Outsourcing and the Political Economy of Globalization

1. Outsourcing and the Political Economy of Globalization Doug Nelson Tulane University & University of Nottingham

2. Two Observations: 1 • Outsourcing is an empirically significant phenomenon. • Intra-firm trade is large; • Trade in intermediate goods is large; • Vertical trade is large; and • Case studies at the industry level identify large outsourcing.

3. Two Observations: 2 • Our systematic knowledge about outsourcing and its effects is modest. • It is inherently internal to the firm and, thus, difficult to observe in aggregate data; • It is intimately related to trade, FDI and even migration • With respect to most theories of the firm, industry and economy, [in at least some aspects] outsourcing is transformative. • This interferes with inference in our standard theoretical and empirical frameworks.

4. Political Economy of Outsourcing, I; Direct Effects, A • Factor market effects: relative wages • Theoretically, effects are ambiguous; • Empirically, outsourcing appears to have somewhat larger effects than standard Stolper-Samuelson effects as estimated in mandated wage regressions. • But: • The methods in use are of dubious applicability; and • It is far from clear that the Heckscher-Ohlin (or Ricardo-Viner) model is the appropriate framework for analysis of the aggregate effects of outsourcing.

5. Political Economy of Outsourcing, I; Direct Effects, B • Factor market effects: equilibrium unemployment • Most research on globalization assumes full employment, but • Taking institutions as fixed, it is entirely possible that outsourcing affects the equilibrium unemployment rate (e.g. NAIRU). • This would certainly affect both welfare and political economy calculations, but • We’ve got nothing here.

6. Political Economy of Outsourcing, I; Direct Effects, C • I think that the evidence in favor of sizable links between equilibrium relative wage effects and political preferences and/or behavior are rather weak. • Much less studied, but finding strong evidence in ad hoc empirical work, is relatively short-run unemployment effects.

7. Political Economy of Outsourcing, I; Direct Effects, C [Adjustment Costs] • Why adjustment costs are important. They are: • individually large, • asymmetrically distributed, and • follow patterns systematically different from the long-run distributional effects. • These have strong individual effects that are imperfectly correlated with long-run relative wage effects. • These properties link strongly to fairness considerations that seem to be politically potent.

8. Political Economy of Outsourcing, II; Indirect Effects, A • Research on direct effects holds institutional structure constant and seeks to identify the distributional effects that are taken to be the foundation of policy preferences. • Research on indirect effects seeks to identify the effects of globalization on institutional structures that support the income distribution. • Consider the effects on unions and welfare state policies.

9. Political Economy of Outsourcing, II; Indirect Effects, B • Outsourcing and Unions • Unions are important to the modern political economy: • countries with encompassing labor market institutions have: • lower wage inequality (OECD, 1997); • lower unemployment (OECD, 1997); • higher growth (Calmfors, 1993; Danthine/Hunt, 1994); and • as unionization has declined, wage inequality has increased (Freeman, 1998). • Especially in the context of coordinated market economies, unions play an essential cooperative role (what Freeman and Medoff call “collective voice”).

10. Political Economy of Outsourcing, II; Indirect Effects, B (continued) • Outsourcing affects the union-firm relationship • Outsourcing improves the firm’s outside option, raising improving its outcome in most bargaining models. • Even the threat of outsourcing has this effect. • The presence of outsourcing in a sector may increase the competitiveness and lower profits available for sharing (of course it might also raise profits available to remaining core workers). • This increases the insider-outsider problem. • By reducing the payoff to union membership, globalization may trigger reductions in firm membership (and thus both bargaining and political influence).

11. Political Economy of Outsourcing, II; Indirect Effects, C • Outsourcing and Welfare State Policies • Welfare state policies play an important role in affecting the distribution of income in AICs. • Direct effects of progressive taxation and delivery of services; • Indirect effects by supporting union, and non-union, wage bargaining. • Outsourcing affects welfare states • Unions play a major role in the support of welfare state policies, if outsourcing weakens unions we would expect welfare state provision to be weakened. • To the extent that outsourcing worsens the insider-outsider problem, taxpayer support for welfare states may be weakened

12. Political Economy of Outsourcing, III; Alternatives to Preference-Induced Equilibrium, A • Endogenous policy theory has delivered considerably less in the analysis of trade policy than in other fields. • Unlike school bonds, there are very few referenda on trade; • Lobbying is not straightforwardly on firm or sector specific policy [protection is administered under rules] • Empirical work, e.g. Goldberg and Maggi, does a better job of identifying what we don’t know about than what we do (i.e. state ‘preference’ explains most of the level of trade restriction).

13. Political Economy of Outsourcing, III; Alternatives to Preference-Induced Equilibrium, B • There are no compelling, preference-induced accounts of the single biggest fact of contemporary trade policy: the mystery of missing protection. • To the extent that globalization is putting commitment to a Liberal international economic order at risk, we need to understand how big changes happen. • Cross-sectional variance in protection is clearly of second-order importance.

14. Political Economy of Outsourcing, III; Alternatives to Preference-Induced Equilibrium, C • The standard model assumes that preferences are: • fixed, and • determined by factor-ownership. • A first step would be to try to determine how trade policies are evaluated. • Link to research on sociotropic voting; and • Development of positive political economy of fairness. • How are these linked to preferences of politicians?