Outsourcing and rising wage inequality in the United States and Germany

Talking or writing about the outsourcing of jobs can conjure up images of jobs moving abroad. Increasingly, however, economists are demonstrating the importance of the domestic outsourcing of jobs in the U.S. labor market. A recent paper by Lawrence Katz of Harvard University and Alan Krueger of Princeton University highlights the importance of the “offline” gig economy, such as the rise of independent contractors in the years since 2005, rather than the more talked about role of the online gig economy (think Uber) in domestic outsourcing. A book by David Weil, the outgoing Department of Labor Wage and Hour Administrator, also documents the “fissuring” of the U.S workplace as more and more work is outsourced by firms within the United States.

But how much is the increased domestic outsourcing of jobs affecting the wages of workers?

A recent paper offers an answer, at least for German workers. Deborah Goldschmidt and Johannes Schmeider of Boston University look at how the increase in domestic outsourcing has affected wages and the wage distribution in Germany. The two economists take data that records not just information about workers (wages, education level, age) but also information about the employers they work for (by industry, the wages of other workers at the firm, and other factors) These data allow Goldschmidt and Schmeider to see what happens to the wages of workers after outsourcing occurs.

The data don’t directly show when an individual worker is moved to a contractor firm despite doing the same work, so the authors of the paper create measures that let them determine if a worker has been outsourced. They then compare the wages of a worker who has been outsourced to a similar worker who stayed inside the original firm. Goldschmidt and Schmeider find that domestic outsourcing leads to wage reductions of about 10 percent.

What’s behind this decline in wages? Well, workers who get outsourced are missing out on the “rent” (essentially excess profits) that the firm is sharing with the rest of the workers. Work on the rise of wage inequality in both Germany and the United States points to the importance of inequality within firms. By siphoning off “non-core” workers into contracted firms, management at the original firm is denying access to the wage benefits of working at the firm. Such a firm effect is a good sign that firms have the power to set wages—rather than the commonplace belief that wages are set by perfectly competitive labor markets.

Godlschmidt and Schmeider’s results are specific to the German experience and can’t directly speak to the U.S. labor market. But research on outsourcing in the United States also finds significant declines in wages for outsourced workers. An analysis similar to the German one could be done for the United States by accessing data from sources such as Longitudinal Employer-House Dynamics program or the Social Security Administration. Research on inequality in the United States using social security data points toward increasing “wage segregation” as a source of rising interfirm inequality. Yet given the rising attention toward outsourcing it would be good to have more concrete estimates of its impact on affected workers’ wages by tapping both data sets.