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The Effects of Outsourcing on the Elasticity of Labor Demand

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Mine Zeynep Senses

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Abstract

In this paper, I focus on the effects of outsourcing on conditional labor demand elasticities. I begin by developing a model of outsourcing that formalizes this relationship. I show that the increased possibility of outsourcing (modeled as a decline in foreign intermediate input prices and an increase in the elasticity of substitution between foreign and domestic intermediate inputs) should increase labor demand elasticities. I also show that, a decline in the share of unskilled labor, due either to skill biased technological change or to movement of unskilled labor intensive stages abroad, can work in the opposite direction and reverse the increasing trend in elasticities. I then test the predictions of the model using the U.S. Census Bureau’s Longitudinal Research Database (LRD). The instrumental variable approach used in the estimation of labor demand equations is the main methodological contribution of this paper. I directly address the endogeneity of wages in the labor demand equation by using average nonmanufacturing wages for each location and year as an instrumental variable for the plant-level wages in the manufacturing sector. The results support the main predictions of my model. U.S. manufacturing plants operating in industries that heavily outsource experienced an increase in their conditional labor demand elasticities during the 1980-1992 period. After 1992 elasticities began to decrease in outsourcing industries. This finding is consistent with the model which suggests that a decline in the share of unskilled labor in total cost could result in such a decrease in labor demand elasticities, precisely when the level of outsourcing is high. Estimates at the two-digit industry level provide further evidence in support of the hypothesis that heavily outsourcing industries experience greater increases in their elasticities.

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Paper provided by Center for Economic Studies, U.S. Census Bureau in its series Working Papers with number 06-07.

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Date of creation: Mar 2006
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  1. Erkki Koskela & Rune Stenbacka, 2007. "Equilibrium Unemployment with Outsourcing and Wage Solidarity Under Labour Market Imperfections," IZA Discussion Papers 2733, Institute for the Study of Labor (IZA). [Downloadable!]
  2. Christopher Johann Kurz, 2006. "Outstanding Outsourcers: A Firm- and Plant-Level Analysis of Production Sharing," Working Papers 06-02, Center for Economic Studies, U.S. Census Bureau. [Downloadable!]
  3. Erkki Koskela & Rune Stenbacka, 2007. "Equilibrium Unemployment with Outsourcing and Wage Solidarity under Labour Market Imperfections," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  4. Koskela, Erkki & Poutvaara, Panu, 2008. "Outsourcing and Labor Taxation in Dual Labor Markets," IZA Discussion Papers 3522, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  5. Koskela, Erkki, 2008. "The Effects of Labour Tax Progression under Nash Wage Bargaining and Flexible Outsourcing," IZA Discussion Papers 3501, Institute for the Study of Labor (IZA). [Downloadable!]
  6. Erkki Koskela & Rune Stenbacka, 2007. "Equilibrium Unemployment with Outsourcing under Labour Market Imperfections," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
  7. Michael Hübler, 2007. "A Simple Model of Outsourcing with Cournot Competition," Kiel Working Papers 1320, Kiel Institute for the World Economy. [Downloadable!]
  8. Koskela, Erkki & Schöb, Ronnie, 2008. "Outsourcing of Unionized Firms and the Impact of Labor Market Policy Reforms," IZA Discussion Papers 3566, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
  9. Christopher Johann Kurz, 2006. "Outstanding outsourcers: a firm- and plant-level analysis of production sharing," Finance and Economics Discussion Series 2006-04, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  10. Torben M. Andersen & Allan Sørensen, 2008. "Globalisation squeezes the public sector - is it so obvious?," Economics Working Papers 2008-08, School of Economics and Management, University of Aarhus. [Downloadable!]
  11. Koskela, Erkki & Poutvaara, Panu, 2008. "Flexible Outsourcing and the Impacts of Labour Taxation in European Welfare States," IZA Discussion Papers 3699, Institute for the Study of Labor (IZA). [Downloadable!]
  12. Erkki Koskela & Rune Stenbacka, 2007. "Equilibrium Unemployment with Outsourcing under Labour Market Imperfections," IZA Discussion Papers 2628, Institute for the Study of Labor (IZA). [Downloadable!]
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