Innovation Can Offset Negative Effects of Offshoring

INNOVATION CAN OFFSET NEGATIVE EFFECTS OF OFFSHORING

Innovation in information and communication technologies (ICT) and research and development (R&D) more generally can help to mitigate the negative effects of companies offshoring large parts of their production on a country’s economy. That is one of the findings of research by Ioannis Bournakis and colleagues, to be presented at the Royal Economic Society’s 2012 annual conference.

The study looks at company data from the US, Japan and several European countries between 1990-2005. It finds that an increase in the use of ICT in an economy not only favours the most technological intensive service sectors, but also traditional sectors such as textiles and basic metals. R&D, meanwhile, helps companies to specialise and compete more effectively in the global economy.

The research cites the example of Finland, which has particularly focused on boosting R&D. Finland has experienced fast growth in high-tech sectors such as the electrical equipment industry (around 6% per year).

The authors conclude:

‘Cuts to education and the innovative potential of a country can have serious long-term impacts not only on the competitiveness of a nation but also on the job prospects of workers, even the high-skilled.’

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Offshoring parts of production abroad is often blamed for job cuts in the domestic economy, particularly for less skilled workers. Less is known about the impact of offshoring on the industrial structure of the domestic country.

Offshoring is essentially trade in tasks and as such can increase production capabilities in the domestic economy, by releasing resources towards more productive and high-technology sectors, hence fostering the country’s comparative advantage.

The researchers test this by using industry data for the US, Japan and European countries for the period 1990-2005. They challenge the neoclassical view by showing that offshoring causes a reduction in the value added shares of both high-tech and low-tech manufacturing. In addition, the increasing trend in service offshoring also threatens the service industry, which has acted as a buffer for the decline of the manufacturing sector in developed economies.

The work also shows the importance of accounting for innovative capital inputs, such as investment in communication technologies (ICT) and R&D. An increase in the national endowment of ICT capital not only favours the most technological intensive service sectors, but also traditional sectors like textiles and basic metals.

R&D capital, either at the national or industry level, has a strong positive effect on specialisation. This implies that there can be beneficial effects from offshoring if more resources are invested in R&D and other innovative activities.

In fact, countries like Finland, which have particularly focused on boosting their R&D, have experienced fast growth in high-tech sectors such as the electrical equipment industry (6.2% over the period under investigation).

Hence cuts to education and in general to the innovative potential of a country can have serious long-term impacts not only on the competitiveness of a nation but also on the job prospects of workers, even the high-skilled.

ENDS