DRIVES SERVICE OFFSHORING

The leading driver of offshoring is that it creates opportunities to lower the cost of producing goods and services, owing to much lower wages in developing countries.3 Wage differences between offshore labor, given that domestic outsourcing appears much more extensive than offshoring (for example, in the data presented in Amiti and Wei).
4 That can also be a source of productivity growth for the overall economy. In fact, Amiti and Wei estimate that service offshoring accounts for about 11 percent of U.S. productivity growth in 1992-1999, although their finding of such a large contribution is surprising given the small amount of service offshoring and the indirect nature of their offshoring measure. (In their estimate, the productivity boost comes from an annual average increase of about 0.014 percentage points in the share of imported service inputs in total non-energy inputs. Furthermore, domestic outsourcing is not distinguished from offshoring in their data. The benefit of contracting out to specialized firms applies to domestic outsourcing as well as offshore outsourcing.)
7 developing countries and the U.S. have existed for a long time, but it has become possible to take advantage of them for production of services only in recent years, especially over the past decade, thanks to the rapid progress of IT technologies. The dot-com boom of the late 1990s may have also contributed to the feasibility of offshoring by leading to substantial investments in fiber-optic cable installations around the world and in other IT technologies, which reduced communication costs and thereby made offshoring of services less costly. Those developments changed the trade-off between costs and benefits of locating service jobs to remote locations, giving rise to offshoring.
In addition to lowering labor costs, another channel by which offshoring reduces costs is that it helps firms concentrate on their main areas of expertise by enabling those firms to contract out their auxiliary tasks to specialized firms, which are likely to be more efficient at those tasks and hence do them at lower cost.