“Offshoring” and “outsourcing” are two widely used terms. Some people treat them as synonyms, but this is misleading as they refer to two distinct business decisions: location (domestic or abroad) and ownership (in-house or external) choice for production processes.2 This two-dimensionality is illustrated in Figure 6.1. If production processes are located domestically, they can be conducted in-house or by an external supplier, and international
1See Feenstra (1998, pp. 31-32), Hummels et al. (2001, p. 76), and Bottini et al. (2007, p. 3) for information on the authors using the respective terms.
2The term “production processes” includes both manufacturing and service activities.
location
Figure 6.1: Definition of offshoring and outsourcing. ...mamaSourcSo...S Source: Adapted from Bottini et al. (2007) and Kirkegaard (2008).
trade is not involved. If production processes are relocated abroad,3 they can be carried out by an affiliate or by an unaffiliated supplier. These two modes of offshoring are associated with intra-firm trade and arm’s length trade, respectively.4 Following the widespread terminology in the recent literature, the bold terms in Figure 6.1 represent the terminology we adopt across the paper: “offshoring” includes both “FDI” and “offshore outsourcing”, whereas
“outsourcing” includes “domestic outsouring” and “offshore outsouring”.5 Thus, the two concepts overlap as both include “offshore outsourcing”, and the fourth organizational form,
“domestic integration”, is not comprised in either concept.
Unfortunately, this clear terminology is not universally adopted in the literature. Some papers use the term “international outsourcing” for both modes of “offshoring”, an example being Amiti and Wei (2005a). Moreover, the business literature restricts the term “offshoring”
to production relocation within MNEs, which we call “FDI”.6 Following the widespread terminology in the industrial organization and trade literature, we use the term with the broader meaning.
Concerning the term “outsourcing”, some authors take narrower definitions than the standard one we follow. For instance, Bhagwati et al. (2004) restrict the term to comprise
3In this context, “abroad” means a country different from where a firm’s headquarter is located.
4As long as headquarter services are needed for final good production, at least trade in these services is involved.
5See, for example, Helpman (2006) and Grossman and Rossi-Hansberg (2008). These and many other authors use the terms “offshoring” and “outsourcing” as we do. The terminology for the four organizational forms varies slightly between different sources. “FDI” is, for instance, also called “vertical FDI” and “pro-duction transfer within MNEs”. Terms used instead of “offshore outsourcing” are, for instance, “international outsourcing” and “arm’s length contract”.
6An example that adopts this approach is Kirkegaard (2008).
only offshore outsourcing of services. Additionally, Markusen (2005) interestingly points out that there exists a long-standing literature which labels the business practice of outsourcing with the inverse term “internalization”.
A term which should be briefly mentioned in the context of offshoring is “inshoring”.
According to Trefler (2005) and Bottini et al. (2007), “inshoring” refers to the same process, i.e., the cross-border relocation of production, but from the point of view of the target country. Some authors label it “insourcing” instead.7 However, “insourcing” is a rather confusing term, since it has also been used for trade-unrelated issues, namely for domestic internal production and domestic outsourcing from the point of view of the receiving firm.
Having distinguished offshoring from outsourcing, we now classify offshoring on the basis of the type of relocated activity. “Material offshoring” refers to the relocation of manufacturing activities, such as assembly or intermediate input production, while “service offshoring” describes the relocation of service activities, e.g., call-centers, after-sale services, or accounting.8
As a next step, we take a closer look at the activities of MNEs by discussing the traditional division of FDI into horizontal and vertical FDI. The term “horizontal FDI” is generally used for “subsidiaries that serve the local market in the host country” (Helpman, 2006, p. 596).
Thus, this kind of FDI is driven by market-seeking motives. “Vertical FDI”, in contrast, refers to “subsidiaries that add value to products that are not destined (necessarily) for the host country market” (Helpman, 2006, p. 596).9 Cost-saving motives underlie this sourcing strategy.10
As we define the term “offshoring” very broadly, it encompasses both forms of FDI. In contrast, Kirkegaard (2005, p. 4) states that “not all FDI is offshoring”, since his narrower definition excludes horizontal FDI. This perception is adopted, for example, by Bottini et al.
(2007) and Crin`o (2009). Another issue to add is that, in practice, the above mentioned traditional categories of FDI lose importance because of the growing complexity of MNEs’
sourcing and integration strategies (cf. Lipsey, 2002, and Helpman, 2006).
7For instance, Amiti and Wei (2005a) use this term for international outsourcing in the opposite direction.
8These definitions are widely used. See, for instance, Bottini et al. (2007) and Crin`o (2009).
9As pointed out by Bottini et al. (2007), the value added may take the form of specific intermediate goods, final goods, or services.
10Cost-saving motives refer to the saving of production cost and not to the saving of trade cost for a final good, which may be associated with horizontal FDI.
To refer to the phenomenon of offshoring, the term “international fragmentation” is used especially by one stream of literature. As pointed out by Grossman and Rossi-Hansberg (2008, p. 1980), the focus of this literature lies on the modeling of the “breakdown of technology for producing some good into discrete parts that can be separated in space”.
Other frequently used terms focusing on global production systems are “slicing up the value chain”, “global value chain”, and the like.11
Due to technological development ever smaller slices of the value chain are tradable. This fact is addressed by the new concept of “trade in tasks”. As a crucial novelty, Grossman and Rossi-Hansberg (2008, p. 1978) “conceptualize production in terms of the many tasks that must be performed by each factor of production”.
Lastly, it should be briefly mentioned that some studies use very general terms like “global-ization” or “economic integration”. Subsuming various aspects, these terms refer to the phenomenon of offshoring as well as trade liberalization for final goods and other aspects.
To sum up, the terminology used in the literature is sometimes confusing. Therefore, we stick to our definitions throughout the literature survey in order to clarify the issues. In the following, some general facts and consequences of offshoring are stated.