Are offshoring firms superstars? Evidence from Italy

Lorenzo Casaburi, Valeria Gattai, G. Alfredo Minerva 08 April 2008

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In a recent article published on Vox,(1) Thierry Mayer and Gianmarco Ottaviano suggested six policy questions that should be prioritised in the empirical investigation of European firms and their response to globalization. One of these questions concerns the link between international fragmentation of the production process and firms’ performance. While the media debate primarily concentrates on the impact of fragmentation on job destruction, an increasing body of research attempts to examine the specific characteristics of firms involved in international activities (offshoring, exporting, and engaging in foreign direct investment). As a result, wide evidence for a large number of countries shows that only a restricted subset of firms is involved in international activities and fully exploits the chances given by increased international integration. In light of this consideration, the distinction between winners and losers from globalisation also applies to firms, not just workers. From a policy standpoint it is crucial to have a clear understanding of who is benefiting from trade integration and who is not, especially at a time when calls for protection from imports are growing louder.(2) In a world where offshoring strategies are becoming more pervasive, the political economy of trade liberalization is also becoming more complex. Trade policy is no longer just a matter of seeking a balance between the interests of consumers and producers, but it necessarily involves the interests of consumers, offshorers, and domestic producers.(3)

Which firms offshore production?

When studying firms' international fragmentation, it is important to carefully describe the business activities involved. For instance, firms can offshore service-intensive stages of the production process, or manual-labour-intensive ones. Similarly, they can offshore the production of intermediate inputs (vertical offshoring) or the whole process leading to manufacturing of final products (horizontal offshoring). In another Vox column, Francesco Daveri and Cecilia Jona-Lasinio use Italian industry data to show that offshoring of intermediate inputs is positively correlated with labour productivity growth, while the offshoring of services is not.(4)

In our recent research,(5) based on a large and representative sample of Italian manufacturing firms, we study, among other things, the most prominent features of offshoring firms, distinguishing between the vertical and horizontal dimensions of delocalization. Firms involved in offshoring are just 7% of the sample, and account for 12% of sales. While there is considerable variation across industries, , firms belonging to traditional sectors (such as textiles, clothing and leather) are more strongly involved in vertical offshoring and firms operating in high-tech sectors (such as office equipment and PCs, and medical, precision, and optical instruments) show a clear preference for horizontal offshoring.

Based on our research, offshoring firms turn out to be "better" along several dimensions, as summarized in the table below. The overall "offshoring premia" are clearly driven by firms involved in horizontal offshoring, while evidence is weaker when looking at vertical offshoring. For example, we find that value-added per worker in horizontal offshoring firms is on average 28% larger than in non-offshoring firms, while the difference between non-offshoring and vertical offshoring is close to zero. However, companies that offshore inputs appear to be bigger (in terms of sales and employees) than non-offshoring ones.

Table 1. Offshoring premia

 
Average for Non-Offshoring Firms
 
Offshoring Premia
 
Final Goods Offshoring Premia
 
Inputs Offshoring Premia
 
Sales
34,000
170%
218%
94%
Employment
122
122%
124%
105%
Capital per Worker
62
37%
53%
9%
Value Added per Worker
8
16%
28%
2%
Average Wage
32
5%
9%
-2%

Note: Data are from 2003. Monetary measures are in thousands of euros. The offshoring premia are computed from a model that includes industry fixed effects.

Finally, we focus on a finer measure of successful firms’ performance, called total factor productivity. Total factor productivity is the portion of a firm’s value-added that cannot be explained by the stock of assets held or the number of skilled or unskilled workers employed. For this part of the analysis, we compare the productivity of inputs' and final goods' offshorers with that of purely domestic producers, that is firms that neither export nor offshore. Overall, the number of domestic firms accounts for 23% of the sample, 13% in terms of total sales.

In the figure below, we draw graphs of the empirical (estimated) cumulative distribution functions of productivity for the three categories of firms we are interested in: the higher is the estimated average productivity for a particular category of firms, the lower is the corresponding graph of the distribution function.

Figure 1. Cumulative distribution function of total factor productivity for three types of firms

The figure shows that purely domestic firms are the least productive. Firms involved in inputs offshoring are at an intermediate productivity level, while firms involved in final goods offshoring are the most productive. What is driving these results? They could be explained in two different ways. The first is to consider that offshoring necessarily involves fixed costs (such as finding a foreign partner and/or setting up a foreign plant, fixing the details of the production process offshore in terms of technical and legal requirements, etc.) that only more productive firms are able to afford. Moreover, fixed costs associated with horizontal offshoring turn out to be higher than those associated to vertical offshoring since specific marketing activities are needed in the former case (such as advertising, searching local sales representatives abroad, etc.). The existence of these fixed costs then drives the offshoring decision. The second way of explaining our results is to posit that firms beginning to offshore at some point in time may then improve their efficiency as a consequence of this strategy. The exposure to international operations may actually benefit them, so that a process of “learning by offshoring” sets in. This process is stronger for firms that offshore final goods and weaker for firms that offshore inputs.
These two explanations of the link between productivity and offshoring could both be relevant. A rigorous assessment of this issue needs data with multiple observations of the same firms over time. This is an issue that we plan to concentrate on in future work.

Conclusions

The evidence we present in our study is a step in a broader research agenda that aims to understand the relation between international fragmentation of production and firms' performance. We show that different types of firms make different internationalization choices, based on a wide menu of complex strategies, and that there is considerable heterogeneity between domestic and offshoring firms, and among offshoring firms themselves, according to the production stage that is offshored. As stressed above, we think that this research matters for European trade policy. Knowing which firms are likely to gain and which are likely to lose from protectionist (or non-protectionist) measures is an important piece of information for the current policy-making debate.

References

(1) Mayer T. and G.I.P. Ottaviano (2007). “Europe’s superstar firms,” VoxEU, 7 November.
(2) “Barroso warns on protectionist pressures,Financial Times, 2 March 2008.
(3) An illustrative example is the one provided by the energy-saving bulbs’ trade dispute, that recently received considerable attention in the press. See, for instance: “Targetti to sue EU over light bulb tariffs,” Financial Times, 14 October 2007; and Onida F. (2008) Il fascino illusorio dei dazi contro la Cina. Il Sole 24 Ore, 7 March 2008.
(4) Daveri F. and C. Jona-Lasinio (2007). “Offshoring, not enough to beat Italy’s productivity slowdown,” VoxEU, 29 November.(5) Casaburi L., Gattai V., Minerva G.A. (2008) “Firms’ international status and heterogeneity in performance: Evidence from Italy,” Fondazione Eni Enrico Mattei Working Paper No. 3.2008 available at http://www.feem.it, and forthcoming in L. Lambertini, ed., Firms’ Objectives and Internal Organization in a Global Economy: Positive and Normative Analysis. Basingstoke: Palgrave Macmillan.

 

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Topics:  Productivity and Innovation

Tags:  manufacturing, offshoring, total factor productivity

Doctoral candidate in Economics, Harvard University

Post-doctoral researcher at Bologna University and lecturer at Bocconi University.

Assistant Professor of Economics at the University of Bologna