Measuring Productivity, Offshoring and Wages when Statistics Lie

April 19, 2007

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A recently revised study proposes that the federal government's measure of productivity growth of the U.S. manufacturing sector may be widely overstated due to outsourcing and the shift to offshore production of goods. It also finds "a direct link" between productivity measurement, offshoring and workers' wages. Statistics can lie, so how do we measure manufacturing productivity?

Of late, we've been wondering about the number of statistics and growth measurements we come across and often report on this blog. To some extent, they give us a general, use-a-very-broad-brush-stroke idea of what's going on. Other times they can be fairly off, by an unreasonable standard of deviation.

For instance, we're reminded of the December 2005 Duke University study that framed the engineering outsourcing debate by calling out the often-claimed, but apparently erroneous, statistics of engineers produced in China, India and the United States. (See Drowning By Numbers: Engineering in China, India, U.S.)

The Federal Reserve and the Institute for Supply Management both study and report numbers on production, the Bureau of Labor Statistics analyzes more than one type of productivity.

How do we measure manufacturing productivity accurately? Can we?

Then we noticed a study by Susan Houseman of the Upjohn Institute for Employment Research (via Manufacturing & Technology News). The study, entitled Outsourcing, Offshoring and Productivity Measurement in U.S. Manufacturing, proposes that the federal government's measure of productivity growth of the U.S. manufacturing sector over the past 15 years may be widely overstated due to outsourcing and the shift to offshore production of goods.

"The growth of outsourcing and offshoring in industrialized countries makes it exceedingly difficult for government statistical agencies to measure changes in the flows of inputs into the production process and hence to accurately measure productivity growth," Houseman states. "In addition, the growth of outsourcing and offshoring raises conceptual issues about what productivity statistics do and should measure, with implications for how they should be interpreted and who will benefit from measured productivity gains."

First published last June, the Upjohn Institute for Employment Research study was revised this month and says:

Reasons why manufacturing productivity statistics should be interpreted with caution in light of the recent growth of domestic and foreign outsourcing and offshoring. First, outsourcing and offshoring are poorly measured in U.S. statistics, and poor measurement may impart a significant bias to manufacturing and, where offshoring is involved, aggregate productivity statistics. Second, companies often outsource or offshore work to take advantage of cheap (relative to their output) labor, and such cost savings are counted as productivity gains, even in multifactor productivity calculations.

Just today, The New York Times reports that Eastern Europe is on its way to becoming an outsourcing center: "The Czech Republic and other Central European countries like Poland, Hungary and Slovakia are clamoring to serve the needs of multinational corporations — and themselves." And American companies are cashing in. Recent years have seen I.B.M., Dell, Accenture, Unilever and Morgan Stanley, among others, outsourcing services to Eastern Europe, or helped other American companies do so. Providing some perspective, NYT said that "Eastern Europe, with an outsourcing business estimated at about $2 billion this year, represents just a fraction of the global outsourcing market, estimated this year at nearly $386 billion." However, Robert H. Brown, an outsourcing analyst at Gartner Dataquest, expects "growth in Eastern Europe to outstrip the rest of the market in the next four years, expanding close to 30 percent by 2010, compared with 25 percent for the global market."

Will productivity there be measurable?

After manufacturing companies outsource functions and offshore production for cheaper labor and lower costs, the cost savings are then recorded as productivity improvements in the multi-factor productivity calculation.

Houseman calculated that outsourcing of manufacturing services jobs accounted for about half of a percent point of the growth in manufacturing productivity between 1990 and 2000, dropping the growth rate from 3.71 percent to 3.17 percent

Manufacturing & Technology News summarizes:

It's more difficult to factor in offshoring of production overseas in the manufacturing sector because the government does not track the shift of production offshore. It's also difficult to ascertain productivity growth in the overall manufacturing sector because virtually all of the gains in productivity during the 1990s were driven by the high-tech industry. That industry was a leader in shipping its work offshore.

"Foreign labor is counted as a separate input, weighted by its cost share, and hence, in as much as lower hourly foreign labor costs are not commensurately matched by lower productivity, cost savings from offshoring will be counted as productivity gains," writes Houseman. "To the extent that offshoring is an important source of measured productivity growth in the economy, productivity statistics will, in part, be capturing cost savings or gains to trade but not improvements in the output of American labor."

Thus, productivity statistics should be interpreted with caution.

Even more, Houseman says that her findings provide "a direct link between productivity measurement, offshoring and inequality."

"Productivity growth is the basis for improvements in workers' standard of living," Houseman writes. "Yet widespread improvement in American workers' wages has not accompanied the rapid growth in measured U.S. productivity.

"Outsourcing and offshoring may help explain some of this puzzle."

As for the companies themselves that are offshoring, there's that little matter that the relative cost advantage of the leading offshore destinations declined almost universally last year.

Sources

Outsourcing, Offshoring, and Productivity Measurement in U.S. Manufacturing by Susan Houseman W. E. Upjohn Institute for Employment Research, June 2006, last revised: April 2007

Manufacturing Productivity Growth Isn't What The Government Measures by Richard McCormack Manufacturing & Technology News, April 16, 2007

Eastern Europe Becomes a Center for Outsourcing by John Tagliabue The New York Times, April 19, 2007

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