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In or Out: How Insourcing Foreign Input Production Affects Domestic Production

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Abstract

When a firm imports inputs from foreign countries, the management faces two options: buying from unaffiliated firms or insourcing the foreign production. This paper suggests that this decision directly affects domestic production because international insourcing affects the operational flexibility and the firms’ opportunities for accessing knowledge and capabilities developed abroad. Empirical results based on firm-level data of Swiss firms confirm this hypothesis. Concretely, the insourcing of international production increases domestic productivity, decreases (at least in the short run) domestic employment and possibly investments. In line with transaction cost literature, we observe that contractual hazards moderate these effects.

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Notes

  1. In some of the literature, the term outsourcing is used for all imports, i.e. for all types of international activities that are external to the domestic firm. In order to avoid confusion, this paper uses the term international outsourcing only for international activities that are external to the firm, i.e. imports that stem from unaffiliated foreign firms. International activities as a whole is denoted as offshoring.

  2. While this insight allows us to formulate hypotheses regarding the relationship between international insourcing share and domestic production, we remain agnostic regarding the relative magnitude of the two potential channels.

  3. According to OECD statistics, Switzerland has the largest manufacturing value added share of high-tech products among European countries (2010: 62.5 vs. 61.4% in Germany and 54.2% in Denmark). Also the export share of high-tech products is the highest among European countries (2013: 48.9%). This share has increased significantly since 2000 (from 32.3 to 48.9%), which can be interpreted as a hint that less complex production in low-tech industries has been relocated at a large extent to foreign destinations. This is in accordance with the decrease of the value added share of low-tech industries such as textiles, cloth and food industry in the last 15 years. The Swiss economy has also a large value added share of knowledge-intensive service industries such as financial services, computer services, and engineering, so that the entire knowledge-intensive sector of the economy amounted 2010 to 48.6% of business sector value added (Germany 50.2; USA 52.6%).

  4. In countries where firms with less specific assets dominate, it is likely that the effect goes in the opposite direction. Based on data for Spanish SMEs Rodríguez and Nieto (2016) for example find that international insourcing of R&D shows a significantly lower effect on sales growth than international outsourcing of R&D.

  5. The questionnaire is available in German, French and Italian on http://www.kof.ethz.ch/en/surveys/structural-surveys/other-surveys/survey-internationalisation-swiss-economy-2010/.

  6. In order to ease the interpretation of coefficients, the original ordinal variable enters as the log of the midpoint of each category of the ordinal scale (0, 3, 8, 13, 18, 25.5, 35.5, 45.5, and 75.5%). Using alternatively the original ordinal variable (1–9) or dummy variables indicating whether insourced imports is zero, low (1–20%) or high (21–100%), yield qualitatively similar results. These results can be obtained from the authors upon request.

  7. This information stems from a prior survey of the firm conducted in 2009 in the course of the KOF Innovation Survey (for more information, see https://www.kof.ethz.ch/en/surveys/structural-surveys/innovation-survey/). This information was used to construct industry averages of price and non-price competition on the three-digit industry level (NACE Revision 2).

  8. Estimating a model with firm fixed effects is not possible because we observe international insourcing share in 2008 only.

  9. While these estimates require dropping the industry dummies, they continue to account for unobserved heterogeneity across firms by including the lagged dependent variable.

  10. The results remain qualitatively the same when we additionally control for the firms’ R&D activities abroad to capture a potential correlation between contractual hazards of production at home and abroad.

  11. Rodríguez and Nieto (2016) argue that international outsourcing is linked to greater flexibility than international insourcing and they find some evidence for their prediction for Spanish SMEs, i.e. they find that international insourcing of R&D shows a significantly lower effect on sales growth than international outsourcing of R&D. This finding is in accordance with aggregated data that indicate that the average contractual hazards are lower for the average Spanish than for the average Swiss firm. An alternative explanation could be that the composition of the samples of firms used in the Spanish and Swiss study is quite different. While Rodríguez and Nieto (2016) focus on SMEs only, our sample entails the full population of firms. However, preliminary analysis suggests that our qualitative results hold for both small and large firms, though the sample reduction renders some coefficient estimates insignificant.

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Acknowledgements

We thank the State Secretariat for Economic Affairs (SECO) for financial support and the participants of the conference on Leading Issues in International Trade and Finance as well as three anonymous referees for useful comments and suggestions.

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  1. ETH Zurich, KOF Swiss Economic Institute, Zurich, Switzerland

    Spyros Arvanitis & Thomas Bolli

  2. University of Jyväskylä, Jyväskylä, Finland

    Tobias Stucki

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  1. Spyros Arvanitis
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Correspondence to Thomas Bolli.

Appendix

Appendix

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Table 5 Summary statistics
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Table 6 Correlation matrix
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Arvanitis, S., Bolli, T. & Stucki, T. In or Out: How Insourcing Foreign Input Production Affects Domestic Production. Manag Int Rev 57, 879–907 (2017). https://doi.org/10.1007/s11575-017-0322-2

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