Offshoring is a controversial aspect of globalisation, and its impact on source country welfare remains ambiguous. This column analyses the impacts of offshoring on local labour market outcomes in Japan. It finds that offshoring exposure led to higher local employment, and particularly for non-offshoring firms. Furthermore, offshoring helped mitigate the negative effects of Chinese import competition on manufacturing employment. It highlights the increase in production by domestic plants as a potential mechanism to explain the positive effects of offshoring.
One of the most controversial aspects of globalisation is offshoring, meaning the transfer of manufacturing operations and business functions overseas. While the simple Ricardo-Viner model, which is also known as the specific factors model, suggests that the international factor movement generally enhances welfare of both offshoring source and host countries, more general models indicate the ambiguous effect of offshoring: the welfare of the source country may fall (e.g. Acemoglu et al. 2015, Egger et al. 2015).
Based on this understanding, the public tends to dislike offshoring. In the US, for example, less than 2% of survey respondents consistently support it (Mansfield and Mutz 2013, Figure 1) because of the possible negative economic consequences. For instance, when firms relocate their production abroad, workers may lose their jobs. Such negative impacts go beyond workers and affect the local economy (Frieden 2019), having negative effects on workers in auxiliary companies and local suppliers, and causing decreases in local income and property values, which eventually leads to young people leaving the area, and the decline of social services (Rickard 2021). Nonetheless, "there is little agreement among academic economists regarding the sign of offshoring's effects on domestic labour market outcomes, let alone the magnitude" (Kovak et al. 2021: 381). However, the studies on the local labour market effects of offshoring exposure are still limited.
Based on this background, in a new paper (Kiyota et al. 2022) we investigate the impact of offshoring exposure on local labour market in the manufacturing sector in Japan. Figure 1 presents the changes in manufacturing employment and the share of foreign production to total production from 1995 to 2016 for Japan (Note 1). The figure indicates that, while manufacturing employment declined from 10.3 million to 7.6 million workers over the analysed period, the share of foreign production increased from 22.8% to 40.9% during the period. These observations imply that offshoring, as well as import competition, might lead to a decline in manufacturing employment.
It is also important to note that the effects of offshoring exposure could differ between the regions within a home country. Figure 2 presents the changes in manufacturing employment from 1995 to 2016 by urban employment area (UEA), which is the Japanese version of the metropolitan statistical area in the US and is widely used in urban economics studies. The green indicates a large positive change while the pink indicates a large negative change. This figure indicates the spatially uneven pace of the decline in employment in manufacturing. While some urban employment areas exhibit significant declines, others exhibit increases. Similar to the local labour market effect of import competition, the effect of offshoring exposure could be heterogeneous within a country.
To examine the local labour market effects of offshoring, we develop novel matched foreign affiliate-domestic/parent-domestic plant data in order to estimate the local labour market effects of offshoring exposure. This rich dataset enables us to measure both local-level employment and offshoring in a precise manner. Note that the foreign affiliates of manufacturing firms engage in both manufacturing activities (i.e. production) and non-manufacturing activities (e.g. sales, financing). To estimate the relationship between domestic and foreign production activities, we must exclude non-production activities from foreign activities. We thus focus only on the manufacturing activities of foreign affiliates owned by Japanese manufacturing firms, which we refer to as offshoring. In other words, we exclude the effects of foreign affiliates' non-manufacturing activities from the analysis.
Our sample period is 1995-2016, when the Japanese economy experienced a decline in manufacturing employment and an increase in offshoring. We define the local labour market as that at the level of the urban economic area. Urban economic areas provide a more plausible definition than jurisdictional areas, such as cities, because the labour market sometimes extends beyond jurisdictional boundaries, especially in urban areas with good public transportation.
Figure 3 presents the changes in offshoring from 1995 to 2016, by urban economic area. The green indicates a large positive change while the pink indicates a small positive change. This figure indicates that offshoring exposures are heterogeneous within a country.
Based on the matched foreign affiliate-domestic/parent-domestic plant data, we conduct more detailed statistical analysis by regressing the long difference of local manufacturing employment using offshoring exposure. We address the endogeneity in offshoring exposure by using shift-share instrumental variable approach. Note that the share of Chinese imports rapidly increased in our study period in Japan. As Autor et al. (2013) have shown, Chinese import exposure has a significant negative impact on local manufacturing employment. We also address this issue by introducing the Chinese import exposure in the manner of Autor et al. (2013) in our estimation equation.
The results indicate that, while imports from China negatively affect local manufacturing employment, offshoring exposure contributes to mitigating such negative effects. We find that a 10% increase in foreign manufacturing employment drives a 1% increase in local employment. We also found that offshoring exposure has a significantly positive effect on the employment of non-offshoring firms in the same local labour market. As a possible mechanism, we find the suggestive evidence that the production of domestic plants increases as a consequence of offshoring.
These results have important policy implications. Policies supporting firms' offshoring are sometimes controversial because they may negatively affect domestic employment. Our results suggest that this is not the case, even at the local labour market level. Indeed, offshoring manufacturing activities can mitigate the decrease in domestic manufacturing employment. Overall, our results indicate that offshoring positively affects local employment.
Editor’s note: The main research on which this column is based (Kiyota et al. 2022) first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan.
This article first appeared on www.VoxEU.org on May 31, 2022. Reproduced with permission.