How Offshoring by Multinational Corporations Contributed to the Decline of US Manufacturing

The offshoring activities of multinational firms explain about one-third of the aggregate decline in US manufacturing employment, according to a new study. 

 

 

Workers in an automobile factory in Beijing, China.

Between 1990 and 2011, the US manufacturing sector lost one of every three jobs. This scarring decline has left policymakers seeking explanations, as well as appropriate policy responses.

 

Explanations for the decline in manufacturing employment are predominantly of two types. First, this period could have coincided with intensive investments in labor-saving technology by US firms, thereby resulting in reduced demand for labor. Second, the production of manufacturing goods may have increasingly occurred abroad, also leading to less demand for domestic labor.

 

At the surface, the second explanation appears particularly promising. The large decline in manufacturing employment—from nearly 16 million workers in 1993 to just over 10 million in 2011, as shown by the black line in Figure 1—coincides with a surge in outward foreign direct investment (FDI) by US firms (the blue line in Figure 1). Nevertheless, existing theories of trade and multinational production make ambiguous predictions regarding the link between foreign production and US employment. 

 

Figure 1: US Manufacturing Employment and US Outward FDI. Source: Bureau of Economic Analysis (BEA) for FDI; Longitudinal Business Database (LBD) and authors’ calculations for employment.

 

In a new research paper, co-authored with Aaron Flaaen, we use a novel, highly detailed dataset to provide empirically-grounded estimates of the role that trade and foreign investment played in the recent decline of US manufacturing employment. With data covering the universe of manufacturing plants linked to import and export data in the United States, we show that US multinationals intensified their production of intermediate inputs (inputs necessary for the production of the final product sold to consumers) abroad and imported these goods back to the US, thereby replacing domestic manufacturing employment. While our findings do not rule out that other mechanisms—such as investments in labor-saving technology—were also at work, this research strongly supports the view that trade and foreign investment had a negative effect on US manufacturing employment in recent decades.

 

Facts on Manufacturing Employment, Trade, and Multinational Activity

 

By combining several confidential firm-level datasets housed at the US Census Bureau, we provide a unique, comprehensive picture of the domestic and foreign operations of US firms. This data reveals that US multinational firms (defined as US-headquartered firms with foreign-owned plants) contributed disproportionally to this decline in employment. While 33.3 percent of US manufacturing employment in 1993 was in multinational-owned establishments, multinational corporations directly accounted for 41 percent of the subsequent decline. 

 

Figure 2: Net US Manufacturing Job Creation Rates by Type of US Firm. Source: Authors’ calculations based on the LBD, Directory of Corporation Affiliations (DCA), and Longitudinal Foreign Trade Transactions Dataset (LFTTD).

 

In Figure 2, we show that multinationals exhibited consistently-lower net job creation rates in the manufacturing sector, relative to other types of firms. Relative to purely domestic firms and non-multinational exporting firms, multinationals created fewer jobs (equivalently, shed more jobs) in almost every year in our sample.

 

Of course, these patterns may not be causal, and other characteristics of multinationals could be driving the low job creation rates. We test this possibility in our data by controlling for observable plant characteristics and find that plants owned by multinational firms have lower employment growth than non-multinational owned plants within the same industry, even when the plants in the control group have the same size and same age. 

 

An alternative way to assess the role of multinationals’ activity on US employment with our data is to use an “event study” framework. We compare the employment growth trajectories of plants that open production facilities abroad to otherwise similar plants (in terms of their industry, firm age, and size). As can be seen in Figure 3A, prior to their multinational expansion, the growth patterns of these plants are no different than the control group. However, in the years following multinational expansion, there is a brief positive followed by a sustained negative trajectory of employment at these manufacturing plants. By the end of the sample, employment at the manufacturing plants of these newly multinational firms is about 20 percent smaller than an otherwise similar plant.   

 

Figure 3: US Employment and Import Dynamics at New Multinational Plants. Source: Authors’ calculations based on LBD, DCA, and LFTTD.

 

In a similar fashion, newly multinational firms subsequently increase imports following the expansion abroad. As Figure 3B demonstrates, these firms substantially increase imports both from related parties (affiliates abroad) and from other firms (arms-length). Taken together, Figures 3A and 3B suggest that offshoring can explain the observed negative relationship between trade and employment.

 

Foreign Reallocation or US Growth Through Global Efficiency?

 

While the patterns we identify above suggest that increased production of intermediate inputs abroad by multinational firms leads to a decrease in US manufacturing employment, they are not necessarily causal. Standard theories of why firms choose to source inputs globally make ambiguous predictions as to whether foreign sourcing is associated with increases or decreases in domestic employment.

 

At the heart of this ambiguity are two competing forces. On the one hand, when a firm begins to source from abroad, the firm produces some of its value-added abroad. Foreign workers now produce what was previously produced within the US. This “reallocation effect” has a negative effect on US employment. On the other hand, production abroad grants firms access to cheaper labor and hence the costs associated with producing one unit of the firm’s good fall. The fall in unit costs allows the firm to sell more of its output—output that must be produced with additional labor. This “scale effect” could theoretically dominate the reallocation effect and lead to positive employment effects of offshoring.

 

We use our data to estimate the relative strengths of these two competing forces. Our results demonstrate that between 1993 and 2011, the reallocation effect was much larger than the scale effect. In other words, during this period of aggregate manufacturing employment decline, multinationals’ foreign production of intermediate inputs was leading to a net decline of manufacturing employment within these firms. 

 

It is important to point out that the model we use only speaks to employment changes within existing firms, and does not take into account equilibrium forces, such as the lower prices of goods sold to consumers, or the entry of new firms into production, that can also affect employment.

 

Since such equilibrium effects are inherently difficult to assess, estimates of how much of the observed decline can be attributed to offshoring by multinational firms are uncertain and often require stronger assumptions. We therefore proceed under two alternative sets of assumptions. Under the first, we ignore equilibrium forces. Under the second, we model these equilibrium forces explicitly. For both of these scenarios, we find that the offshoring activities of multinationals explain about one-third of the aggregate US manufacturing employment decline.

 

Implications for Policy

 

Our research shows that the global sourcing behavior of US multinational firms was an important component of the manufacturing decline observed in the past few decades. These firms set up production facilities abroad and imported intermediate goods back to the US, reducing demand for domestic labor. While our research suggests that offshoring had a negative impact on employment, we caution that it does not support the view that offshoring and trade should be contained through tariffs or other policy interventions. While previous research has shown that both trade and offshoring are critical for consumers’ access to affordable goods in the US Instead, our research suggests that government assistance for displaced manufacturing workers could facilitate their transition to new jobs in other sectors.

 

Christoph Boehm and Nitya Pandalai Nayar are assistant professors at UT Austin’s Department of Economics.

 

Reference

 

Christoph Boehm, Aaron Flaaen, and Nitya Pandalai Nayar, 2019. “Multinationals, Offshoring, and the Decline of U.S. Manufacturing,” NBER Working Paper No. 25824.

 

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