On a global scale wage differences are enormous across countries ranging from, for example, 1,10 € per hour in China to almost 28 € per hour in Germany (see, e.g. Sinn (2006)). Wage differences like this constitute a central explanation for the increasingly dominant business practice of international outsourcing across a wide range of industries. For example, Business Week (2003), Amiti and Wei (2004) as well as Rishi and Saxena (2003) refer to the huge difference in labour costs as the key explanation for the strong increase in outsourcing of both manufacturing and services to countries with low labour costs. However, the exploitation of the marginal cost advantages offered by production in low-wage countries typically requires that the firms make sunk investments into the establishment of networks of suppliers in the relevant low-wage countries.
In countries with strong labour market imperfections the labour unions, and sometimes citizens more generally, typically express deep concerns when facing the challenge of large-scale outsourcing. These concerns often seem to focus on the consequences of large-scale outsourcing for employment in high-wage countries. This is the topic of this article.
More precisely, we design a model to answer the following questions: What is the effect of a commitment to outsourcing on wage formation in an imperfectly competitive labour market where labour unions and firms negotiate over wages? What are the associated effects on equilibrium unemployment in a country with such labour market imperfections? We also explore the relationship between outsourcing and wage formation in the other direction, by asking: How does the presence of labour market imperfections in the high-wage country impact on the outsourcing incentives of firms? Will stronger labour market imperfections increase the optimal scale of outsourcing?
We find that the wage elasticity of labour demand is increasing as a function of the share of outsourcing, a result consistent with existing empirical research, as we will see below. Furthermore, within the framework of our model we show that a production mode with a higher proportion of outsourcing reduces the negotiated wage in the high-wage country with an imperfectly competitive labour market. For this reason outsourcing reduces equilibrium unemployment. Finally, we characterize the optimal production mode and show that stronger labour market imperfections lead to a production mode with a higher share of outsourcing.
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Equilibrium Unemployment with Outsourcing under Labour Market Imperfections
