Offshoring and Firm Performance: Evidence from the Italian Manufacturing Industry

• Published date: 01 February 2014
• Date: 01 February 2014
• DOI: http://doi.org/10.1111/rode.12067

Offshoring and Firm Performance: Evidence from

the Italian Manufacturing Industry

Ida D’Attoma and Silvia Pacei*

Abstract

The fundamental question of whether offshoring is value enhancing and, more specifically, whether

Italian manufacturing firms that undertake offshoring benefit from higher productivity and profitability is

explored. Using data from the tenth wave of the “Survey on Manufacturing Firms” conducted by

Unicredit-Capitalia, it was found that, compared with domestic firms, firms relocating activities to a

foreign country have different characteristics, and “better” firms might self-select into offshoring decision.

To disentangle the effect of offshoring on firms’ performances from the effect of firm characteristics,

several variants of propensity score matching are used. A mild and insignificant positive effect of

offshoring on profitability was found and also evidence of a statistically significant positive effect of

offshoring on productivity.

1. Introduction

The phenomenon of geographically fragmented production processes has increased

without precedent over the years 1990–2010 because information and communica-

tion technologies (ICTs) have made it possible to divide the value chain and

perform activities in any location (Grossman and Helpman, 2005), while the con-

tinuous decline of transportation costs has facilitated the worldwide flow of goods.

The “globalisation of the value chain” involves the physical fragmentation of pro-

duction and is motivated by a number of factors. One motivating factor is the desire

to reduce operating costs by sourcing inputs from more efficient producers, either

domestic or international, either within or outside the boundary of the firm. Other

factors include the wish to enter emerging markets and access strategic assets that

can help tap into foreign knowledge and the opportunity to exploit fiscal or legal

benefits. The fragmentation of production, notwithstanding the obvious benefits it

offers, also involves costs and risks for those firms involved. Indeed, it gives rise to

considerable business restructuring, including the “offshoring” or “international out-

sourcing” of certain functions (Organisation for Economic Co-operation and Devel-

opment (OECD), 2007).

The phenomenon of offshoring dates back to the beginning of the 1970s, when it

involved economies characterized by large-scale enterprises and relatively high labor

costs, such as those of the USA (Levitt, 1983). In the actual period, the increasing

level of competition in international markets has also compelled manufacturing firms

in countries with salaries below those of the USA, such as Italy, to take advantage of

lower production costs abroad. This was initially true for the largest firms, but it is

now also true for small- and medium-sized firms, which represent the majority of

* D’Attoma: Department of Statistical Sciences, University of Bologna, via Belle Arti 41-40126, Bologna,

Italy. Tel: +39-051-2094613; Fax: +39-051-232153; E-mail: Ida.dattoma2@unibo.it. Pacei: Department of

Statistical Sciences, University of Bologna, via Belle Arti 41-40126- Bologna, Italy.

Review of Development Economics, 18(1), 29–44, 2014

DOI:10.1111/rode.12067

© 2014 John Wiley & Sons Ltd

manufacturers in a country such as Italy and have proven capable of splitting up the

production cycle without incurring any substantial diseconomies (Mariotti et al.,

2008). International outsourcing has emerged as a new type of trade in the years

1990–2010 and today trade in intermediate products is more important than trade in

finished products, so that the expression “Made in X” should be replaced by a more

appropriate term “Made in X, Y and Z” or disappear altogether (Kierzkowski and

Chen, 2010).

Various theories have been posited regarding offshoring. The transaction costs ana-

lytical framework, however, represents the main theoretical reference and concen-

trates on the trade-off between costs and benefits associated with different forms of

governance, such as markets, hierarchies (firms), and hybrids (or subcontracting net-

works). According to transaction costs economic theory, offshoring is attractive only

when transaction costs incurred from asset specificity, incomplete contracting and

search efforts are lower than the production costs advantage (Williamson, 1975). In

general, offshoring may have a number of sometimes unexpected effects on the

organization of production, trade flows and international specialization and on the

distribution of income and labor markets, and these effects may vary across activities,

regions and social classes. A particular strand of the literature has focused on how

outsourcing affects growth paths, modifies the production function and hence skill

premium in developed and developing countries, in the theoretical ground of the

classic Heckscher–Ohlin model of intermediate trade (Hu et al., 2005; Sayek and

S¸ ener, 2006; Tang, 2012).

The relationship between offshoring and firms’ productivity has been studied by

international production theorists. The results show that higher international

involvement tends to be associated with higher productivity at any given level of

corporate innovativeness, as gains typically arise from the exploitation of the com-

parative advantages and economies of scale offered by external suppliers (Grossman

and Helpman, 2005). Goods and services may be more efficiently produced in

another country and, consequently, imported at a lower price. This access to better,

cheaper and more varied (final and intermediate) inputs helps improve firms’ prod-

uctivity. In addition, by offshoring, firms may focus on their core skills and thus

increase their level of innovation. Several studies (Hijzen, 2006; Castellani and

Zanfei, 2007; Olsen, 2006) have found a positive correlation between productivity,

outsourcing, R&D expenditures and, hence, innovation processes. Nevertheless, the

sign and the size of the effect of offshoring on companies’ accounting figures have

seldom been studied in a systematic, in-depth manner (Olsen, 2006). One reason for

this is that these variables can only be revealed by empirical studies conducted at

the firm level, and it is generally rather difficult to measure offshoring, as firms are

sometimes reluctant to offer details on their offshoring policies (OECD, 2007) and

public surveys necessary to measure offshoring are only available in few OECD

countries (Daveri and Jona-Lasinio, 2008). Because of the lack of appropriate data

on shifted activities, measures of offshoring are often based on trade flows, i.e. a

consequence of offshoring rather than the shift of the activity itself. Imported inter-

mediates ignore causes of offshoring that do not give rise to imports and include

imports that are not the result of offshoring. In addition, focusing on intermediates

implies leaving out cases where the final stage of the production process is offshored

(Michel and Rycx, 2012). Moreover, imported intermediate inputs considered in

value terms are a biased measure of offshoring if activities are offshored because

imported intermediate inputs are cheaper than domestically produced intermediate

inputs (Michel and Rycx, 2012).

30 Ida D’Attoma and Silvia Pacei

© 2014 John Wiley & Sons Ltd