Introduction

A growing number of recent studies dealing with the economic impacts of production fragmentation on the labour market have increasingly weighed in on the phenomenon of a widening income gap between skilled and unskilled workers in developed countries. In these studies, the evidence pointed to the international dimension of production fragmentation — particularly, international outsourcing or the uses of intermediate imports — as a key catalyst of this trend in that technical advances in information technology and closer trade ties to the global market have entailed surges in outsourcing of less skillintensive activities to unskilled labour-abundant countries, thereby spurring the worsening wage inequality in terms of exporting unskilled jobs to developing countries (Amiti and Wei 2009). A theoretical relationship between imports of intermediate inputs and a shift in relative demand for skilled workers observed in the industrialized economies lies with the standard Heckscher-Ohlin (H-O) Theorem. In this well-known theoretical framework, the industrialized economies where skilled labour is typically well-endowed are predicted to specialize more skill-intensive production activities and make use of less skill-intensive intermediate imports from developing countries where unskilled labour is relatively abundant. Given the perfectly competitive labour market, the reallocation of resources toward skillintensive sectors will ultimately shift the relative demand for skilled workers in industrialized economies.

Recent developments, nonetheless, indicated that developing countries are also affected by fragmentation of the production. In fact, outsourcing activities have increased substantially among the Southeast Asian countries (Ahn et al. 2008). Even though Japan has long been an important source of intermediate inputs for these regions, the evidence shows that the Southeast Asian countries are also emerging as crucial source countries for intermediate inputs. Concurrently, it has been observed that the Southeast Asian countries have experienced staggering increases in intermediate imports from China and other key Southeast Asian members, especially Indonesia, Malaysia, the Philippines and Thailand. These observations therefore highlight that firms operating in this region procure intermediate inputs from both local and foreign suppliers.

In this regard, the idiosyncratic nature of outsourcing activities in this region forces me to approach this empirical question in a non-standard way. The impacts of production fragmentation on labour markets in developing Southeast Asia must pertain not only to the imports of intermediate inputs, but also to contracting out production activities at arm's length locally.

Introduction

Changes in productivity of a firm are perhaps the most fundamental question of the economic impacts of production fragmentation (or outsourcing). It appears to be widely accepted that outsourcing has become an increasingly imperative option for manufacturing and non-manufacturing sectors to lower their operation costs, enhance their profitability performance, and maintain their competitiveness in domestic and international markets. Görg and Hanley (2005) documented: “A recent survey involving CEOs from 440 product and service companies found that respondents who outsourced intermediates (material inputs and services), realised higher profits and revenue than those that did not.” Productivity improvements outsourcing conveys emanate from specializing in in-house production of core-competent activities, accessing technical expertise unavailable in-house, and acquiring a larger, cheaper pool of intermediate materials and services.

The purpose of this chapter is to empirically examine the impacts of outsourcing on productivity performance by employing Thailand's establishment-level data. The simple empirical exercise presented in this chapter produces the following interesting findings. Firstly, outsourcing helps boost productivity of an establishment, measured by the ratio of output to capital assets in Thailand's manufacturing industries. Secondly, the productivity gains may be attributable to the fact that establishments with higher outsourcing intensity are more likely to employ high-tech capital, such as computer machinery and equipment, intensively, thereby augmenting its productivity. Thirdly, a breakdown of the establishmentlevel dataset into two categories — one which pertains to international outsourcing and the other which contracts out the production stages purely locally — reveals that productivity gains outsourcing entails tend to be more pronounced for the former. In this sense, outsourcing locations have a say in the relationship between outsourcing and productivity improvements. Last but not least, nationality of ownership matters. The empirical evidence shows that a foreign-owned establishment reaps greater benefits in terms of higher productivity from contracting out production stages at arm's length than does a locally-owned one.

This chapter contributes to the existing research that examines the impacts of outsourcing on productivity and performance at the firm or industry levels. Much literature has been devoted to empirically examining such a linkage in industrialized economies, especially the United States (U.S.), the European Union (EU), and many newly industrialised economies (NIEs). The lack of evidence in developing countries is due largely to the absence of detailed statistics that enable one to analyse its economic consequences.

Industrial Productivity Development

Since the last two decades, the formation of production fragmentation and networks in Southeast Asia has provided a wide array of business opportunities for local firms and Multinational Enterprises (MNEs) to leverage on ever-increasing productivity growth, especially in Malaysia, Singapore, Thailand and Vietnam. Based on this firm operating model, production stages are finely partitioned into many stages and carried out in different locations across regions and economies. As discussed in Chapter 3, there are at least two key mechanisms through which the prevalent use of production fragmentation accounts for a surge in firm productivity.

The first driver lies with vertical division and specialization of production factors, known as productivity gains from specialisation, and is attributable to technological advancement like computer and electronic revolutions in business management and operations. Thailand's machinery industry, for instance, participated in production and distribution networks by producing parts and components and supplying them to the growing mobile cluster industry. In this sense, outsourcing of parts and components allows the automobile and machinery industries to carry out what they are good at and ultimately enhance their productivity and competitiveness as a whole.

The other catalyst of productivity development is concerned with the improved access to intermediate inputs which are available at lower costs and/or better quality than what outsourcing firms had obtained by in-house production. This driving force of productivity growth emanates mainly from technology transfers and spillovers that help defray costs, expand varieties, and improve quality of intermediate inputs available to them. Furthermore, in comparison with in-house production, contracting out of production stages at arm's length offers much larger adjustability and resilience of production patterns and thus much more opportunities for firms to reap benefits from technology transfers or spillovers, especially the physical movements of technology and managerial know-how.

The latter productivity-enhancing mechanism is particularly vital to developing Southeast Asia as recent developments of production fragmentation and networks have presented new challenges of technology transfers and spillovers across industries and regions. Under the competitive business environment, arm's length transactions that entail industrial agglomerations and vertical division of production factors boost firms’ absorptive capacity of technology — a crucial element of technological spillover process. It would put pressure on local firms and MNEs to actively seek productive business partners and/or suppliers to secure their sources of intermediate parts and components at acceptable quality, specifications, prices and delivery timing.

Introduction

The past few decades witnessed a remarkable increase in production fragmentation and outsourcing activities in the world (Abraham and Taylor 1996; and Díaz-Mora 2007). The dominance of outsourcing which has become part and parcel of business practices is attributed to persistent plunges in transaction costs as a consequence of the prevalent uses of the information and transportation technology and trimmed trade barriers. The lack of intuitive understandings of its impacts on domestic labour markets gives rise to an exploding number of studies that inquire one of the main research questions in the literature — how does outsourcing elicit changes in labour productivity? The production theory suggests that outsourcing may be beneficial for productivity of labour employed in-house in at least two ways (Amiti and Wei 2009). First, the decision to outsource intermediate inputs is concerned with compositional changes. Fragmented stages of production allow a firm to contract out non-core production activities and reallocate the existing labour to core-competent activities. As workers become more concentrated on and/or specialized in the activities in which a firm possesses comparative advantage, one would expect higher productivity and performance workers can exert. Furthermore, outsourcing also results in structural changes — an outsourcing firm tends to have advantages over an integrated firm in terms of the superior access to a cheaper pool, more variety and higher quality of intermediate inputs. These structural improvements ultimately enable labour to materialize higher productivity via learning.

Using Thailand's establishment-level data, the present chapter empirically investigates the impacts of outsourcing on labour productivity, measured by output per worker. My empirical estimates reveal that outsourcing contributes to labour productivity growth in Thailand's manufacturing industries and hence are rather consistent with the findings by previous research, including Görzig and Stephan (2002), Egger and Egger (2006), and Amiti and Wei (2009), among many others. I also attempt to account for two establishment-specific characteristics — outsourcing locations and foreign ownership. The extension confirms the findings by Chongvilaivan and Hur (2011) that the effects of outsourcing on labour productivity are more pronounced for an establishment that pertains to international outsourcing, and therefore sheds further light on the crucial roles of outsourcing locations in explaining a shift in labour productivity.

Introduction

Much research has been devoted to attempts to empirically investigate the extent to which disintegrating production affects an economy. These include the effects on firm performance, factor productivity and labour markets. In these studies, the notion of production fragmentation has to do with the aggregate uses of materials and services inputs. However, recent developments witnessed a growing amount of evidence showing that there are different economic effects pertinent to contracting out of different types of intermediate inputs. This implies that a more refined treatment of outsourcing activities is indispensable for obtaining more accurate empirical results.

The role of outsourcing typology is not new. Several studies in various economies have pushed forward different types of outsourcing activities that exert different economic effects. There are at least three main approaches prevalently employed in the literature to take in heterogeneous effects of outsourcing typology.

Firstly, the nature of outsourced inputs (tangibles or services) is perhaps the most commonly utilized approach to separation of outsourcing types. A number of recent studies showed evidence that outsourced materials and services matter to the underlying economic impacts in contrasting ways. Görg and Hanley (2005), for instance, empirically examined a relationship between outsourcing activities and firm-level productivity using the firm-level data for the electronics industry in Ireland. They found that materials outsourcing contributes to total factor productivity growth whereas there is no such positive effect observed for services outsourcing. Using the same Irish dataset, Görg et al. (2008) attempted to control for firm-level heterogeneity and further revealed that potential productivity improvements from outsourcing of services inputs accrue only to exporters. Likewise, Amiti and Wei (2009) investigated productivity effects of international outsourcing of materials and services inputs in the United States (U.S.) manufacturing industries. They found rather contrasting evidence that outsourcing of both materials and services inputs rendered positive effects on productivity and accounted for around 10 and 5 per cent of observed productivity growth, respectively, in the period of 1992–2000. Their robustness checks further indicated that productivity gains from services outsourcing are robust across all specifications, but those from materials outsourcing are not.

Production fragmentation is a phenomenon of great worldwide interest. Due to technical advances in both production and communication technology, fragmenting and contracting out production of intermediate materials and services have spilled over into the Southeast Asian arena. Even though fragmentation which has become part and parcel of manufacturing production has stimulated keen research interest in its economic consequences, there have been loopholes in the literature. First of all, most existing research on the subject is primarily concerned with the issues related to the industrialized countries. The economic impacts on developing Southeast Asia, however, has received only little attention. Second, despite countless reports on the magnitude and growth of production fragmentation, the distinctive nature of production fragmentation in developing economies like those in the Southeast Asian region makes thorough understandings of its impacts greatly subtle. Last, and perhaps most importantly, the absence of rigorous research is largely attributable to the lack of solid evidence that hallowed a continuous public debate without a strong information base.

This book attempts to bridge these gaps in the existing studies. In contrast with the existing literature, this book provides complete, yet non-technical, analyses of production fragmentation effects and thus targets a wide range of readers — including academics, researchers, policy-makers, students, entrepreneurs, and anyone who is interested in this subject. It investigates the economic impacts of production fragmentation, such as its effects on firms’ performance, wage inequality and skills upgrading in Southeast Asia with a focus on Thailand's experience of emerging as a global hub of fragmentation and outsourcing. This book studies these phenomena from the perspectives of developing countries and thus elucidates new evidence in connection with production, industrial organization and labour economics theories, providing interesting insights for formulating industrialization and labour development policies.

Usual caveats apply. Although a number of issues such as measurement errors, causality problems, potential endogeneity biases, and modest goodness of fit statistics are by all means indispensable, they remain unanswered in my analyses, and therefore my findings should be contemplated as tentative. Tackling these issues requires extensive discussions and analyses and hence may be far beyond the scope of this book. I leave them for the possible avenues of future research.

The objective of this chapter is to explore characteristics of the establishments operating in Thailand's manufacturing industries based on the establishment-level data retrieved from the reports of the 2003 Manufacturing Industry Survey, provided by the National Statistical Office (NSO), Thailand. The main purpose of this survey is to collect basic information on industrial establishments with at least one person engaged throughout Thailand. This survey contains establishment-level information on production and cost structures such as numbers of employees, values of remuneration, raw materials, parts and components purchased, sales of goods produced, and fixed assets, among others. The information gathered contributed to the formulation of economic and industrial development policies as well as the decision-making process in both government and private sectors.

According to the survey, a manufacturing establishment refers to an establishment engaged in the mechanical or chemical transformation of substances into new products. The assembly of the component parts of manufactured products is also considered as manufacturing. Manufacturing activities are classified according to the 4-digit International Standard Industrial Classification (ISIC) Rev. 3. The survey pertained to sixty-two categories of manufacturing activities (4-digit ISIC) in twenty-three industries (2-digit ISIC).

As portrayed in Table 2.1, there were 8,862 manufacturing establishments pertinent to this dataset. Food and beverages manufactures accounted for approximately 25 per cent of the total samples and thus were the largest in terms of the number of establishments, followed by furniture (9.4 per cent), fabricated metal products (8.81 per cent) and textiles (8.80 per cent). The large numbers of establishments in these industries may suggest that the establishments encountered the high degree of competition. In contrast, office, accounting and computing machinery, recycling, refined petroleum products and tobacco were relatively less competitive as there were merely 14, 33, 36 and 47 establishments, respectively, operating in these industries.

Table 2.2 reveals the international exposure of establishments in Thailand's manufacturing industries in terms of foreign ownership, exports and use of imported intermediate inputs. These attributes have crucial implications on outsourcing decisions now that establishments with intensive exposure to foreign markets tend to find vertical disintegration less costly than domestic establishments, thanks to their superior knowledge and/or information on foreign markets and input providers (Markusen 1995 and Girma and Görg 2004). The first column reports the numbers of foreign-owned establishments.

The ruins of Tughluqabad Fort are a formidable reminder of a particularly painful period for the inhabitants of Delhi. The massive ruins built of enormous blocks of stone with walls as thick as ten metres in some areas were constructed between 1321 and 1325 by Ghiyas-ud-din Tughluq. On the southern side of the fort, a causeway runs across the dry bed of an artificial lake to reach a mausoleum surrounded by fortified walls. Within the mausoleum, a square sandstone structure topped by a white marble dome, lie buried Ghiyas-ud-din Tughluq and his son Mohammad Tughluq. The Tughluq dynasty, which lasted for about a hundred years from 1320 to 1414, was a period of profound misery for the Indian populace during which the atrocities perpetuated by the Tughluqs was capped by the massacre or enslavement of the non-Muslim population of Delhi in 1398 by the central Asian invader, Timur. Perhaps there were worse periods of misery in India but the misery of the fourteenth century was recorded in gloating terms by its perpetuators. The contemporary accounts include the history written by Barani whose family worked for several of the Sultans, Timur's own account of his invasion of India, and the descriptions of India by the Moroccan traveller, Ibn Battutah.

A fortress city associated with so much suffering spawns its own legends. It is said that the walls of Tughluqabad contain the skulls of thousands of captured Mongols. Ghiyas-ud-din, who was the general responsible for the defence of the kingdom against the Mongols during the rule of the last Khalji ruler, suggested to his master that a fortress be built at the site. The Khalji ruler replied with sarcasm that when his general became ruler he could do so. The last Khalji ruler reigned for less than five years and his general became the ruler and built the colossal fortress.

In popular folklore, the demise of the fortress is attributed to a quarrel between a Sufi religious leader and Ghiyas-ud-din. When Ghiyas-ud-din ordered the workers building a stepwell for the Sufi leader to work on his fortress, the Sufi leader cursed the fort saying it will be deserted. When the Sufi leader was told that the Sultan would be returning to Delhi and could presumably punish him for the curse, his prophesy was “Delhi is yet far away.”

Patna, on the southern bank of the Ganges at its junction with the Son, lies over the ancient city of Pataliputra. Though it is the capital of a state with more than eighty million people, it is a modest sized city in need of maintenance. There is little evidence of the past grandeur of Pataliputra, the greatest city of ancient India, except perhaps, at the Patna Museum where exquisite polished sandstone sculptures from the Mauryan period are exhibited. There is a faint glimpse of the ancient city about six kilometres from the train station, at Kumhrar, where excavations at a waterlogged site have revealed remnants of an eighty-pillared hall. Bihar has many developmental priorities to address before it can embark on excavations to uncover the lost city of Pataliputra beneath the several meters of alluvial laid down by the Ganges. Meanwhile, the magnificence of the city can be inferred from the accounts of the Greek ambassadors to the Mauryan court.

Megasthenese, the Greek ambassador at the court of Chandragupta Maurya, described the extent of Pataliputra as a parallelogram, 14 kilometres from east to west along the river and three kilometres from north to south. It was protected by massive timber palisades that were pierced by sixty-four gates and protected by watchful eyes from five hundred and seventy towers. The city exceeded the splendour of the Persian city of Susa and was, for that period, probably the greatest city in the world. A broad deep moat encircled the city serving both as a defensive barrier and as a sewer. In the year 321 BCE, in this city, Kautilya enthroned his protege Chandragupta Maurya as King of Magadha and India's first Emperor.

Kautilya was a Brahmin Jain from the South Indian village of Chanaka. Although endowed with a brilliant mind, he was hideously ugly and had deformities in his limbs. After studying at Taxila, he sought his fortune in Pataliputra, where his scholarship gained him the position of president of the Sangha, an assembly of academics. When he took the seat of honour at the royal court reserved for the president of the Sangha, presumably without the consent of the Nanda king, he was unceremoniously thrown out.

When Akbar's first children, a pair of twins, died shortly after they were born, he consulted a Sufi teacher, Salim Chishti, who lived as a recluse at Sikri, twenty-six miles west of Agra. Salim Chishti predicted that Akbar would have a son. When a son was born to Akbar in 1569, the child was named Salim. The next year, Akbar decided to build a magnificent new city at Sikri. The city was a recreation of the Mughal tent city but built with sandstone instead of canvas. The grandeur of Mughal power was expressed through the erection of a huge gateway, the Buland Darwaza. This gateway, thirty-five meters wide and fifty-three metres high, rose majestically from the top of a forty-two step stairway and was the world's highest gateway at the time of its construction. In a panel on the archway the following words are inscribed:

“Jesus, Son of Mary (on whom be peace) said: The world is a bridge, pass over it, but build no houses upon it. He who hopes for a day, may hope for eternity; but the world endures but an hour. Spend it in prayer, for the rest is unseen.”

Through the gateway, one enters the courtyard to encounter the two streams of belief prevalent among Akbar's Muslim nobility. There is a large Mosque which reflected the orthodox Sunni ideology and the marble tomb of Salim Chishti which reflected Sufi beliefs. Within Fatehpur Sikri, many buildings were constructed to meet Akbar's official and personal needs. The emperor conducted his private audiences at the Diwan-I-Khas.

In 1582, Akbar had to leave Fatehpur Sikri to chastise his half-brother in Kabul. Before he left, he conducted a ceremony in the Diwan-I-Khas to initiate his courtiers into a new religious order called the Din-I-Ilahi or Divine Religion. One by one, each initiate took off his turban and placed his head at Akbar's feet. The emperor raised each suppliant and placed the turban back on the head. The initiate then promised loyalty and pledged to place the four sacrifices at the emperor's disposal – his property, his life, his honour, and his religion. Henceforth, the initiate would greet another member of the order with the greeting: Allahu Akbar which means “God is great”. The reply to such a greeting would be Jalla Jalaluhu or “God's glory shines forth”.

On the western side of the Mahabodhi Temple in Bodhgaya, Bihar, is a large pipal tree. Under the shade of the tree, on its eastern side, an exquisite diamond throne has been erected. At this very site, in the year 528 BCE, the thirty-five year old Gautama attained enlightenment and became the Buddha. We have no contemporary records of this event or of the events that occurred during Gautama's life time. The earliest Buddhist records, the Tripitaka, were written at least a hundred years after Gautama's death. Nevertheless, from these records, Jain scriptures and the Buddhist Jataka stories, we can piece together the intertwined history of the lives of Gautama and the two most powerful kings of this period and their sons – King Prasenajit of Kosala and his son Virudhaka and King Bimbisara of Magadha and his son Ajatasatru.

Occupying the less fertile hilly lands north of the three Gangetic kingdoms of Kosala, Kasi and Magadha were a number of republics or gana-sanghas. Gana means equal and sangha means assembly. These were not true republics, but oligarchies in which power was shared by a number of ruling families who met at the assembly, while the majority laboured unrepresented. Sakya, just north of the powerful kingdom of Kosala was one such gana-sangha with about 80,000 families. Though they were subject to the overlordship of the Kosala kingdom, the Sakyas were a proud people who considered themselves socially superior to all others including the brahmins. Some gana-sanghas banded together to form confederations of which the Vrijian confederacy north of Magadha was the most powerful.

Gautama's father, the chief of the Sakyas married two sisters. In 563 BCE, the elder of the two sisters was travelling to her parents’ home when she delivered Gautama in a grove at Lumbini, 16 kilometres east of Kapilavatsu, the principal town of the Sakyas. As his mother died seven days later, Gautama was brought up by his mother's younger sister. Gautama was also called Siddhartha which meant “child of destiny”. The young aristocrat led a life of comfort marrying his cousin in his mid teens. After coming across sickness, old age and death, he became dissatisfied with his life and decided he needed to understand the meaning of life and death. Shortly after the birth of his son, Gautama aged twenty-nine, renounced the world to become an ascetic.