One of the main consequences of the process of globalisation is the increasing international fragmentation of production. This phenomenon is likely to have important implications for both the composition and the pattern of international trade.
International fragmentation of production leads to the establishment of international production networks, which are associated with trade in intermediates. Some recent studies have provided evidence of the growing importance of trade in intermediates (Campa and Goldberg, 1997; Yeats, 2001). From the data for the UK used in this paper it follows that total outsourcing in terms of value-added increase from 38% in 1984 to 53% in 1995, while outsourcing within the same industry increased from 11% to 16% over the same period.
However, fragmentation does not only affect the composition of international trade but may also change the pattern of trade. In the literature on fragmentation the main driving force behind outsourcing is the existence of differences in factor prices across national borders. Unskilled labour intensive stages of production tend to be shifted to unskilled labour-abundant developing countries, while more technologically advanced stages remain in skilled labour-abundant developed countries. As a result the increasing international fragmentation of production enhances the integration of developing countries in the world economy. Indeed for the UK the share of imports from developing countries over total imports increased from 18% to 22% over the period 1982-1996 indicating increased competition from low-wage countries.
It is, therefore, worth analysing the impact of fragmentation on labour markets and in particular on the skill structure of demand. Many have expressed the fear in developed countries that outsourcing will tend to reduce the demand for unskilled workers resulting in either falling relative wages or increased unskilled unemployment. However, from the theoretical literature it follows that this is not necessarily the case. Moreover, it is an empirical question whether outsourcing is a sufficiently large phenomenon in order to account for significant labour market effects.
This paper relates fragmentation to wage inequality as there still does not exist a consensus on the predominant source of the trend in wage inequality. Some argue that skill-biased technological change is responsible for the shift in the relative demand of skilled workers, others hold increased import competition from low-wage countries reducing employment for the unskilled responsible for the growing income divide within countries. Most empirical work indicates that technological change explains the lion’s share of the increase in wage inequality, although trade appears to play a significant role as well.
The purpose of this paper is to re-examine the trade-based explanation by focusing on international outsourcing in UK manufacturing. Outsourcing differs importantly from import penetration in final goods in the sense that it explicitly takes into account the extent to which firms move production activities abroad. Moreover, labour demand is not only affected in import competing industries, but in all industries that use foreign inputs. Hence, the impact of outsourcing may not be limited to changing labour demands between industries, but also affects the relative demand for labour within industries.
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