1

Ministry of Economy and Finance

Department of the Treasury

N°2 - March 2012

Economic Focus

ISSN 1972-4128

INTERNATIONAL PRODUCTION RELOCATION

Valentina Saieva*

ABSTRACT

Over the last few decades we have witnessed a spectacular integration of global economy with a significant increase in the cross-border movement of goods, services, income and financial flows. The increasing integration of world markets has brought with it an international fragmentation of production processes. One part of this fragmentation involves the relocation of a production process from the home country to a new host country. This note examines the phenomenon of international production relocation through the comparison of several different measures adopted in the literature and in statistical studies. The goal is to evaluate the increased importance reached in the global trade. We pay special attention to Italian firms and highlight the necessity to integrate traditional FDI literature with different approaches and empirical studies which can provide helpful insights on the complex phenomenon of off-shoring business operations.

* Italian Ministry of Economy and Finance, Department of the Treasury, Economic and

Financial Analysis and Planning Directorate. Rome, Italy. E-mail: vsaieva@yahoo.it I gratefully acknowledge Lorenzo Codogno, Cristina Quaglierini and Francesco Nucci for their comments and suggestions.

JEL: F14, F21, F23, D57

Keywords: Offshoring, fragmentation, relocation

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INTRODUCTION

The phenomenon of offshoring has been recently at the forefront of public debate and has received large attention in the economic literature. The extreme variety of processes involved in offshoring makes it difficult to identify a single appropriate measure to appraise the extent of this phenomenon. Most theoretical and empirical studies concerning firms‟ cross-border operations belong to the FDI literature. Nonetheless this approach cannot capture exhaustively offshoring, being aimed to the assessment of multinational enterprises‟ (MNEs‟) activities. In fact, even though data on FDI flows and stocks represent the most widely available information on international production relocation, this type of information, however, overlooks off-shore processes undertaken by small firms. Besides the internationalization of production processes realized through foreign investments, new ways have recently emerged, enabling the fragmentation and the relocation of firms‟ production. Over the last years, the lowering of transport costs and trade barriers has facilitated the offshore relocation of production stages previously realized domestically. This process has fostered a significant increase in international trade of intermediate inputs. Hence, an alternative approach has recently been developed in order to evaluate the phenomenon of offshoring on the basis of data concerning intermediate inputs. Studies based on this approach, therefore, can capture more accurately the extent of offshoring processes involving also small and medium firms. In the first part of the note, we present the two main approaches outlined in the literature and some statistical methodologies aimed to assessing the relevance of offshoring on the basis of different information. In the second part we focus on the analysis of empirical data concerning offshoring processes realized by Italian firms. In particular, we consider information related to: FDI flows, processing trade, supply and use tables.

THE INTERNATIONAL PRODUCTION RELOCATION

The lowering of trade and investment barriers as well as technological progress in transportation and communications have recently facilitated the globalization of production processes. In this context the international production relocation has become a phenomenon of rising importance in the global economy. Companies are now finding it profitable to relocate offshore stages of the production process previously realized domestically. Thanks to the international fragmentation of production, firms increasingly take advantage of the cost savings and other benefits that result from making or buying inputs, goods and services where they can be produced more efficiently. In the public debate and in the economic literature, this phenomenon, generally known as offshoring, has been described as the process of

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relocation of manufacturing and service activities/functions from the home country to a foreign country not only for the purpose of supplying the relocating company but also for serving the home country‟s and other foreign markets with intermediate or final goods. The multiplicity of concepts currently used in order to describe these processes makes it important to clarify the difference between offshoring and outsourcing

1, terms often employed interchangeably

in the literature. According to the OECD, outsourcing refers to the decision of the firm to source inputs from unaffiliated firms located either domestically (domestic outsourcing) or internationally (international or offshore outsourcing). Offshoring instead refers to firms‟ purchases of intermediate goods and services from foreign providers, or to a transfer of particular activities within the firm to a foreign location. Hence the displacement of production outside national boundaries is the main feature of offshoring: whereas outsourcing refers to the relocation of jobs and processes to external providers regardless of the provider‟s location, offshoring refers to the relocation of jobs and processes to any foreign country without distinguishing whether the provider is external or affiliated with the firm. In fact the phenomenon of offshoring includes both international outsourcing or offshore outsourcing and international in-sourcing or captive offshoring. In the first case, production of goods and services is partially or totally transferred abroad to independent parties (unaffiliated trade): this type of international production relocation refers both to offshoring and outsourcing (firms make the decision to outsource and to offshore to a foreign supplier simultaneously). While the phenomenon of international in-sourcing or captive offshoring occurs when production activities are transferred to foreign affiliates (intra-firm sourcing or affiliate trade). Thus, offshoring of inputs, goods and services entails a change in the geographic location but not necessarily in the firm‟s boundaries. According to a broader view we can distinguish different ways through which the international production relocation can take place:

Imports of intermediate goods and services from another firm located abroad. This form of production relocation entails a vertical specialization and a fragmentation of production processes leading to trade flows of intermediate inputs from foreign countries.

Subcontracting agreement. The subcontracting occurs when the production is partially or totally delegated from the contractor to an individual or a company (subcontractor) that realizes the project following the indication given by the contractor.

FDI (Foreign Direct Investments). FDI is a category of investment that reflects the objective by a resident enterprise in one economy (direct investor) of establishing a lasting interest in an enterprise (direct investment enterprise) that is resident in an economy other than that of the direct investor. Lasting

1 See Olsen (2006), Sako (2005), Fessler (2006), Norwood et al. (2006), Osservatorio Filas (2004), UNECE (2008).

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interest implies the existence of a long-term relationship between the direct investor and the direct investment enterprise, and a significant degree of influence on the management of that enterprise

2. This distinguishes FDI from

portfolio investment, which is not aimed at acquiring a lasting interest or control over the invested enterprise. Furthermore we can distinguish two kinds of foreign direct investment: greenfield and brownfield investment. A greenfield investment is the investment in a manufacturing, office, or other physical company-related structure or group of structures in an area where no previous facilities exist. The second type of investment instead occurs when a company or government entity purchases or leases existing production facilities to launch a new international production activity.

Joint ventures. A joint venture is a business agreement in which parties (co-venturers) agree to develop, for a finite amount of time, a new entity and new assets by contributing equity. They both exercise control over the enterprise and consequently share revenues, expenses, assets and risks.

APPROACHES PROPOSED IN THE LITERATURE TO MEASURE OFFSHORING

In the literature several different studies have been recently developed in order to estimate the phenomenon of cross border production relocation. Most of these theoretical and empirical contributions belong to the FDI literature and are aimed at measuring the extent of investment activities performed by multinational firms. However, this measure can‟t explain exhaustively the phenomenon of offshoring. Besides the large amount of contributions in the FDI literature, recent studies based on the import of intermediate goods and services are becoming of rising importance. Thus, we can distinguish two main approaches in the literature: 1) the multinational enterprise approach; 2) the import of intermediate goods approach. The first approach evaluates flow investments originated from the production relocation of multinational enterprises in a foreign country.

3

The MNEs activity captured through this approach entails the relocation of the whole production process and reflects a lasting interest over the enterprise resident in the foreign economy. An interesting study, recently developed by Hansson

4, tries to estimate

the effects of offshoring on labor demand and skill upgrading within Swedish MNEs.

2 United Nations, European Commission, IMF, OECD, United Nations Conference on Trade and Development, WTO (2002), Manual on Statistics of International Trade in Services, Department of Economic and Social Affairs Statistics Division, Statistical Papers, Series M, No.86, Geneva, Luxembourg, New York, Paris, Washington, D.C. 3 See Fessler, P. (2006), Home country effects of offshoring - A critical survey on empirical literature, Wirtschafts Universität, Wien, 14 December. 4 Hansson, P. (2005), Skill Upgrading and Production Transfer within Swedish Multinationals, Scandinavian Journal of Economics, 107.

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On the one hand, this approach offers the advantage of measuring offshoring processes involving the relocation of a whole production process. On the other hand, this measure also includes every merger and acquisition of foreign companies, as long as the ownership of the parent company remains in the home country. It refers to the overall investment activity of a company in a foreign country, in terms of investments, sales, profits or employees. Thus, this kind of measuring does capture too much to describe offshoring accurately. Furthermore it doesn‟t take into account the growing amount of offshoring that is currently realized by smaller companies. The second approach is based on the theoretical and empirical work of Feenstra and Hanson (1996). The underlying idea of this kind of measuring is that a shift from domestic to foreign suppliers of intermediate inputs and sometimes services takes place. According to this approach, offshoring activities include every purchase of imported intermediate goods by companies in the home country and also every relocation of stages of firms‟ production process to a foreign country with the purpose of supplying the parent company in the home country with an intermediate good. It excludes international relocation involving the whole production process, because the good imported in the country in connection with this kind of offshoring activity is a final good, not an intermediate one. Feenstra and Hanson illustrated in their model the effects of offshore outsourcing on labor markets in the home country, estimating the impact of import penetration

5 on wages in manufacturing industries

6.

Some years later they elaborated the standard methodology for measuring intermediate imports on the base of the import proportionality assumption

7.

The Feenstra-Hanson (FH onwards) index, for each industry i, can be written as:

Offshore outsourcing =

CM

YX

j

j

j i

ij (1)

where Xij is input purchases of good j by industry i, Yi is total non-energy input used by industry i, Mj is import of good j, and Cj is the domestic demand of good j. This measure is called the broad measure of offshore outsourcing, i.e. the share of imported intermediate inputs over total intermediate costs. It is broad in the sense that it is not restricted to imports of an industry from the same industry. According to the FH methodology, the offshore outsourcing of, say, manufacturing intermediates of the electronics industry would be equal to the share of the various intermediate purchases of electronics from other manufacturing industries over total non-energy input purchases of electronics corrected by the import share of each intermediate over total absorption for the entire economy. On the base of this measure they also define a narrow measure of offshoring by restricting the attention to expenditure on those inputs

5 It is defined as the share of imports in domestic consuptions. 6 Feenstra and Hanson (1996). 7 Feenstra and Hanson (1999).

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that the producers purchase from firms in the same industry as the one to which each producer belongs to

8:

Narrow measure of offshoring =

CM

YX

i

i

i i

ii (2)

The narrow measure of offshore outsourcing is used more often in recent studies than the broad measure because it is well-regarded as a more accurate measure of offshore outsourcing. By using this restricted measure, it seems to be more likely that the corresponding production process was, or at least could have been, initially in-house

9.

Feenstra and Hanson also employ another measure which is called “differential outsourcing”. This is simply calculated as the difference between their total offshore outsourcing estimate and the narrow measure of offshore outsourcing. STATISTICAL METHODOLOGIES FOR MEASURING OFFSHORING Offshoring business operations is a difficult, elusive and complex phenomenon. It involves several cross-border activities which entail a disintegration of production processes and can be originated from different firm‟s business decisions. The great variety and complexity of this phenomenon makes it widely difficult to identify a unique measure of offshoring operations. Nevertheless we can use different indicators and statistical measures which can provide interesting information in order to analyze the effects and evaluate the extent of this phenomenon. The statistical measuring of offshoring is commonly based on several analysis mostly focused on: 1) FDI flows; 2) activities of affiliates of national firms abroad; 3) outward and inward processing trade; 4) supply and use tables. Foreign Direct Investment As a first general indicator of the processes and choices connected with international production relocation we can consider data on FDI. Foreign direct investment is usually a precondition for the establishment of a commercial presence in a foreign country. The traditional theory distinguishes between horizontal and vertical FDI. Horizontal FDI occurs when firms produce similar goods or services in multiple countries in order to overcome trade barriers, achieve saving costs or obtain benefits from being close to the final customers. While, in vertical FDI firms fragment the value chain into stages to take advantage of differences in input prices through the relocation in more profitable markets, according to the relative

8 The narrow index is obtained when i=j in equation (1). 9 See Olsen (2006), Fessler (2006); Bracci, L. (2006), Una misura della delocalizzazione internazionale, in “Rapporto ICE 2005-2006”, pp. 231-238; Miroudot, S., Lanz, R., Ragoussis, A. (2009), Trade in Intermediate Goods and Services, OECD Trade Policy Working Papers, N. 93, OECD Publishing.

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endowment of inputs. Thus, several authors argue that domestic and foreign productions are substitutes in the case of horizontal foreign investment, because multinationals produce and sell directly in the final markets, and complements in the case of vertical FDI, because firms relocate abroad activities which represent stages of the same production process

10.

Information on flows and stocks of foreign direct investments are mainly obtained from data contained in balance of payment statistics. FDI flows provide a useful indicator of the trends in international capital flows undertaken by MNEs and include both inflows and outflows. While, FDI stock data are an indicator of the overall importance of foreign companies in individual host economies and the world economy as a whole. According to the fifth edition of the International Monetary Fund‟s Balance of Payments Manual

11, the benchmark commonly used to

determine the existence of a direct investment relationship is the ownership of 10% of ordinary shares or the voting share in a firm. Outward FDI are recorded as assets in the financial account of the balance of payment (direct investment abroad), whereas inward FDI represent financial liabilities (direct investment in the reporting economy). In the value of FDI we can distinguish three components: equity capital; reinvested earnings and other capital

12.

FDI flows and stocks data represent the most wide available information on international production relocation. Nonetheless we have to keep in mind that this indirect trade-based measure shows only cross-border operations undertaken by MNEs. Moreover FDI statistics consider that part of investment which is reflected in monetary transactions and do not measure the true extent or use of investment by foreign investors, as recorded in the national account of the host economy

13.

Although various efforts have been made to harmonize definition and measurement of FDI, different discrepancies remain because countries apply different approaches to collecting these flow and stock data, making it complex to realize international comparison, as well as to formulate policies and strategies on FDI

14.

Another important source of FDI data is, for Italy, the Reprint database, developed by Politecnico of Milan and R&P

15. It offers helpful

information from different sources and shows a detailed framework of 10 Markusen, J., Maskus, K. (2001), General-equilibrium Approaches to the Multinational Firm: A Review of Theory and Evidence, NBER working paper 8334; Markusen, J. (2002), Multinational Firms and the Theory of International Trade, MIT Press. 11 IMF (1993), Balance of Payment Manual-fifth edition. 12 See United Nations (2009), UNCTAD Training Manual on Statistics for FDI and the Operations of TNCs, United Nations Conference on Trade and Development Division on Investment and Enterprise, New York and Geneva; Banca D’Italia – Ufficio Italiano Cambi (2004), Manuale della bilancia dei pagamenti e della posizione patrimoniale dell’estero sull’Italia, June. 13 See Quintieri, B. (2006), Le misure della competitività nel nuovo contesto internazionale: dai settori alle imprese, University of Roma Tor Vergata and Fondazione Manlio Masi; Eighth National Conference of Statistics, Rome, 28-29 November. 14 Fujita, M. (2007), A critical assessment of FDI data and policy implications, working paper presented at the Pacific Rim Conference, Guanghua School of Management, Peking University, 12 January. 15 See Mariotti and Mutinelli (2010); Mutinelli (2006).

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firms involved in multinational processes. These statistics include equity investments in foreign affiliates, subsidiaries and joint ventures, capturing more information about companies‟ ownership structure. Foreign Affiliate Trade Statistics Foreign Affiliate Trade Statistics (FATS) measure the commercial presence abroad of service suppliers through affiliates in foreign markets, and therefore are closely related to statistics on FDI

16.

Many firms operate with affiliates located abroad to offer goods and services that require close contact between the provider and the consumer. However foreign affiliates represent resident entities in the host country, so their sales are not recorded in the national accounts of balance of payment, which are only concerned with transactions between residents and non-residents. FATS statistics have been developed in order to capture such information. Inward statistics on foreign affiliates describe the activity of foreign affiliates resident in the compiling economy

17. On the contrary, outward

statistics on foreign affiliates describe the activity of foreign affiliates abroad controlled by a firm in the compiling economy

18.

In Italy, the Italian National Institute of Statistics (ISTAT), for several years has conducted the activity of collecting and releasing data on Inward FATS Statistics related to the operations of majority-owned foreign affiliates in the compiling economy. On the contrary, it is quite recent the production of Outward FATS Statistics that pertain to the activities of Italian affiliates located abroad. The statistical units for the Outward FATS Statistics are the enterprises and all branches abroad that are controlled by an institutional unit resident in the compiling economy

19.

It should be specified that in the case of Outward FATS, “branches” refers to units that are owned by resident investors of foreign origin

20.

Thus, in Outward FATS the target population is composed by all affiliates located in extra-EU countries that are controlled by an institutional unit resident in an EU Member State. The approach used to identify this target population of the reporting units is the “Ultimate Controlling Institutional unit approach” (UCI)

21.

16 See OECD (2001), Manual on Statistics of International Trade in Services, OECD, 6 September; Eurostat (2007), Recommendation Manual on the production of Foreign Affiliates Statistics, Eurostat; Reister, M. (2005), Inward and outward Foreign affiliate trade in services statistics – “FATS”- Overview FATS statistics, Workshop on Statistics of International Trade in Services Panama City, 13-16 September. 17 See Trinca (2008). 18 See Eurostat (2007); Menghinello and Bilotta (2008). 19 The target population as defined in the FATS-R are all enterprises and all branches under foreign control. To be able to compare with the whole business economy, the same breakdown is to be provided for the whole economy and the compiling country. 20 “Branches” shall mean local units without separate legal entity, which are dependent on foreign owned enterprises. They are treated as quasi-enterprises. 21 “Ultimate controlling institutional unit of a foreign affiliate” shall mean the institutional unit, proceeding up a foreign affiliate’s chain of control, which is not controlled by another institutional unit.

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This implies that Italy, as well as other Member States, should report data on affiliates located outside the EU that are controlled directly or indirectly by parent companies resident in the EU which are not controlled by any other entity resident in the EU or elsewhere outside the EU (EU-UCI approach). Compiling outward FATS data is particularly complex in the typical cases where the ownership of a foreign affiliate in a third country can be shared between different shareholders resident in different countries. We can classify these special cases into two broad categories: 1) cases of equally share control of an affiliate between two different partners, such as joint ventures (50/50)

22; 2) cases of multiple

minority ownership of affiliates abroad in which a company resident in the home country may exercise control without having majority ownership

23. In these cases a cooperation and an information

exchange with national authorities from other EU countries is indispensable to ensure the quality of the data compiled. In particular, when minority shares are equal, in addition to ownership information, further information should be collected from the parent firms involved as well as from other sources such as officially filed company reports or the business register of the host country of the affiliate. In cases of multiple minority ownership, where two or more enterprises from different EU-countries control a foreign affiliate, indicators should be attributed to the country of the investor who owns the highest relative share among controlling investors. Other difficulties may emerge in the particular case where the owner is an individual and its nationality does not coincide with its place of residence. In this case we can distinguish two options as regards the allocation of the data: to the country of which the individual is a citizen or the country of residence

24.

Data on Outward Statistics have been recently integrated with further information obtained thanks to the availability of ORBIS Database. It consists in a global database, developed by Bureau Van Dijk, which contains financial information on public and private companies

25.

22 In this case we can distinguish three different scenarios: 1) a foreign affiliate in a non-EU country which is co-owned by a national entity and an EU-based business, both controlling 50% of the voting rights; 2) a foreign affiliate in a non EU-country which is co-owned by two business, one from an EU Member State and one from a third (non-EU) country, both controlling 50% of the voting rights; 3) a foreign affiliate in a non-EU country which is co-owned by two business based in different EU Member States, both controlling 50% of the voting rights. 23 In this case we consider also three different scenarios: 1) two or more national owners with minority share that combine for a controlling stake of more than 50% of the affiliate’s capital; 2) two or more owners from the same EU Member State with minority shares that combine together for a controlling stake of more 50% of the affiliate’s capital; 3) two or more owners from more than one EU Member State with minority shares that combine together for a controlling stake of more than 50% of the affiliate’s capital. 24 The data of foreign affiliate should be allocated to the place of residence of the individual in order to be consistent with FDI statistics. 25 See http://www.bvdep.com/it/ORBIS.html. Moreover see Pinto Ribeiro, S., S. Menghinello and K. D. Backer (2010), The OECD ORBIS Database: Responding to the Need for Firm-Level Micro-Data in the OECD, OECD Statistics Working Papers, 2010/01, OECD Publishing; Istat-ICE (2010), Annuario statistico Istat-Ice 2009 – Commercio estero e attività internazionali delle imprese, Rome, p.351.

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Processing Trade As regards offshoring business operations another trade-based measure relies on processing trade: outward processing trade (OPT) and inward processing trade (IPT). Under this special customs regime (outward and inward processing trade) firms can benefit from tariff exemptions for goods that are temporarily exported or imported for transformation, repair or assembly from a country to another country. In particular, inward processing trade occurs when firms import temporarily raw materials, parts and components, accessories and packaging materials from a foreign country in order to realize further processing (inward processing imports) and subsequently re-export the finished products (inward processing exports). On the contrary outward processing trade implies exports of intermediate or semifinished goods to a foreign country for further processing (outward processing exports) and subsequent imports of the processed goods (outward processing imports)

26.

Those trade flows of goods usually take place between EU countries and extra-EU countries

27 and in both cases the re-imported or re-

exported processed products benefit from an exemption from duties or levies normally applied to traded goods

28.

Processing trade is closely connected with the fragmentation and disintegration of production processes undertaken by enterprises in order to relocate abroad some stages of the value chain. In this perspective several authors argue that information on processing trade is relevant for measuring offshoring. Nonetheless there are some shortcomings of OPT data as a measure of offshoring. First of all, this measure doesn‟t take into account final products because OPT involves mainly trade in intermediate goods. Moreover the lowering of trade barriers, as a result of a rising economic integration, could have attenuated the advantages granted for the OPT. We should consider also that firms can adhere voluntarily to the OPT and consequently the extent of these processes could be underestimated by official statistics

29.

Finally, this measure cannot capture the growing trade realized within the European Union countries

30.

26 See Michel, B. (2008), Trade-based measures of offshoring: an overview for Belgium, Working Paper n. 9, Brussels, March; Egger, H., Egger, P. (2001), Cross-Border Sourcing and Outward Processing in EU Manufacturing, The North American Journal of Economics and Finance. 27 Processing trade is a particular customs regime established in Europe about twenty years ago. It records movements of goods that are processed outside the European area (temporary exports) and flows of European temporary imports from other countries. 28 See Tajoli, L.(2002), Scambi internazionali e frammentazione internazionale della produzione, Fondazione Masi; Valdani, E., Bertoli, G. (2006), Mercati internazionali e marketing, Edizioni

Egea. 29 The OPT is a not obligatory customs regime. So firms can use other ways to realize processing activities abroad. In this case we refer to “unauthorized processing trade”: it is an export operation without a change of ownership and entails the loss of the advantages related to tariff exemptions. 30 See Tajoli (2002); Bacci (2006).

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Supply and use tables Over the last few years, with the fragmentation of production and the increasing importance of offshoring, trade in intermediate inputs has been steadily growing. To measure trade in intermediates several authors adopt a statistical methodology based on the analysis of supply and use tables

31.

Supply and use tables give detailed information on the production processes, the interdependencies in production, the use of goods and services and the generation of income in production. The supply table provides a picture of the supply of goods and services by domestic production and imports. While the use table provides information on the use of goods and services for intermediate consumption and final use (consumption, gross capital formation, exports). It also shows how the components of value added (compensation of employees, other net taxes on production, consumption of fixed capital, net operating surplus) are generated by industries in the domestic economy. Thus, supply and use tables show the structure of the costs of production and income generated in the production process, the flow of goods and services produced within the national economy, and the flows of goods and services with the rest of the world

32.

These tables also form the basis for deriving symmetric input-output tables by applying certain assumptions to the relationship between outputs and inputs. Country I-O tables contain information about the use of intermediate goods and services as inputs in different industries. In particular, they show how much of the output of one industry is used as an input by another industry. Furthermore, these tables are used for input-output analysis with several different purposes

33. Their format can

either be made on the basis of an industry by industry or product by product classification. Thus, I-O tables allow in the same matrix the identification of both the industry of origin and the using industry. In fact, a symmetric input-output table rearranges both supply and use tables in a single table, describing the domestic production processes and the transactions in products of the national economy in great detail. To measure offshoring activities further information can be obtained from the analysis of another table: the import matrix. The intermediate use part of this matrix shows the use of imported goods and services by product and industry in production. While the final demand part of the import matrix shows the use of imported goods and services by categories of final use. In the columns the table has the same format as the use table. It distinguishes two main submatrices, one for the intermediate use and one for the final use of products. The total use of imports must be equal

31 Campa and Goldberg (1997); Feenstra and Hanson (1999); Hijzen et al. (2004); Ekholm and Hakkala (2005); Bracci (2006); Cheung and Rossiter (2008). 32 Eurostat (2008), Eurostat Manual of Supply, Use and Input-Output Tables, Methodologies and working papers, Luxembourg. 33 See Galasso, A., Infantino, G. (2008), Analisi input-output: presupposti teorici e possibili applicazioni, Ministry of Economy and Finance, Department of Treasury, Economic Focus n.7, November.

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to the total supply of imports as shown in the supply table. This equality is given for each of the products distinguished in the supply and use system. On the basis of these tables we can formulate a measure of offshoring, under the assumption that the import share of a commodity used as an intermediate input is the same as the share of imports in total domestic consumption of this commodity .

In fact, following Feenstra and Hanson (1999) an important indirect index of offshore outsourcing can be constructed as the share of imported intermediate inputs in either total output, total intermediate inputs or value added

34.

THE INTERNATIONAL PRODUCTION RELOCATION IN ITALY Over the last few years, offshoring operations performed by Italian firms have shown a steadily growing importance in international trade. Several studies have pointed out the intensification of this phenomenon, both referring to the whole national economy and to specific geographical areas or industrial sectors

35.

Nonetheless, Italian firms‟ internationalization of production seems to be quantitatively smaller than that of other advanced economies. This is likely to be the consequence of the Italian economic system, characterized by a large predominance of small and medium firms and also by the importance of industrial districts

36.

It is important to bear in mind these structural features, when we analyze offshoring processes in Italy. In fact, if we rely only on studies based on FDI data we could underestimate the real extent of the phenomenon, especially in the case when offshoring activities are mainly realized by small and medium enterprises. Hence, for Italian firms, studies based on sectorial data could be more appropriate in order to evaluate offshoring. Furthermore, we can obtain helpful information on the increasing international trade of intermediate goods and services from the analysis based on supply and use tables.

34 See Bracci, L., Una misura della delocalizzazione internazionale, in “Rapporto ICE 2005-2006- L’Italia nell’economia internazionale” pp. 231-238; Bracci, L., Astolfi, R., Giordano, A. (2006), La rappresentazione delle importazioni per settore di attività economica e di utilizzazione, Rome, June; Cheung, C., Rossiter, J. (2008), Offshoring and its effects on the labour market and productivity: a survey of recent literature, Bank of Canada Review. 35 See Bracci (2006); Conti et al. (2006); Corò et al. (2006); Prota and Viesti (2007); Palmieri (2008). 36 See Federico, S. (2006), L’internazionalizzazione produttiva italiana e i distretti industriali: un’analisi degli investimenti diretti all’estero, Banca d’Italia, Temi di discussione, n. 592; Amighini, A., Presbitero, A. F., Richiardi, M. G. (2010), Delocalizzazione produttiva e mix occupazionale, MoFiR, working paper n.42, May.

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Italian Foreign Direct Investment If we examine Italian FDI trend, we can see that both inflows and outflows of foreign direct investment have been steadily increasing, over the last few decades. In particular, outward FDI showed a marked rise at the end of the „80s, reaching $ 7,614 million in 1990. Overall, their value grew from $ 114 million in 1970 to $ 43,918 million, in 2009. As regards inward FDI, their value rose from $ 624 million to $ 30,538 million in the same period (1970-2009). FDI inflows plummeted in 2008 in Italy, as well as in other countries belonging to all three major groupings – developed, developing and transition economies. This global decline reflects the weak economic performance in many parts of the world, as well as the reduced financial capabilities of MNEs

37.

Fig. 1: Italian FDI trend (1970-2009)

Source: UNCTADstat, Inward and outward foreign direct investment flows. (Values in millions of US dollars at current prices and current exchange rates).

Over the last thirty years, both inflows and outflows FDI have reported a more moderate growth compared with that of the other advanced economies. In particular, if we take a look at Italian outward FDI, we can see that they still remained at a lower level than that in other European developed countries.

37 UNCTAD (2010), World Investment Report.

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Fig. 2: Outward FDI of more developed European countries (1970-2009)

Source: UNCTADstat, Annual outward foreign direct investment flows. (Values in millions of US dollars at current prices and current exchange rates).

Nonetheless it is worth to notice that, in recent years, Italian outward FDI, as their share of world total FDI outflows, have increased significantly. The incidence of these flows with respect to global flows grew from 0.8% in 1970 to 4% in 2009. In particular, we can observe a significant enhancement of Italian outflows as their share of outward FDI in EU countries. Over the last thirty years, this share rose by 9.05 p.p., reaching the percentage of 11.3 in 2009.

Fig. 3: Italy’s share of outward FDI (%)

Source: Own calculations on UNCTADstat data.

If we analyze the destination of Italian FDI flows, we can see that they are directed mainly to rich and large countries, with similar factor

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endowments (horizontal FDI based on market-access strategy). The major countries involved in Italian firms‟ investment operations are the European Union countries and the United States. Over the last decade, net Italian FDI flows directed to EU rose by 200.41%, reaching a value of € 30,663 million in 2009

38. In particular

these flows reached a peak of € 61,306 million in 2007. Similarly, FDI outflows towards America grew by 331%, from 2000 to 2006, but they dropped by 97% to € 12,243 million, over the last four years, and recorded a value of € 372 million in 2009. This recent contraction reflects the global economic and financial crisis that weighed on FDI outflows from developed countries.

Fig. 4: Italian outward FDI by main destination area (2000-2009)

Source: Annuario statistico Istat-Ice 2009. (Values in millions of euro).

By referring to Europe, over the last ten years, Italian firms have realized foreign investments mainly in these countries: Netherlands, Germany, France, Ireland, Spain and United Kingdom. In particular, FDI outflows directed towards Netherlands grew significantly from 2000 to 2006: their value rose from € 473 to € 14,862 million, but declined to € 10,847 million in 2009. A significant value has also been recorded in Spain: Italian outward FDI reached the value of € 23,370 million in 2007. Furthermore it is worth to note the increase of FDI outflows directed to Ireland: their value grew from € 103 to € 3,840 million in the considered period (2000-2009).

38 We consider the value of Italian outward FDI on the net of the divestments.

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Fig. 5: Italian outward FDI directed to main European countries (2000-2009)

Source: Annuario statistico Istat-Ice 2009. (Values in millions of euro).

A further analysis of Italian outward FDI by industry highlights that most of these flows are directed to the sector of energy products. The FDI outflows towards this sector increased significantly from 2000 to 2007: their value rose from € 45 to € 27,574 million and dropped to € 12,038 million in 2009. With regard to outward FDI directed to industrial products sector, we can observe an overall increase by 52.23%, from 2000 to 2009 (their value was equal to € 7,333 million in 2009). Also FDI outflows concerning the sector of market services rose considerably from 2000 to 2006: their value grew from € 5,647 to € 13,545 million, but declined to € 6,100 million in 2009.

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Fig. 6: Italian outward FDI by industry ( 2000-2009)

Source: Annuario statistico Istat-Ice 2009. (Values in millions of euro).

Italian Processing Trade It is also important to analyze data on processing trade flows as a proxy of offshoring operations, given the growing relevance of the fragmentation of production in international trade. As regards inward processing trade (IPT), this measure should be interpreted as a proxy of the attractiveness of the country as a destination of the production relocation processes. In this case, we consider flows concerning temporary imports and re-exports of processed products, as well as outward processing trade (OPT) flows concerning temporary exports and subsequent re-imports of products that are processed abroad. This is the proxy usually examined for measuring offshoring operations undertaken by national firms. If we analyze Italian flows of processing trade, we can observe that flows related to inward processing trade have shown a higher amount than those of outward processing trade, although they were declining over the last decade. In particular, temporary imports showed an amount of € 8,914 million in 2009 (with a decrease by 10.76% respected to 2000), while the value of re-exported products decreased from € 10,454 million in 2000 to € 8,871 million in 2009. As regards flows related to OPT, from 2000 to 2007 we can see that both temporary exports and re-imports increased. In particular, temporary exports grew by 25.46% reaching a value of € 4,065 million in 2007, while re-imports rose by 34.17% to € 4,688 million, in the same year. Nonetheless, in 2009, their values dropped respectively to € 2,957 million and to € 3,804 million.

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Table 1: Italian processing trade (2000-2009)

Source: Annuario statistico Istat-ICE 2009 and own calculations.

An index of the propensity to the fragmentation of production processes can be calculated as the ratio between temporary exports and total exports. This ratio is particularly high in North-East Italy, although it declined by 0.76 p.p. over the last ten years: the value of temporary exports as their share of total exports decreased from 2.07% in 2000 to 1.31% in 2009. Whereas, in Central Italy, the incidence of temporary exports increased by 0.58 p.p., reaching a percentage of 1.41% in 2009.

Fig. 7: Share of temporary exports over total exports by Italian areas (%)

Source: Own calculation on the basis of data of Annuario statistico Istat-ICE 2009

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Final flows

Exports 260,413 272,990 269,064 264,616 284,413 299,923 332,013 364,744 369,016 290,800

Imports 258,507 263,757 261,226 262,998 285,634 309,292 352,465 373,340 382,050 295,855

Inward processing trade (IPT)

Temporary imports 9,989 9,207 9,156 7,992 8,817 8,874 9,418 9,600 8,526 8,914

Re-exports 10,454 9,737 9,973 8,409 8,824 9,324 10,275 10,267 10,145 8,871

Outward processing trade (OPT)

Temporary exports 3,240 3,232 3,082 2,850 3,252 3,091 2,786 4,065 3,720 2,957

Re-imports 3,494 3,865 3,445 3,123 3,504 3,355 3,170 4,688 4,568 3,804

Incidence of processing trade

Re-exports/total esports 4.01 3.57 3.71 3.18 3.10 3.11 3.09 2.81 2.75 3.05

Temporary imports/total imports 3.86 3.49 3.51 3.04 3.09 2.87 2.67 2.57 2.23 3.01

Temporary exports/total exports 1.24 1.18 1.15 1.08 1.14 1.03 0.84 1.11 1.01 1.02

Re-imports/total imports 1.35 1.47 1.32 1.19 1.23 1.08 0.90 1.26 1.20 1.29

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Analysis on the basis of Italian supply and use tables We can obtain significant information on the phenomenon of offshoring from the analysis based on the supply and use tables. In particular, the international production relocation is examined on the basis of information contained in the table of imports. This table is used in combination with the total use matrix in order to evaluate the content of the inputs employed by firms in production processes. Following Feenstra and Hanson (1999), a measure of offshoring can be obtained calculating an index defined as the ratio between the imported intermediate inputs and the total intermediate inputs of products, by restricting the attention to those inputs that are purchased in a given industry from the same industry. This measure is called “narrow measure of offshoring” and is calculated as the ratio between the diagonal elements (related to the same industry) of the two use tables: the use table of imports and the total use table. Thus, this index is constructed as the ratio between the import of intermediate inputs of good i by industry i and the total purchases of intermediate inputs by industry i from industry i. This means that imported intermediate inputs are limited to product categories that are considered as main output of an industry. It contains the implicit assumption that for any product the share of imports is the same in all uses, i.e. no matter whether the product is used as intermediate input or for final demand. This is the so called “proportionality” assumption that any manufacturing industry would resort to intermediates or market services to the same extent in a particular year

39.

As regards the Italian context, we analyze the so-called “narrow measure of offshoring” on the basis of the most recent available data on the imported intermediate inputs, over the period 1995-2007. The significant increase of this measure, observed with reference to several economic sectors, confirms the progressive propensity of firms to replace domestically produced inputs with imported inputs. In particular, this index grew mainly in these following economic sectors: Food products and beverages; Textiles; Wearing apparel and furs; Leather and leather products; Wood and products of wood and cork (except furniture); Coke, refined petroleum products and nuclear fuels; Chemicals, chemical products and man-made fibres; Basic metals; Office machinery and computers; Air transport services; Post and telecommunication services; Insurance and pension funding services. First of all, the analysis highlights a relevant increase of the narrow measure of offshoring concerning textiles and wearing apparel: in particular, the index was equal to 30.26% in 2007 (it increased by 9.73 p.p. compared to 1995) for textiles; while as regards the wearing apparel sector, it rose by 38.96 p.p., reaching a percentage of 52.67 in 2007. These results reflect the substantial changes which interested the production structure of the apparel industry in recent years.

39 It is implicitly assumed that an industry uses an import of a particular product in proportion to its total use of that product

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The value of this index for food industry was 25.48% in 2007, increasing by 3.45 p.p. with respect to 1995. As regards Coke, refined petroleum products and nuclear fuels, the measure rose from 29% to 66.46%, in the same period. While, referring to Office machinery and computers, the offshoring index increased by 18.98 p.p., confirming the growing relevance of this sector in international strategies undertaken by firms. It is also relevant the growth of the index in the sector of chemical products (+15.34 p.p.) as well as that observed in the sector of basic metals (+13.3 p.p.). Hence, we can deduce that the international production relocation has recently fostered the replacement of domestically inputs with imported intermediate inputs. The only sectors which do not show this tendency are: Products of agriculture, hunting and related services; Pulp, paper and paper products; Radio, television and communication equipment and apparatus; Motor vehicles, trailers and semi-trailers. Nonetheless the last three sectors still show relatively high values of the narrow measure of offshoring.

Fig. 8: “Narrow measure of offshoring” concerning the main economic sectors (%)

Source: Own calculations on the basis of ISTAT data (Supply and Use tables, January 2011).

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CONCLUSIONS The analysis conducted in this paper is focused on the international production relocation realized by Italian firms over the last decades. The recent expansion of international transactions and activities reflects the increasing liberalization in global trade as well as the technological improvements in telecommunications and information flows. Nonetheless Italian firms‟ internationalization of production seems to be quantitatively smaller than that of other advanced economies. This is due to two main specific features that characterize the Italian production structure: the large predominance of SMEs (small and medium enterprises), on one hand, and the great relevance of industrial districts, on the other hand. Bearing in mind these structural features we must not restrict our analysis only to information obtained from FDI data. In particular, for Italian firms, studies based on sectorial data could be more appropriate in order to examine the phenomenon of offshoring. Moreover, further helpful information can be obtained from the analysis based on data contained in supply and use tables. On the basis of these considerations, the analysis of Italian firms‟ offshoring processes has been conducted with reference to different sources: data on FDI, data on processing trade and data contained in supply and use tables. Firstly, as regards the analysis of FDI, both national and international statistics showed that these flows have grown significantly over the last thirty years, even though their levels remain lower than that of other advanced countries. In particular, we can observe a relevant increase of outward FDI: these flows as their share of FDI outflows in EU countries have risen notably since „90s. The main destination are the European countries and the United States, while by referring to different economic sectors most of these investment flows involve market services and the industry of energy products. Secondly, the analysis conducted on the basis of processing trade data showed that flows related to IPT have a higher amount that those of OPT, although they have been declining over the last decade. While the latter flows have shown a significant enhancement over the period 2000-2007. Finally the analysis of supply and use tables has allowed the construction of the so-called "narrow measure of offshoring", on the basis of Feenstra and Hanson's works. This measure is calculated as the ratio between imported intermediate inputs and total intermediate inputs, using data contained in both the two use tables: the use table of imports and the total use table. The significant enhancement of this index, which can be observed in several economic sectors, confirms the growing propensity of firms to replace domestically produced inputs with imported inputs in production processes.

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2011, Valentina Saieva The document can be downloaded from the website www.dt.tesoro.it and freely used, providing that its source and author(s) are quoted. Editorial Board: Lorenzo Codogno, Mauro Marè, Libero Monteforte, Francesco Nucci, Franco Peracchi Organisational coordination: Marina Sabatini