Global Sourcing in Innovation: Theory and Evidence from the Information Technology Hardware Industry

Economists, including Paul Samuelson and Jagdish Bhagwati, vigorously debate whether offshore outsourcing in high-tech industries helps or harms the U.S. economy. The main issue is whether insourcing countries, such as China or India, will catch up with and eventually outcompete the U.S. Moreover, the dearth of offshore outsourcing data has hindered the study of the impact of offshore outsourcing. To explore the impact of offshore outsourcing, I examine how the heterogeneity of offshore outsourcing demand affects insourcing rms' innovation choices and how these innovation choices connect with the technology-driven productivity growth of the insourcing industry. This paper contributes to our understanding of offshore outsourcing in three vital ways: First, I collect rm-level data of offshore outsourcing in IT hardware industries, a type of data that was previously nonexistent but sorely needed to deepen our understanding. Second, my empirical results show that the rise of offshore outsourcing, especially outsourcing in R&D activities, does help our overseas partners, such as China, gain technology-driven productivity growth, and hence narrows the technology gap between rms in outsourcing countries and in insourcing countries. This result offers some support for Samuelson's negative view that offshore outsourcing enhances Chinese productivity growth in the IT industry, with subsequent adverse impacts on the U.S. economy. Adverse effects, however, still depend on market forces behind the identi ed asymmetric holdup problem between outsourcing and insourcing rms. Third, this paper goes beyond the debate by showing why U.S. IT rms are increasingly outsourcing innovation overseas. These results have policy implications regarding strategic supplier management, technological progress, reverse brain drain in new industries, and the rapid market growth in China and India. ∗University of California, Los Angeles. E-mail: [email protected]. †I am extremely grateful to my advisor, Michael R. Darby, for his belief and guidance in this research. Deep gratitude and thanks are owed to Lynne G. Zucker, Harold Demsetz, Arnold C. Harberger, and Lee E. Ohanian for their encouragement and inspiring comments throughout the project. For helpful comments I am grateful to Jinyong Hahn, William Zame, Sandra Black, Steven Klepper, Aaron Tornell, and participants at UCLA Anderson School's Innovation Workshop and UCLA Industrial Organization and International Proseminars. I gratefully acknowledge nancial support from Chiang Ching-Kuo Foundation Dissertation Fellowship and data support from Market Intelligence Center. ‡Special thanks go to Paul A. Samuelson for his encouragement and valuable comments on this research. § c © 2006 by Wendy Li. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including c © notice, is given to the source.