figure 16 : China’s Real GDP per Capital & Trade openness

Source: Paul Mason, IMF – pdp/01/04

Figure shows the relationship between real GDP and openness of the economy

(computed as total of import and export to GDP). It provide interesting information, if

we look at the period from 1960-1980 the growth is stagnant, this is period marked by

the trade protection policies, volume of trade in this period is quite low. On the hand

the boost in the growth coincides with period of high influx of foreign direct

investment, and economic liberalization in china. Trend in the graph vindicates the

57

conclusion of the Dolla and Kraay that influx of trade is positively associated with

economic growth. However the most important source of sustainable economic growth

comes from knowledge spillover and skill upgrading as it motivates people to climb

the ladder of economic prosperity by acquiring skills and education in order to get

accer to higher economic wages.

8. Synergies from Outsourcing interaction

Outsourcing may be a zero a sum game for the developing countries if looked through

short term pessimistic perspective. Increase in outsourcing does cause a significant

amount of job losses. However short term trend without a long term perspective is

useless and does not depicts the whole picture. A zero sum outsourcing could be a

source for the long-term prosperity and growth for both developing and developed

countries if is taken as an opportunity to re adjust economic disparities in the global

economy through global trade ingeneration.

For the developed countries outsourcing is painful in the short term since they have to

bear the heavy cost mass layoffs and readjustment cost in labor intensive

manufacturing sector. However it also provides them with the opportunity re-adjust

the rigidities (labor market laws) in the economy that may have worsened the situation.

Above all outsourcing provides developed countries with the opportunity to shift the

structure of the manufacturing sector from low skill intensive activates to more

specialize high skill production. This will provide platform for the future competitive

advantage for Danish and UK industries.

The benefits for the developing countries are not only restricted to the productivity

gains that have been discussed in paper. Cheap product from low cost countries also

provide low income group in the developed countries with the cheaper alternative and

eventually enhance their purchasing power, thus giving this group opportunity to send

more money on the relatively height technology products produce in developing

58

countries. In addition lower input from cheap countries help developed countries keep

the price inflation low.

UK and Denmark could also benefit in the long run from the improvement in living

standards in the China, FDI, technological and knowledge spillovers provide

tremendous potential for the economic growth and development for China. Increase in

the real income will cause Chinese customer to demand more high skill intense goods,

thus opening up huge market for Danish and UK firms that are specialized in hi

technology goods. UK and Danish hi technology companies that are already in some

kind of outsourcing might even benefit to a greater extends by profiting from the

existing market knowledge. Finally, outsourcing provides with most important benefit

of all by lifting millions of people out of poverty through economic growth and

welfare.

9. Conclusion:

After studying different aspects of foreign outsourcing and their potential impact on

the different stakeholder of the economy, it is not possible to outright reject all the

skepticism and stereo types attached to the foreign outsourcing. However a systematic

look provides a framework to understand evolution of the phenomenon.

There has been significant increase the outsourcing intensity in manufacturing

industries in Denmark and United Kingdom from 1980 to 2003. The outsourcing

intensity is relatively higher in UK manufacturing than that of Denmark. Labor

intensive industries seem to be the prime target of outsourcing, Leather and footwear,

wearing apparel and textile industries have experience the highest outsourcing

intensity in both countries. In the case of united Kingdom relatively more skill

intensive industries like pharmaceutical, radio and television and communication

industry shave also suffered from high outsourcing intensity, which indicates

outsourcing phenomenon is not only limited to low skill intensive industries. It is also

worth mention to note that industries that are ranked high import exposure (based on

59

net import penetration ratio) e.g. iron and steel and Non-ferrous metal have not

experienced dramatic increases in our sample. The reason for that could be that they

are already dependent on the foreign inputs and restructuring has already taken place.

Regression analysis using demand factor of labor confirm our hypothesis that

outsource does have negative effect on the employment. In the case of Denmark 14 out

25 manufacturing industries resulted positive with statistical significance, the

employment in these industries could be explained by the reduction in Output, increase

in wage rate and outsourcing intensity. Strongest effect of job losses is evident in the

apparel and rail road equipment. UK regression results presented are more upbeat than

those of Denmark, Statistical results for 24 out 26 industries are significant. About 75

percent of variation in employment could be explained in 5 high outsourcing intensity

industries. Thus confirming the hypothesis that outsource has negative effect on

employment.

Decomposition of outsourcing by origin further vindicate that there is sudden rise

imported inputs from low wage countries is the most probable cause of the

employment loss in developing countries. To understand the phenomenon we explore

look at he driver of foreign outsourcing. The world economy has gone through the

transformation in last 30 years. Traditional artificial and non artificial trade barriers do

not exist anymore. The revolution in communication technologies coupled with the

low cost of transportation economic liberalization has changed the face international

trade. National markets are no longer protected and the globalization of the industry

taking place. Changing environment put the local producer from Denmark and UK in

the same playing field as the producer from China, who obviously has comparative

advantage through access to cheap labor.

Since both Danish UK market posses some level of rigidities, adjustment of wages can

not take place and firm has no choice to look for the low cost inputs in the foreign

market where wages are low. The preventive action of the domestic firm results in the

reduction of the local output and job losses.

60

As a consequence of domestic UK and Danish firm to move part of the production

plant abroad or replace it with supplies from low wage countries results in the direct

productivity effect on the plant level. I have found positive productivity growth in the

both Danish UK manufacturing. Results in the pharmaceutical industry that has high

outsourcing intensity through out our sample are exemplary, since pharmaceutical has

not experienced such high unemployment. It indicate that outsourcing could be

strategic when used skill intensive industries, where Danish and UK industries have

comparative advantage.

The impact of outsourcing in Chinese market is also very favorable; outsourcing is an

important Source of FDI. Presence of foreign Danish or UK results in the knowledge

and technology transfer through demonstration, labor turnover and direct relationship

with foreign supplier, these spillovers are crucial for sustainable economic progression.

To conclude we could say that outsourcing high short term cost in terms job losses in

the domestic market, even though it helps firm to improve productivity and remain

competitive in the in international market, which in turn should boos the performance

of home country. On other hand outsourcing is critical for developing countries like

china and give them hope and strength to climb on the ladder of economic properity.

61

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Appendix = 1 Industry classification

Chnages In the Global Environment

Trade Liberlaization

Technological

THREAT:

Increase Import competetion

Increase Domestic competetion

OPPERTUNITIES:

Aceess to W

orld m

arkets

Posible Productivity gains

New

Business Oppertuntities &

Threats

Reduced Transaction internacional

transaction cost

Startegic response by firm to defend

& enhance competeive porition

Increase Outsourcing

Intesnsity

Improvered T&C techjnologoies at low cost

Hassle free- Cost effeceient access to int.