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jobs—the mid-level wage jobs. This means that low- and mid-level wage categories were
impacted with lower employment in the 1980s, while in the 1990s, the mid-level wage
workers were more heavily impacted. This reflects a trend toward greater loss for mid-
level wage workers.
Polarization of the job market means that there is employment growth for high-paying
and low-paying jobs, but less growth or even a decline in jobs with mid-level wages. The
explanation for this phenomenon is that routine jobs—whether they are manual or
cognitive—can be replaced by computers and offshoring.
We still need to be able to explain how it is possible that during the 1990s, the relative
wage of nonproduction labor increased, while employment fell. This contradicts the
predictions in our model. But, suppose that routine cognitive jobs done by nonproduction
workers were offshored or replaced by computers. These nonproduction routine workers
earned lower wages than the nonproduction nonroutine workers who were not replaced.
This means that the remaining workers in nonproduction earned an average higher wage
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2 The Gains from Offshoring
From the previous section, we know that offshoring leads to an increase in the relative
demand for high-skilled labor, which in turn raises those workers’ wage, as compared
with low-skilled labor. Consequently, high-skilled labor benefits from offshoring,
whereas low-skilled labor suffers a loss. However, in addition to high-skilled labor,
consumers also gain through the lower cost of final goods passed on to them by the
offshoring firm. The question we examine in this section is whether the gains enjoyed by
the winners outweigh the losses faced by the losers.
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Simplified Offshoring Model
We begin by examining the gains and losses of offshoring, and thus the validity of the
comment made by Samuelson, by simplifying the offshoring model to consist of just two
processes: components production and research and development (R&D). Both activities
Production in the Absence of Offshoring Let’s begin by assuming that the firm initially
partakes in both components production and R&D at Home (i.e., the firm does not
offshore these activities). With the two production processes used to produce the final
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Equilibrium with Offshoring Now we will ease our previous assumption by allowing
the Home firm to engage in offshoring. By opening up to trade, the Home firm finds that
it can import the components more cheaply than it could produce on its own because it
faces a lower world-relative price of components, (PC /PR)W1 < (PC /PR)A. The lower
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Gains from Offshoring Within the Firm The gain the Home firm experiences through
offshoring is measured by the increase in the amount of final good it produces, namely,
the difference between Y0 and Y1. More specifically, the firm has become more
productive because it is capable of producing more final goods using the same total
“endowment” of high-skilled and low-skilled labor as in the absence of offshoring. The
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Terms of Trade
To further understand Paul Samuelson’s comment, we reintroduce the concept of terms
of trade from previous chapters. Recall that the terms of trade is given by a country’s
Fall in the Price of Components Suppose Foreign improves its productivity in
components production, leading to a fall in the world-relative price. As an importer of
components, Home experiences a rise in its terms of trade due to the fall in the relative
price of components. With an even flatter world-relative price, (PC/PR)W2, as shown in
Figure 7-14, the Home firm dedicates more resources to R&D by moving to point B
′
along its PPF and producing a greater amount of final goods given by point C
′
on Y2.
Thus, due to the fall in the price of components production, the Home firm enjoys
additional benefits through offshoring.
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Fall in the Price of R&D Let’s examine the case in which the world-relative price of
R&D falls instead of the relative price of components production. Illustrated in Figure 7-
15, the fall in world-relative price of R&D means that Home faces a steeper price line,
(PC/PR)W3, compared with the situation before the decline in the price of R&D. With the
decline in the world-relative price, the Home firm shifts some of its resources from R&D
to components production, moving from point B to point B
′
. It follows that the firm’s
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However, as noted by Paul Samuelson, unlike traditional trade in final goods, a fall in the
terms of trade with offshoring could have a negative impact on the Home country in that
APPLICATION
U.S. Terms of Trade and Service Exports
Merchandise Prices Figure 7-16 shows the U.S. terms of trade for merchandise goods,
excluding petroleum. Between 1990 and 1994, the terms of trade worsened for the United
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Service Prices Let’s check other traded services. We can examine a similar study in U.S.
terms of trade for services using international prices on air travel, available from 1995.
The air-travel terms of trade, equal to the price foreigners pay traveling on U.S. airlines
divided by the price Americans pay on Foreign airlines, do not exhibit any systematic
Service Trade Because prices are not available for services other than air travel, we will
use the amount of service traded to examine whether there is any evidence to support
Paul Samuelson’s comment. Table 7-1 shows that the United States enjoyed a surplus in
Figure 7-17 presents the combined trade surpluses in computer and information services,
insurance, and financial services for the United States, the United Kingdom, and India
from 1970 to 2014. The U.S. surplus steadily grew from 1985 and exceeded that of the
United Kingdom until 2002. Since that time, the U.K. and United States have been
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The Future of Offshoring and You
We found in this chapter that the gains from offshoring went to nonproduction skilled
labor. In the 1980s, these gains were in the form of additional employment and higher
wages relative to production workers. The 1990s told a different story due to job
polarization, which made the task of measuring labor demand much more complex.
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Examples of jobs that are not easily offshored are medical services. Many medical
services have been offshored to India, for example, reading X-rays or radiology. While
many working in this profession Stateside grew concerned, over the years, it has turned
Moreover, it seems that many of these jobs actually complemented existing U.S. jobs.
For example, only “nighthawk” X-ray jobs in the hospitals were offshored. Such
overnight preliminary X-ray readings done offshore were reviewed again the next day by
Because radiology is a profession involving decisions that cannot be codified with written
rules and procedures, there will continue to be a demand for highly trained radiologists
In addition, the costs of effective communication and quick decision making to respond
to design changes in production have caused many companies to start “onshoring,”
bringing the production processes back home, and “quicksourcing,” improving the speed
and flexibility of existing local production processes. The benefits of hiring workers
HEADLINES
Mexico: The New China
Too often, citizens worry about offshoring and losing jobs to cheaper Mexican or Chinese
labor. But, a new paradigm for production is thriving. What manufacturers are realizing is
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This feature concerns an innovative U.S. firm that wanted to produce small drones but
faced stiff competition from a Chinese company that could produce its product using both
cheaper labor and top-rate engineers. Nevertheless, the U.S. firm was able to get the
attention of venture capitalists’ funds by convincing them of the value of quicksourcing,
What are the advantages of speed and flexibility over cheap wages? Here is the short
answer:
1. “Quicksourcing” minimizes the length of the supply chain by producing the
product closer to home. Small firms can contract with firms across the border for
2. Quicksourcing also provides more visibility and enables more control over
quality. This minimizes the risk of errors in design and makes for quick recovery
These are just a few examples of the value of quicksourcing. Thus, the future of supply
chains and offshoring may be more about nimble shorter supply chains than about
cheaper wages abroad. This encourages new jobs in the United States as offshoring
Needless to say, quicksourcing could very well impact the conclusions of the models
discussed in this chapter. Adjustments to our models may need to be made in order to
