The ICT revolution and the international organisation of the firm

Sergi Basco, Martí Mestieri 05 October 2013

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The Information and Communication Technology (ICT) revolution has changed how goods and services are produced. ICT has rendered some jobs obsolete while spurring the creation of new ones (Autor et al. 2003). Moreover, they have transformed the organisation of production itself. The ICT revolution has enabled a finer degree of specialisation in the production process, allowing it to be more fragmented than in the past, a phenomenon coined by Baldwin (2006) as the “Second Great Unbundling”.

From an international trade perspective, this unbundling has allowed countries to compete in very narrowly defined segments of the production process. In the past, international trade was carried mostly at the product level (think of wine for cloth, or Fords for BMWs). Now competition can happen at a much finer level. ICT make possible, in some cases, for competition to occur at the level of the tasks performed by workers. This has led to the offshoring of some production stages, as opposed to the entire production process.

This unbundling has allowed firms to exploit countries' comparative advantages to a greater extent than in the past. As a result of this fragmentation, some emerging countries have joined the supply chain of multinational firms at different stages of the production process (Baldwin, 2012). The flip side of this unbundling process is that some stages of production are not being done in rich countries anymore, since these jobs are exposed to global competition (Blinder, 2006). Some jobs which were considered non-tradeable before (for example, telephone operators or data entry) are now being offshored. New theoretical frameworks have been proposed to study these effects.1

New research: The ICT revolution and the international organisation of the firm

Our recent research explores the economic logic of how this new wave of globalisation can generate novel distributional effects among workers (Basco and Mestieri 2013a). The distributional effects of this new globalisation process can be quite different. While traditional north-south trade tended to increase wage inequality in both northern and southern countries, the offshoring induced by the ICT revolution generates wage polarisation in rich countries.2 Moreover, we show that there is a complementarity between these two types of trade, wage polarisation being delayed by the volume of traditional trade.

In order to reap the benefits of unbundling production, firms have also changed the organisation of global supply chains.3 One possible channel through which ICT have affected the incentives of multinationals to reshape their supply chains is the fall in monitoring costs. Software like Enterprise Resource Planning has allowed headquarters to acquire relevant information of the production process in real time and, thus, better monitor production (Bloom et al., 2011). This idea is illustrated by the following quote from The New York Times (March 19, 2011).

" ... supply lines are longer and far more complex than in the past. The ability to manage these complex networks, experts say, has become possible because of technology — Internet communications, RFID tags and sensors attached to valued parts, and sophisticated software for tracking and orchestrating the flow of goods worldwide.."

ICT, international mergers and global value chains

In our new work, we analyse how the ICT revolution has affected the incentives of firms to engage in cross-border mergers and acquisitions (M&As) (Basco and Mestieri, 2013b). We focus on cross-border M&As because they represent a large and growing fraction of foreign direct investment and, yet, little is known about their determinants.

The premise of our analysis is that the ICT revolution has reduced the costs of monitoring some of the tasks required for production. Since different industries require different bundles of tasks, the reduction in monitoring costs made possible by the ICT revolution has been heterogeneous across industries. How the ICT revolution has affected M&As is a priori ambiguous, as it depends on the distribution of monitoring cost reductions across industries and alternative organisational forms.

In order to investigate this question, we develop a task-based model of organisational choice of upstream production with agency problems. We assume that the ICT revolution has expanded the set of tasks which can be easily monitored. This assumption implies a complementarity between the ICT revolution and monitoring costs; traditionally harder-to-monitor industries receive relatively more M&As.

Empirical analysis

To give empirical content to the notion of hard-to-monitor industries, we use the routine task index developed by Autor and Dorn (2009). An industry is defined as routine-intensive when the average task performed in that industry requires relatively tight and standardised procedures. Accordingly, we argue that it is more difficult to monitor production in industries with less standardised tasks.

We focus our empirical analysis on vertical north-south M&As (where northern countries are defined as having 50% or more than the US income per capita). The reason is that agency problems are more prevalent when a supplier is located in the south, while they are much less important in the north. We obtain data on mergers from SDC Thompson Platinum, which is the most comprehensive data set publicly available. A merger is classified as vertical if the four-digit SIC of the target and acquirer firms are different and if these industries are linked through the 1997 direct requirements US Input-Output table. We use internet adoption as a proxy for the ICT infrastructure in a given country.

We start by presenting evidence consistent with two empirical predictions of our model. First, we show that harder-to-monitor industries tend to have fewer M&As. Second, we show that, as ICT diffuse within a country, the set of industries receiving M&As expands towards harder-to-monitor industries.

Consistent with the complementarity implied by our model:

  • We show that the effect of the adoption of ICT on the number of M&As is decreasing with the routine intensity of the industry.

Our interpretation is that, in southern countries with low ICT adoption, northern headquarters find it optimal to acquire a firm only in very routine-intensive industries, where monitoring problems are of little importance. However, in southern countries with more ICT adoption, northern headquarters will also find it optimal to acquire in less routine-intensive industries, because the adoption of ICT reduces monitoring costs.

Quantitatively, we find that if ICT adoption in a southern country raises from the 25th to the 75th percentile of the distribution – ceteris paribus – the increase in the number of mergers in a low routine-intensive industry (e.g., non-metallic products) would be 29% higher than in a high routine-intensive industry (e.g., computer and electronics).

Our result is robust to using adoption of Enterprise Resource Planning (ERP) Systems as an alternative measure of monitoring problems. We find that the effect of IT adoption on the number of M&As is larger in industries with lower use of ERP (i.e., more monitoring problems). Since the adoption of ERP software is endogenous, we also use an instrumental variable approach. We obtain the same results when we instrument the adoption of ERP systems with the routine-intensity of the industry.

Concluding remarks

Our research has taken a first step towards understanding how the ICT revolution has changed the global supply chain. Our analysis focuses on cross-border mergers and acquisitions, which make up a large fraction of foreign direct investment. We document a complementarity between the hardness-to-monitor of target industries and ICT adoption of the host country. ICT adoption increases the number of mergers in harder-to-monitor industries to a relatively greater degree. These results suggest that ICT appears to be a channel through which southern countries may climb rungs in the global supply chain ladder; when southern countries invest in ICT technologies, they gain comparative advantage in harder-to-monitor industries, which tend to be more skill-intensive.

References

Autor, D and D Dorn (2009), “This Job Is “Getting Old”: Measuring Changes in Job Opportunities Using Occupational Age Structure,” American Economic Review Papers and Proceedings, 99(2).

Autor D H, L F Katz and M S Kearney (2008), “Trends in US Wage
Inequality: Revising the Revisionists”, The Review of Economics and Statistics, 90(2).

Autor D H, F Levy and R J Murname (2003), “The Skill Content of Recent Technological Change: An Empirical Exploration”, Quarterly Journal of Economics, 118(4), November.

Baldwin, R (2006), “Globalisation: the great unbundling(s)” in Globalisation challenges for Europe, Secretariat of the Economic Council, Finnish Prime Minister’s Office, Helsinki.

Baldwin, R (2012), “Global Supply Chains: Why They Emerged, Why They Matter, and Where They are Going”, CTEI Papers, CTEI-2012-3.

Baldwin, R and F Robert-Nicoud (2007), “Offshoring: General Equilibrium Effects on Wages, Production and Trade”, National Bureau of Economic Research Working Paper 12991.

Basco, S and M Mestieri (2013a), “Heterogeneous trade costs and wage inequality: A model of two globalizations,” Journal of International Economics, Elsevier, vol. 89(2).

Basco, S and M Mestieri (2013b) “Deconstructing International Mergers: Information Technologies and Routineness”, TSE Working Paper, n. 13-428, July 2013.

Bloom N, L Garicano, R Sadun and J Van Reenen (2011), “The Distinct Effects of Information Technology and Communication Technology on Firm Organization”, CEP Discussion Paper No 927.

Blinder, A. S., (2006), “Offshoring: The next industrial revolution?,”, Foreign Affairs.

Goos, M and A Manning (2007), “Lousy and Lovely Jobs: The Rising Polarization of Work in Britain”, The Review of Economics and Statistics, 89(1).

Grossman, G M and E Rossi-Hansberg (2008), “Trade in Tasks: A Simple Theory of Offshoring”, The American Economic Review, 98(5).


1 See, for example, Baldwin and Robert-Nicaud (2007) and Grossman and Rossi-Hansberg (2008).

2 Wage polarisation is defined as the decline in the relative wage of middle-to-low-skill workers together with the increasein the relative wage of high-skill workers. Goos and Manning (2007) and Autor et al. (2008) documented the emergence of wage polarisation in several OECD countries in the early 1990s. The leading explanation in the labour literature is the computerisation of the production process. Our paper offered the expansion of ICT-driven trade as an alternative explanation.

3 See for example, Baldwin (2012) and Bloom et al. (2011).

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Topics:  Global economy Industrial organisation International trade

Tags:  global value chain

Economist in the Research Department, La Caixa

Assistant Professor, Toulouse School of Economics

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