Terms like ‘imports’, ‘outsourcing’ and ‘offshoring’ often have negative connotations in the public mind, as they are associated with firm closures and job losses. Trade barriers are often justified as a means of reducing import competition and “protecting” jobs. But the reality is quite different.
Imports can improve firm productivity and export competitiveness, and trade growth can contribute to global economic growth. Firms are outsourcing and offshoring in order to lower costs, acquire higher quality inputs, and generally improve their competitiveness.
Policies that restrict access to foreign sources of intermediate goods and services are more likely to produce firm closures and job losses – the very outcomes they were designed to prevent.
Intermediate goods and services
The key to how imports improve productivity and competitiveness is trade in intermediate goods and services – that is, trade in products that are used to produce other products.
Trade statistics distinguish between three types of goods: intermediate goods, capital goods and consumption goods. For example, a digital camera is a consumption good – the final product you buy in the shop. The machine tools used to make the camera are capital goods – they are part of the production process. And the electronic chip recording the picture is an intermediate good.
As well as goods, services can be intermediate inputs. For instance, the services offered by a consulting firm to the digital camera manufacturer are also intermediate inputs in the production of cameras.
OECD analysis shows that trade in intermediates dominates trade flows, representing 56% of trade in goods and 73% of trade in services in OECD countries.
Offshoring and outsourcing
When a firm sources intermediate inputs for its production process, it faces a choice along two dimensions. Offshoring relates to the location of production and involves the firm moving the production of the intermediate input abroad. On the other hand, outsourcing indicates a change in the boundaries of the firm, where the firm assigns the production of the intermediate input to an independent supplier.
Trade in intermediates will occur if the firm decides to offshore parts of the production process and to source the intermediates from a foreign country. Offshoring can take one of two forms: vertical foreign direct investment (FDI), where the intermediate is produced by a foreign affiliate of the firm, or offshore-outsourcing, where the intermediate is produced by an independent foreign supplier.
A firm may have always sourced an input from a foreign supplier, or may choose to do so in a changing context where it seeks to lower costs and improve its competitiveness. In either event, trade in intermediates should not be seen as a loss of production to foreign countries but rather as an explicit decision by domestic firms to maintain or improve its productivity and its overall competitiveness. Failure to do so would mean job losses, not job savings.
Regional characteristics of trade in intermediates
In regional terms, Europe, Asia and North America are the most important traders of intermediate goods. Asia is a net exporter of intermediate goods to Europe and to North America while Europe is a net exporter to North America. The opposite pattern occurs for services, with Europe a net importer of intermediate services from North America. The largest inter-regional flow of intermediate goods is actually exports from the Middle East and North Africa to Asia - this relates to primary resources, such as oil or gas.
Intra-regional trade is generally higher than inter-regional trade, indicating the importance of regional production networks. This is because intermediate imports are very sensitive to trade costs. Firstly, firms engage in vertical FDI or offshore outsourcing to cut costs and improve their productivity. Secondly, production networks are subject to geographic and time constraints, so distance can have a major impact on the decision to trade. Finally, some intermediate inputs are of a bulky nature. This is the case for raw material inputs whose value is low compared to their weight. For these intermediate goods, the impact of distance is higher simply because transport costs are too high for these goods to be traded from a remote location.
Emerging economies: integration through trade in intermediates
Major emerging economies are well integrated into global production networks, with intermediates exceeding 70% of total goods imports. This provides benefits both to their own economies and to those with whom they trade. Brazil, China, India and Indonesia each has a share of intermediates in total imports of more than 70%, well above the OECD average of 56%.
Firms in emerging economies can first specialise in the production of intermediate inputs because intermediates are less prone to home bias than final products. Once foreign firms producing intermediates are known and have more experience with the destination market, they can switch to the production of the final goods or services. For example, computer manufacturers in south-east Asia started by exporting parts and components to US and Japanese manufacturers and now have moved on to selling hardware to final consumers under their own brands.
Implications for trade policy
As the global economy begins to recover, but with employment growth lagging and high public debt levels in many countries, governments should have trade in intermediates in mind when formulating their trade policies.
More open markets offer widespread benefits, while protectionist trade policies impose high costs. Import barriers can deny firms access to the goods and services they need to compete internationally. Rather than protecting domestic jobs, trade restrictive policies can produce plant closures and job losses. On the other hand, more liberal trade policies allow firms to fully benefit from international production networks.
Trade comprises both imports and exports; both are beneficial for individuals, firms, countries and global economic performance.
For more detailed analysis and data on this subject, please read the reports:
How Imports Improve Productivity and Competitiveness (pdf, 426 KB)
Trade in Intermediate Goods and Services (OECD Trade Policy Working Paper No. 93) (pdf, 969 KB)
Trade and the Economic Recovery: Why Open Markets Matter
Trade, policy and the economic crisis