Offshoring of white-collar jobs: Theory and evidence

Klimek, Artur Article Offshoring of white-collar jobs: Theory and evidence International Journal of Management and Economics Provided in Cooperation with: SGH Warsaw School of Economics, Warsaw Suggested Citation: Klimek, Artur (2021) : Offshoring of white-collar jobs: Theory and evidence, International Journal of Management and Economics, ISSN 2543-5361, Sciendo, Warsaw, Vol. 57, Iss. 1, pp. 69-84, https://doi.org/10.2478/ijme-2021-0003 This Version is available at: https://hdl.handle.net/10419/309729 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/4.0/ International Journal of Management and Economics 2021; 57(1): 69–84 Artur Klimek* Offshoring of white-collar jobs: theory andevidence1 https://doi.org/10.2478/ijme-2021-0003 Received: July 26, 2020; accepted: December 15, 2020 Abstract: Foreign direct investment (FDI) in advanced business services (ABSs), referred to here as the offshoring of white-collar jobs, has become one of the major developments in the operations of multinational corporations (MNCs). However, a specific theoretical approach to this phenomenon has not been adequately defined. In this article, we have two objectives. The first objective is to outline the key elements of the theoretical framework and introduce a simple formal model for business services within MNCs. The second objective is to verify the assumptions of the model in the empirical part. We use the sample of the largest European companies having foreign affiliates. Special attention is paid to Visegrád economies (i.e. Czech Republic, Hungary, Poland, and Slovakia) as host economies. We applied here a multinomial logistic model, which indicates the probability of having an ABS subsidiary taking into consideration the characteristics ofMNCs. Keywords: advanced business services, Europe, foreign direct investment, multinational corporation JEL Classification: F21, F23 1 Introduction Business services create a distinctive group within the broad sector of services. Moreover, business services are far from being homogenous. A very important category of business services is advanced business services (ABSs), which are defined here as relying heavily on knowledge and professional expertise. From the business perspective, forms of ABS are as follows: business process outsourcing (BPO), shared service centers (SSCs), information technology outsourcing (ITO), and research and development (R&D) centers. These services are also labeled as modern business services. The important characteristics of ABS are also their high levels of standardization and tradability. Therefore, many tasks can be provided from distant locations, thus increasing the propensity of firms toward offshoring of white-collar work [Metters, 2008]. The topic of offshoring is relevant both for advanced and emerging economies [Feenstra and Hanson, 1992; Ebenstein et al., 2014]. The transfer of white-collar tasks may alter the business structure in both groups of countries and influence their economic performance. As a consequence, this type of offshoring has attracted a lot of attention of economists and policymakers; however, developments within multinational corporations (MNCs) have not been directly associated with the phenomenon. Indeed, offshoring of whitecollar services has been introduced and expanded chiefly by MNCs as a part of the global configuration 1 Earlier versions of the paper were presented during the ETSG 2017 Conference, which was conducted in Florence (Italy); the Göttinger Workshop “Internationale Wirtschaftsbeziehungen” 2018, which was conducted in Göttingen (Germany); the European International Business Academy Workshop 2018, which was conducted in Budapest (Hungary), and the Conference on International Economics 2018, which was conducted in Vila-real (Spain). Empirical Paper *Corresponding author: Artur Klimek, Wroclaw University of Economics and Business, Wroclaw, Poland. E-mail: artur.k[email protected].pl Open Access. © 2021 Klimek, published by Sciendo. This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivs 4.0 License. 70 A. Klimek of their operations. The inclusion of MNCs in the analysis is crucial, since they frequently dominate many industries and economies. The role of services in an economy and its tertiarization have been frequently pronounced in macroeconomics. Moreover, services have become a key element of business strategies through digitization and servitization of manufacturing [Martín-Peña et al., 2019]. However, the role of knowledge-intensive services within firms, especially MNCs, has not been sufficiently defined. The mainstream models of MNC-type operations assume the following two types: headquarters activities and manufacturing activities [Grossman et al., 2006]. We argue that to make the picture complete, an additional category of activities should be included—advanced business services. They are related both to the headquarters and the production, and for this reason they can be perceived as providing a link between these two operations. Most theories and models of MNCs have predominantly focused on manufacturing operations. Thus, the role of business services was on the margin of the discussion and was subordinated to the production function. In our opinion, the distinction of services is necessary due to the changing nature and geographic structure of global value chains (GVCs). In many cases, MNCs have their headquarters in a developed country, manufacture in a developing country, and locate services either in a developed or in a developing country. The ABSs are also very dynamic. Automation and artificial intelligence are rapidly changing services. Therefore, ABSs require a new treatment from the theory of a firm, since they became a central part of every advanced organization. In this article, we have two objectives. The first objective is to outline the key elements of the theoretical framework and introduce a simple formal model for business services within MNCs. The second objective is to verify the assumptions of the model in the empirical part. We use a sample of the largest European companies having foreign affiliates. This is one among few attempts to analyze affiliates with respect to their core and support roles. Special attention is paid to Visegrád economies (i.e., Czech Republic, Hungary, Poland, and Slovakia) since they have recently become attractive locations for offshoring of business services with hundreds of thousands of jobs having been created. To the knowledge of the author, this is one of the first attempts to analyze the operations of MNCs with respect to their ABS activities. We applied here a multinomial logistic regression approach, which indicates the probability of having an ABS subsidiary considering the characteristics of MNCs. In other words, we define the factors influencing decision-making in relation to offshoring of white-collar jobs. The novelty is also focusing on services’ subsidiaries in two types of economies: advanced and emerging. The remainder of the article is organized as follows. Section 2 delivers a review of previous contributions in the field of determinants of ABS; Section 3 contains a simple model of an MNC; Section 4 contains data description; Section 5 delivers the outline of an econometric strategy; Section 6 contains results of the analysis; and Section 7 delivers concluding remarks. 2 Previous theoretical and empirical contributions White-collar services have been rather neglected in the theory of international trade or MNCs. Even though an indirect approach to ABSs could be derived from some theories, they do not explicitly model those complex activities. Among the few attempts to model service activities of MNCs, the approach of Markusen and Strand [2009] has been particularly relevant. They prepared a theoretical model in which an earlier explanation of international production by MNCs has been enhanced with service activities. They are based on the knowledge-capital model by Carr et al. [1998]. The first insights into the international configuration of MNCs were provided by Markusen [1997]. His original model assumed that knowledgeintensive services of MNCs may be separated from production, and that knowledge capital is skilled-labor intensive relative to production and can be supplied to additional production facilities at low cost. This prepared the ground for analyzing services in isolation from production activities. The model of Markusen and Strand [2009] considered different types of barriers to trade and establishing a commercial presence in services. Two main groups of barriers to trade in services were identified in their approach: “natural” Offshoring of white-collar jobs 71 economic costs and “policy-imposed” costs. They influenced the viability of operations in services on the international scale. The complex operations of MNCs in various international configurations were explained by Yeaple [2003] and Grossman et al. [2006]. They proposed a more detailed explanation of MNCs’ activities. However, they all focused on enterprises which were found to be active in the production and this was the subject of the international division of labor. They did not take into account services that are essential in every MNC. Grossman and Rossi-Hansberg [2008] advanced the theoretic discussion regarding international division of tasks within the GVC. They also took into consideration trade in business services. Ray [2012] extended their model and considered manufacturing operations as being prior to complementary services. In this approach, services were subordinated to manufacturing. An additional element that has been taken into consideration when analyzing the development of the service sector is the liberalization of the service trade, which influences the welfare of home and host economies. Export-platform approach to MNCs might be also relevant here [Ekholm et al., 2003]. Indeed, most SSC/ BPO units in emerging Europe export their services to the headquarters in advanced economies or other units of MNCs anywhere in the world. Frequently, the reach is greater than the home region. We can notice that many ABS subsidiaries are global providers of specialized services within MNCs. On the basis of these observations, we can conclude that ABSs are mostly exported and only a small fraction is consumed in the country of origin by the other units of an MNC. For example, just after the collapse of the iron curtain, many Western European firms established production subsidiaries in Eastern Europe. The operations are still continuing in spite of the rising production cost. Moreover, many Western companies in the middle of the 2000s started establishing service units in emerging Europe. Thus, the former units provide services for production units in both groups of countries. Some argued that it is possible to separate information from physical manufacturing operations [Evans and Wurster, 1999]. In this sense, the advanced services can increase the fragmentation of GVCs. This also requires an additional assumption in economic modeling of white-collar workers’ offshoring. The tasks can be executed remotely and the distance plays almost no role. This also leads to the possibility of organizing global service centers, which consolidate operations of many separate units in the world. The idea is to develop and deliver the service anywhere in the world [Youngdahl and Ramaswamy, 2008]. The necessity to include offshoring of services in GVCs is linked to the fact that the narrow approach to offshoring meant imports of materials from the same sector, whereas around 40% of employment in manufacturing is related to services functions, which are also prone to offshoring [Nordås, 2019]. Another important aspect is the standardization of knowledge-intensive services. Even in the 1990s, the execution of services was not considered as a process and diagrams similar to those for an assembly line did not exist [Metters and Verma, 2008]. Standardization of operations related to accounting or stockcontrol in companies having hundreds or more units led to increased profits. The profits are even greater when the operations are consolidated in one global service center which provides services to every unit in the world. Together with the issue of standardization comes the automation of knowledge-intensive services. It is understood as an application of advanced algorithms to execute tasks previously reserved for human beings. Besides performing some repetitive tasks by programmed machines, even cognitive tasks can be executed, consequent to various forms of artificial intelligence [Kaplan and Heanlein, 2019]. This is considered to be one of the most important changes in offshoring and will profoundly transform international provision of services [Klimek, 2020]. The issue of professional qualification and licensing is crucial to services. The licenses are designed to protect users of services (like legal services), but they are also important barriers to entry of new companies. In the case of ABS the issue of licenses was overcome by the fact that ABS operations are rather a back-office type than front-office ones. Moreover, they work for other units within the same business group or for unrelated companies, and thus ABS is a business-to-business type. Sale of the services is conducted by local units according to the local regulation. For example, many operations in banks may be processed by remote units anywhere in the world, but direct contact with customers is provided by the local staff. 72 A. Klimek The models of Markusen and Strand [2009] and Yeaple [2003] best explain the operations and impact of MNCs on markets and therefore will be used as the basis for constructing a new model of complex structures in MNCs, including activities in business services. Moreover, the new model will be constructed in the general equilibrium, which will enable us to assess the impact of foreign direct investment (FDI) on a host economy and particular markets. The design of the model of Yeaple [2003] allows for the adjustment to a more detailed explanation of the activities of MNCs, for example, in the context of emerging economies [Klimek, 2016]. 3 Model We develop a simple model of an MNC with offshoring of white-collar tasks. As the basic scenario, the firm can choose between performing the white-collar task at the headquarters or engaging in offshoring. When it decides to offshore, it faces an array of choices, since there are countries of various levels of development and labor costs. There are three countries: West (h), East (f), and South (g). West and East are northern countries with high labor costs and South is an emerging country with a cheap labor force. The decision about engagement in FDI in knowledge-intensive services depends on the differences in costs of whitecollar labor between North and South. It is in line with the business decisions made by MNCs regarding the execution of knowledge-intensive tasks. Rarely, an MNC performs these processes inside the headquarters and does not engage in offshoring of white-collar services. Frequently, MNCs operate in various developed markets and besides the core processes they also relocate some white-collar processes to particular countries. However, recently, MNCs decided to move white-collar processes into not only emerging economies such as India, the Philippines, but also Poland or other Central and Eastern European economies [Klimek, 2020]. This model is based on Markusen [1997]. The annotations here are also kept very similar to his model to facilitate analysis and comparability. Although he designed the model to explain the manufacturing operations of an MNC, an important element of the model was “knowledge-intensive producer services.” Again, although Markusen [1997] did not precisely refer to offshoring of advanced business services, this approach was discussed as one of the strands in explaining offshoring of white-collar services and operations of multinational firms [Markusen, 2005]. The starting point is the introduction of the market conditions for the products of MNCs. There are two goods. The output of Y in each country can be expressed as CES function:   () =++      YaLaS 1i =h,f,g. iiyiy 1/ (1) where Liy and Siy stand for unskilled and skilled labor used in the production of good Y in a country i (Y is a numeraire). The elasticity of substitution (1/1-e) is greater than 1. Good X is produced with increasing returns to scale by Cournot-type firms. The consumption of goods takes place only in northern countries. This is consistent with the evidence that many affiliates of MNCs in emerging countries export production to northern markets. It is also the case for the consumption of intermediate services, since there is negligible demand for ABS in an emerging economy. For example, foreign firms operating in ABS in Hungary export almost 100% of their output. These services are delivered to an advanced economy and consumed at the headquarters. There are no direct links to manufacturing operations either in home or in host countries. The lack of direct linkages between manufacturing and office services is confirmed by the evidence from CEE countries. Moreover, the consumption pattern is not crucial in modeling the white-collar activities of MNCs. There is a supply of skilled-labor, which is used predominantly by ABS. In the case of absence of ABS companies, the skilled-labor resources are wasted. The model of an MNC encompasses three main activities: manufacturing, headquarters, and office. We assume captive offshoring in this article; however, outsourcing of services to a specialized firm induces similar costs and has an equal impact on the labor market. We will not model here production operations in detail, since they use different inputs than headquarters or offices. Offshoring of white-collar jobs 73 The production in the North requires skilled (S) and unskilled labor (L). Headquarters and office activities use skilled labor. The production process requires additionally the headquarters and office activities in the form of fixed costs – F. Similarly, in relation to knowledge-capital model (KCM), the size and composition of fixed costs are crucial in decisions concerning the establishment of particular activities in particular economies. There are also fixed costs of coordination the production process – G. The country of origin of an MNC is an advanced economy h. In the basic scenario (1), the operations of offices are included in the headquarters. There are four types of MNC, namely: 1. MNCs with no service operations abroad, 2. MNCs with service operations in advanced economies, 3. MNCs with service operations in emerging economies, and 4. MNCs with service operations in both advanced and emerging economies. More formally, there are six types (regimes or configuration strategies) of firms. We also include national firms without any international operations. The ordering of firms with their skilled-labor intensity is given as follows: 1. ns – national firm with headquarters in S, and the production takes place in the same country, where office activities are incorporated into the headquarters. 2. nN – national firm with headquarters either in E or W, and the production takes place in the same country, where office activities are incorporated into the headquarters. 3. mNN – multinational firm with headquarters either in E or W, and the production takes place both in Eand W, where office activities incorporated into the headquarters. 4. mNNS – multinational firm with headquarters either in E or W, and the production takes place both in Eand W, where the office is situated in an emerging country. 5. mNNN –multinational firm with headquarters either in E or W, and the production takes place both in Eand W, where the office is situated in another developed country. 6. mNNNS – multinational firm with headquarters either in E or W, and the production takes place both in Eand W, where the offices are situated both in developed and in emerging countries. Factor-intensity of particular types of activities is as follows: 1. Headquarters activities are more skilled-labor intensive than production plant. 2. Headquarters activities are more skilled-labor intensive than office. 3. Office activities are more-skilled-labor intensive than production plant. 4. Any type of activity by a MNC in the host country is more skill-intensive than the Y sector. There is an iceberg form of transportation costs. A national firm headquartered in i has the following cost function: wL zS wcXcXG zF() i, j=h, f, i≠j ii n ii n iii n ij nn i n τ += ++ +      + (2) As the consumption is met by a local production a multinational firm based in a country i has the following cost function: wL wL zS zS wcXG wcXG zF zFiii m jij m iii m jij m iii mm jij mm i m j m 12 12 +++= ++     +     ++ (3) A multinational firm based in country i with an ABS unit in another developed economy has the following cost function: wL wL zS zS wcXG wcXG zF zF 22 iii m iij m iii m iij m iii mm jij mm i m j m 12 12 +++= ++     +      ++ (4) 74 A. Klimek A multinational firm based in country i with an ABS unit in emerging economy has the following cost function: wL wL zS zS zS wcXG wcXG zF zF zF i, j, k=h, f, g, i≠j≠k iii m iij m iii m iij m kik m iii mm jij mm i m j m k m 12 123 ++++ =++     +       +++ (5) A multinational firm based in country i with ABS units both in developed and emerging economies has the following cost function: wL wL zS zS zS wcXG wcXG zF zF zF 22 iii m iij m iii m iij m kik m iii mm jij mm i m j m k m 12123 ++++=++     +      ++ + (6) Labor endowments of countries i and j is given as Li and Zi . The market clearing condition for all types of firms is given as: LL nL mL mL iiyii n iii m jji m =+ ++ (7) SSnSmSmS iiy ii n iii m jji m =+ ++ (8) The Zero-profit condition for X sector gives the income of country i as: Mw LzS i=h, f, k. ii iii =+ (9) The function of a representative consumer in each of the northern countries is the Cobb-Douglas function, which is given as: UXYXnX nX mX mX iiciciciii n jji n iii m jji m1 =+ =+++ αα − (10) The demands for X and Y are as follows: XMpY Mp/(1)/ ic ii ic ii αα ==− (11) The inequalities for marginal revenue–marginal cost are given by: pewc X1 iii n ii i n −     ≤     (12) pewc X1() jij n ii j n τ −      ≤+       (13) pewc X1 iii m ii i m −     ≤     (14) pewc X1 jij m ji j m −      ≤       (15) The price elasticity is one, which reduced the firm’s mark-up to its market share. e X X pX M lnmvij hf ,, ,, ij lij l jc jij l j α == == (16) Offshoring of white-collar jobs 75 Zero-profit conditions for particular types of firms as given according to the following expressions– National firm in h: pe XpeX wG zF hhh n hh n fhf n hf n h n h n +≤+ (17) National firm in f: +≤+pe XpeX wG zF fff n ff n hfh n fh n f n f n (18) MNC in h: +≤++ +pe XpeX wG zF wG zF hhh m hh m fhf m hf m h m h m f m f m 11 22 (19) MNC headquartered in h with ABS in f: +≤++ +pe XpeX wG zF wG zF2 hhh m hh m fhf m hf m h m h m f m f m 11 22 (20) MNC headquartered in h with ABS in g: +≤++ ++pe XpeX wG zF wG zF zF hhh m hh m fhf m hf m h m h m f m f m g m 11 22 3 (21) MNC headquartered in h with ABS in f+g: +≤++ ++ pe XpeX wG zF wG zF zF2 hhh m hh m fhf m hf m h m h m f m f m g m 11 223 (22) We substitute mark-ups into MR=MC inequalities for countries i and j: XM pwc p XX,for ,  i ii i ii n ii m 2 β ≥ − (23) XM pwc p X () ,for j ji j ij n 2 βτ ≥−+ (24) Now we substitute inequalities (23) and (24) into zero-profit conditions: National firm in h: βτ () −          +−+                         ≤+ M pwc p M pwc p wG zF h hh h f fh f h n h n 22 (25) National firm in f: βτ () −+          +−                         ≤+ M pwc p M pwc p wG zF h hf h f ff f f n f n 22 (26) 76 A. Klimek MNC in h: M pwc p M pwc p wG zF wG zF ) h hh h f ff f h m h m f m f m 22 11 22 β −          +−                       ≤+ ++ (27) MNC headquartered in h with ABS in f: M pwc p M pwc p wG zF wG zF )2 h hh h f ff f h m h m f m f m 22 11 22 β −          +−                       ≤+++ (28) MNC headquartered in h with ABS in g: M pwc p M pwc p wG zF wG zF zF ) h hh h f ff f h m h m f m f m g m 22 11 22 3 β −          +−                       ≤++++ (29) MNC headquartered in h with ABS in f+g: M pwc p M pwc p wG zF wG zF zF )2 h hh h f ff f h m h m f m f m g m 22 11 223 β −          +−                       ≤+++ + (30) An MNC decides about its optimal configuration strategy after taking into consideration fixed costs of office activities. The highest fixed costs are in the cases of two offices being located abroad. Only the most productive firms are capable of building such a structure. When we consider the lowest costs of office operations, the focus should be on a low-cost country, since fixed cost, as expressed in a unit of skilled labor in an emerging country, is lower than a unit of skilled labor in a developed country. To sum up our theoretical proceeding, we can rephrase the approach formulated by Hummels et al. [2016] that firms decide about the scope and size of their offshoring operations based on external conditions and internal capabilities. 4 Data and stylized facts Besides the introduction of the theoretical model, we aim to apply it to the analyses of operations of European MNCs with respect to their engagement in ABS. We expect that firms endeavor to maximize their profits; therefore they configure their services operations in the most optimal way. The selection of an optimal strategy depends on the characteristics of a firm, such as size, productivity, and profitability. We aim to define the factors that are expected to lead to establishing services operations in Western and Eastern Europe. The source of data on the firms was the Amadeus database, which contains detailed information about millions of companies across Europe. We used here data for European companies and their European subsidiaries. The selected countries create a unique area of free movement of services on a global scale. Therefore, the analysis will focus on the characteristics of firms. First, the sample of 5,003 firms, having their headquarters in 15 Western European countries belonging to the EU and two EFTA countries (Norway and Switzerland), was extracted. The primary criterion of Offshoring of white-collar jobs 83 consultancies who are expecting multiplication of the current level of employment in ABS in emerging Europe in the coming years. Funding This work was supported by the by the National Science Centre, Poland, under Grant no. DEC-2015/19/B/ HS4/00356. References ABSL. 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Services included in empirical analysis according to NACE Rev. 2 (primary codes): 620 - Computer programming, consultancy and related activities 631 - Data processing, hosting and related activities; web portals 639 - Other information service activities 691 - Legal activities 692 - Accounting, bookkeeping and auditing activities; tax consultancy 711 - Architectural and engineering activities and related technical consultancy 712 - Technical testing and analysis 721 - Research and experimental development on natural sciences and engineering 722 - Research and experimental development on social sciences and humanities