Outsourcing, Inequality and Aggregate Output

Abstract

Outsourced workers experience large wage declines, yet domestic outsourcing may raise aggregate productivity. To study this equity-efficiency trade-off, we contribute a framework in which more productive firms either post higher wages along a job ladder to sustain a larger in-house workforce, comprised of many imperfectly substitutable worker types and subject to decreasing returns to scale, or rent labor services from contractors who hire in the same frictional labor markets. Three implications arise: more productive firms are more likely to outsource to save on higher wage premia; outsourcing raises output at the firm level; labor service providers endogenously locate at the bottom of the job ladder, implying that outsourced workers receive lower wages. Using firm-level instruments for outsourcing and revenue productivity, we find empirical support for all three predictions in French administrative data. After structurally estimating the model, we show that the rise in outsourcing in France between 1997 and 2007 increased aggregate output by 1% and reduced the labor share by 3 percentage points.