Service imports, workforce composition, and firm performance

Andrea Ariu, Katariina Nilsson Hakkala , J. Bradford Jensen, Saara Tamminen 22 November 2019

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Global trade in goods increased dramatically between 1990 and 2017, leading to many empirical studies examining the impact of manufacturing imports on domestic labour markets (Feenstra and Hanson 1996, Autor et al. 2013, and Hummels et al. 2014 are three of them). Though starting from a lower level, World Bank development indicators report a six-fold increase in global service trade at the same time. The labour force in most developed economies works predominantly in the services sector, and tradable service industries are more skill-intensive in general than manufacturing (Jensen and Kletzer 2005, Gervais and Jensen 2019). As a result, there is increasing interest in the impact of service imports on job displacement, particularly among high-skilled workers. But detailed information on trade in services is limited, and so there is less research on the impact of service imports.1

In a recent paper (Ariu et al. 2019), we combine detailed information from Finland on firm-level imports of services with worker-level information on firms’ occupation and mix of skills to examine how firms adjust their labour force when they increase foreign sourcing of service inputs. We also investigate how these changes affect firm performance. 

Finland has uniquely detailed employment and trade data, which show that between 2002 and 2012 service imports rose from 7.4% to 12.3% of GDP (according to Statistics Finland). To put this in context, the famous China Shock that Autor et al. (2003) studied involved a relatively much smaller increase in US merchandise imports from China from 0.3% of GDP in 1990 to 2.2% in 2007, according to the US Bureau of Economic Analysis.

We could examine the impact of firm-level changes in service importing on the composition of a firm’s labour force because of rich, detailed information on Finnish firm-level accounts, service trade, and worker occupational and educational characteristics between 2002 and 2012. It provides an unusual level of detail on services trade, workforce composition, and a range of other firm-level measures. 

The rich data meant we could go beyond the usual distinction of blue or white-collar jobs, and low- or high-skilled workers, and identify the precise occupations affected by increasing service offshoring. We could link the transformation of the occupational structure of firm employment to changes in performance using a rich set of variables. 

How many, and which, firms import services? 

Figure 1 shows the number of firms (right-hand scale) and the share of firms (left-hand scale) that reported positive service offshoring, by industry. On average, only 3% of firms sourced intermediate services from abroad – and most of these were in the services sector. The category of 'Business services' accounts for most of them, followed by 'Wholesale and retail', 'Other services' and 'IT services'. The manufacturing sector had many service offshoring firms. Firms that produce goods need service inputs, and they actively sourced them from foreign markets. Thus, they were involved in service offshoring, and we provide results differentiating firms that belonged to the manufacturing and service sectors. The left-hand scale shows that services offshorers represented a small but non-negligible share of firms in their respective sector. For example, they represented 10% of the companies in the 'Paper and chemical' industries, and 8% in 'IT services'. 

Figure 1 Service import participation in Finland by industry, 2002-2012

Source: Ariu et al. (2019).

The number of service offshoring firms may have been small, but the firms themselves were large and important players in the economy. Service offshoring firms outperformed firms that did not offshore services, became more important in aggregate. Between 2002 and 2012, they accounted for 45% of revenues, more than 13% of employment and almost 20% of value added in Finland. 

The revenues generated by firms that imported service intermediates increased from 40% of all Finnish revenues in 2002 to almost 50% in 2012. They also had more employees, showed higher performance in terms of value added per worker, turnover, and capital intensity, and paid higher wages than the average. 

The employment effects of importing services

To estimate the consequences of increasing foreign sourcing of service inputs, we need to address the possible endogeneity of offshoring. That requires a variable correlated with a firm's decision to increase service offshoring, but uncorrelated with the firm's employment and performance changes. 

We could exploit shocks in the export supply of specific service-country pairs that were arguably exogenous to Finland, and allocate them to firms based on the relative importance of each service-country in the total service imports of the firm in the initial year in which it imported services.2

Service offshoring was associated with a reduction in the number of low-skilled workers and an increase in high-skilled workers. This implies that after offshoring, firms employed fewer clerks, personal and protective services workers, salespeople and customer services clerks, among others, but hired more managers. To provide a quantitative assessment of our results, we did a simple back-of-an-envelope calculation that ignores general equilibrium effects. An increase of 10% in the average level of service imports (this would be an increase of €660,000 on average) led to a firm employing 81 fewer low-skilled workers, but 91 more high-skilled workers. Given that the average firm employment in our sample was 418 workers, this is a large change in employment composition. 

For both manufacturing and services industries, service offshoring decreased the production of low-skilled services. The smaller scale of domestic service production can be associated with an increasing need for international coordination caused by increased service offshoring, and this might have led firms to increase the number of managers. For services firms however, the increase in the number and share of high-skilled employees could also also explained by an increase in the category of high-skilled professionals. As a firm increases its involvement in R&D-related activities, it needs more engineers, software developers, lawyers, architects, and scientists. For manufacturing firms, service offshoring can potentially represent just a cost-saving strategy, but for services firms it appears to have allowed them to perform more high-skill activities. 

The performance consequences of importing services

For firms in the services sector, skill upgrading due to offshoring led to a slightly bigger workforce and higher performance in terms of turnover, value of assets and services exports. Service offshoring offered these firms an opportunity to improve their performance by refocusing employment on R&D-related activities. 

Firms in the manufacturing sector could decrease the number of employees without any noticeable difference in the other performance measures. Service offshoring could be seen as a way to survive in highly competitive environments – exit rates for offshoring firms were 3%, against 7.5% for those firms that did not offshore. Indeed, we consistently find that importing service inputs was negatively associated with firm exit in both sectors. 

Conclusion

Our study highlights the opportunities for firms associated with the ability to source services intermediate inputs globally, and the potential challenges for workers, particularly low-skilled workers, as  labour demands change. The effects of services imports on low-skilled workers suggest we need public policies to facilitate and enable worker reallocation in response to the increasing international trade in services. 

On the other hand, the positive effects of services imports on firm survival demonstrate that when firms source inputs at the lowest cost, this is potentially important to competitiveness and survival. Those public policy responses to the challenges of service offshoring also need to recognise these benefits.

References

Amiti, M and S-J Wei (2009), "Service Offshoring and Productivity: Evidence from the US", The World Economy 32(2): 203–220. 

Ariu, A, J B Jensen, K Nilsson Hakkala, and S Tamminen (2019), "Service Imports, Workforce Composition, and Firm Performance", NBER working paper 26355.

Autor, D H, D Dorn, and G Hanson (2013), "The China Syndrome: Local Labor Market Effects of Import Competition in the United States", American Economic Review 103(6): 2121–68. 

Crinò, R (2010), "Service Offshoring and White-Collar Employment", Review of Economic Studies 77(2): 595–632. 

Eppinger, P S (2019), "Service Offshoring and Firm Employment", Journal of International Economics 117: 209–228. 

Feenstra, R C and G H Hanson (1996), "Globalization, Outsourcing, and Wage Inequality", American Economic Review 86(2): 240–245. 

Gervais, A and J B Jensen (2019), "The Tradability of Services: Geographic Concentration and Trade Costs", Journal of International Economics 104(7): 1942–78. 

Hummels, D, R Jörgensen, J Munch, and C Xiang (2014), "The Wage Effects of Offshoring: Evidence from Danish Matched Worker-Firm Data", American Economic Review 104(6): 1597–1629. 

Jensen, J B and L G Kletzer (2005), "Tradable Services: Understanding the Scope and Impact of Services Outsourcing", Peterson Institute for International Economics working paper WP05-9. 

Liu, R and D Trefler (2019), "A Sorted Tale of Globalization: White Collar Jobs and the rise of Service Offshoring", Journal of International Economics 118: 105–122. 

Endnotes

[1] Exceptions include Jensen and Kletzer (2005), Amiti and Wei (2005), Crino (2010), Liu and Trefler (2019) and Eppinger (2019).

[2] This approach exploits a strong empirical regularity in the data: firms tend to purchase the same service input from the same origin country. This means that trade relations are pre-determined and exogenous to over-time variation in firm employment and performance. Thus, we were able to use initial firm-service-origin country weights to distribute aggregate supply shocks that were exogenous to Finnish firms. This feature of service imports is similar to the evidence of a highly specialised sourcing structure for trade in goods presented in Hummels et al. (2014), and allowed us to identify the effect of service offshoring in a similar way.

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Topics:  International trade Labour markets Productivity and Innovation

Tags:  globalisation, services, trade, Finland

Assistant Professor, University of Milan

Chief Research Scientist, Research Institute of the Finnish Economy

Professor of Economics and International Business at the McDonough School of Business, Georgetown University

Leading specialist, Finnish Innovation Fund Sitra

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