Macro Roundup

Firms are using technology to shift work to remote employees and third-party subcontractors. Outsourcing intensity has doubled from 11% in 2005 to 22% in 2021, which may compress white-collar wages going forward. “…Pinning down just how much firms depend on outsiders is tricky—companies do not advertise this sort of thing. A measure, “outsourcing intensity,” [tracks] a firm’s external purchase commitments in the upcoming year as a share of its cost of sales. The Economist has calculated the measure using data from financial reports for a sample of large listed firms from America and Europe. Average outsourcing intensity across our sample has nearly doubled from 11% in 2005 to 22% in the most recent year of data (either 2021 or 2022). This growth is especially pronounced among tech titans such as Apple and Microsoft; businesses that grew little over the analyzed period, such as Unilever, a British consumer-goods giant, saw only small increases. This is consistent with research which finds that as firms grow ever larger and adopt more technologies, thus becoming more complex and unwieldy, they outsource more operations—precisely as Coase would have predicted….”

Economist Staff, “How Technology is Redrawing the Boundaries of the Firm,” The Economist, January 8, 2023, https://www.economist.com/business/2023/01/08/how-technology-is-redrawing-the-boundaries-of-the-firm

How Technology is Redrawing the Boundaries of the Firm

Technology and business are inextricably linked. Entrepreneurs harness technological advances and, with skill and luck, turn them into profitable products. Technology, in turn, changes how firms operate. Electricity enabled the creation of larger, more efficient factories, since these no longer needed to depend on a central source of steam power; email has done away with most letters. But new technologies also affect business in a subtler, more profound way. They alter not just how companies do things but also what they do—and, critically, what they don’t do.

The Industrial Revolution ended the “putting-out system”, in which companies obtained raw materials but outsourced manufacturing to self-employed craftsmen who worked at home and were paid by output. Factories strengthened the tie between workers, now employed directly and paid by the hour, and workplace. The telegraph, telephone and, in the last century, containerised shipping and better information technology (it), have allowed multinational companies to subcontract ever more tasks to ever more places. China became the world’s factory; India became its back office. Nearly three years after the pandemic began, it is clear that technology is once again profoundly redrawing the boundaries of the firm.

In the rich world, fast broadband and apps like Zoom or Microsoft Teams are allowing a third of working days to be done remotely. Jobs are trickling out from big-city corporate headquarters to smaller towns and the boondocks. And the line between collaborating with a colleague, a freelance worker or another firm is blurring.

Companies are drawing on common pools of resources, from cloud computing to human capital. By one estimate, skilled freelance workers in America earned $247bn in 2021, up from about $135bn in 2018. The biggest firms in America and Europe are outsourcing more white-collar work. Exports of commercial services from six large emerging markets have grown by 16.5% a year since the pandemic began, up from 6.5% before it (see chart 1). On January 9th Tata Consultancy Services (tcs), an Indian it-outsourcing giant, reported another bump in profits.

A useful lens for understanding these changes was offered by Ronald Coase in his paper from 1937 entitled “The nature of the firm”. Stay small and you forgo the efficiencies of scale. Grow too big and an enterprise gets unwieldy—think of Soviet-style command-and-control economies. Most commerce happens in between those extremes. Coase, whose insights earned him a Nobel prize in economics, argued that firms’ boundaries—what to do and what not to do yourself—are determined by how transaction and information costs differ within firms and between them. Some things are done most efficiently in-house. The market takes care of the rest.

For example, between the 1980s and the 2010s, globalisation and the it boom boosted economies of scale, which encouraged market concentration. But they also increased competitive pressures and cut the cost of communication and collaboration between firms. The net result was for many companies to shrink their scopes. In research published last year Lorenz Ekerdt and Kai-Jie Wu of the University of Rochester found that the average number of sectors in which American manufacturers were active fell by half between 1977 and 2017. By the 2000s many sprawling industrial conglomerates like Germany’s Degussa, which had a hand in everything from metals to medicine, or British Aerospace, which was poking at cars, had untangled themselves and picked the knitting to stick to (chemicals and aircraft, respectively).

Today Coasean forces are ushering in a new type of corporate organisation. It resembles a 21st-century putting-out system—not for artisan craftsmen but for the white-collar professionals who epitomise modern Western economies. Micha Kaufman, boss of Fiverr, an Israeli marketplace which matches freelances with business around the world, observes that firms are getting better at measuring workers’ performance based on their actual output rather than time spent producing it. This is true both of employees and subcontractors. The result is a reorganisation of businesses both internally, and in relation to other companies in the economy.

Start on the inside. Using data from America’s Quarterly Census of Employment and Wages, The Economist has examined jobs in three sectors particularly compatible with remote work: technology, finance and professional services. We find that such jobs have become far more distributed across America since the pandemic. Big metropolitan areas have lost out to smaller cities and even the countryside. Since the fourth quarter of 2019, the number of jobs in the three sectors has grown by six percentage points more in rural areas than in San Francisco and New York.

Firms are also distributing more work across borders. Oswald Yeo, who runs Glints, a recruiting startup in Singapore, says his firm hires employees in batches by country. That helps the new recruits to form in-person bonds with compatriots, while expanding Glints’s talent pool, Mr Yeo explains. There is a premium for places with a small time difference. In Glints’s case, that is countries like Indonesia.

For American firms, it is often Canada. Microsoft, which opened its first Canadian office in 1985, created a big new one in Toronto in 2022. Google is tripling its Canadian workforce to 5,000. A study last year by cbre, a property firm, of the 50 cities in America and Canada with the most tech workers found that four of the top ten were Canadian. Together, the four added 180,000 tech jobs between 2016 and 2021, an increase of 39%, while the top four American cities gained just 86,000 jobs, or 8%. Lower living costs help; the Canadian quartet were among the 16 cheapest cities in the group in terms of housing.

Barriers to immigration are another factor forcing firms to look abroad, says Prithwiraj Choudhury of Harvard Business School. Mr Choudhury has documented a growing class of firms that help employers forge stable relationships with foreign employees without hiring them directly. One example is MobSquad, a firm that enlists skilled workers unable to obtain visas to America and employs them in Canada instead. Its American clients include Betterment, an investment firm, and Guardant Health, a biotechnology company.

MobSquad’s recruits sit somewhere between outsourced temps and full-time employees. This sort of arrangement points to the bigger Coasean shift—to how firms demarcate which tasks they perform on their own account and which they subcontract.

A survey of nearly 500 American firms by the Federal Reserve Bank of Atlanta last year found that 18% were using more independent contractors than in previous years; 2% said they used fewer. On top of that, 13% relied more on leased workers, compared with 1% who reduced this reliance. mbo Partners, a workforce-management firm, estimates that the number of American workers engaged in independent work for at least 15 hours a week increased from 15m in 2019 to 22m in 2022. Figures from the Bureau of Labour Statistics are more conservative, but still show that nearly 1m more Americans are self-employed than at the start of 2020. Pandemic-era job losses forcing people into less desirable work arrangements cannot be the whole story; a similar surge in self-employment did not occur after the global financial crisis of 2007-09.

The shift is again made possible by technology, notably the spread of platforms for freelance work. Having grown slowly, from 9% of America’s labour force in 2000 to 11% in 2018, self-employment is becoming more common. Gig work is no longer just about ride-hailing or food delivery. Whereas earlier platforms, such as Taskrabbit, focused on routine tasks, emerging new ones recruit freelances for complicated work. Upwork specialises in web development; Fiverr is known for media production. Amazon turned to Tongal, another freelancing platform, when it needed a team to rapidly produce social-media content for its Prime tv shows.

Besides making it easier to tap non-employees, technology is enabling companies to collaborate more seamlessly with other businesses. In 2020 Slack, the messaging platform of choice in many a workplace, launched a feature that lets users communicate with outside firms as they would within their own organisations. More than 70% of the Fortune 100 list of America’s biggest firms by revenue use the feature. The Atlanta Fed’s survey found that 16% of responding firms had increased domestic outsourcing and 6% had offshored more. Already, combined revenues for six big it-services firms with large operations in India—Cognizant, hclt, Infosys, tcs, Tech Mahindra and Wipro—grew by 25% between the third quarter of 2019 and the same period last year.

Pinning down just how much firms depend on outsiders is tricky—companies do not advertise this sort of thing. To get an idea, Katie Moon and Gordon Phillips, two economists, look at a firm’s external purchase commitments in the upcoming year as a share of its cost of sales. As a snapshot of the economy, this measure of “outsourcing intensity” must be treated with caution; it does not capture all types of outsourcing and different firms account for external purchases in different ways. But it usefully illustrates changes over time. image001.png The Economist has calculated the measure using data from financial reports for a sample of large listed firms in America and Europe. They are indeed growing more reliant on others. Average outsourcing intensity in our sample has doubled from 11% in 2005 to 22% in the most recent year of data. This growth is especially pronounced among tech titans such as Apple and Microsoft; businesses that grew more slowly, such as Walmart, a retailing giant, saw small increases. This is consistent with research which finds that as firms grow larger and adopt more technologies, thus becoming more complex and unwieldy, they outsource more operations—precisely as Coase would have predicted.

As technology evolves further, so will the contours of the firm. Companies may gain more flexibility to seek out new workers for new tasks in new places. Portugal has created a visa for digital nomads, who will be able to work from the country for a year. Argentina wants to introduce a preferential exchange rate for freelance workers selling their services abroad: the “tech dollar” would ensure that they were not exposed to the rapidly devaluing peso.

For Western white-collar types, stiffer competition for jobs may compress pay. According to a working paper published last year, by Alberto Cavallo of Harvard Business School and colleagues, wages differ less between countries for occupations that are more prone to outsourcing. That means higher living standards for workers in poorer countries and, possibly higher profits for their employers. And for Coase, it means continued relevance.

Brandon Adams Comment: One of the best papers we’ve ever had in the summary. We should get in touch with Rauh. He’s doing great work on an important topic. It’s interesting that the hit to the CA tax base from out migration is not nearly as big as I would have thought.

“…Figure 2 shows the net departure rates from the state by income tax bracket between 2003 and 2018. Since 2003, only middle-income earners in the 9.3 percent income tax bracket have entered California at higher rates than left during any year over the time period. The top bracket, and the highest earners within the top bracket in particular, display the highest net out-migration rate over the whole period. Higher-income earners who leave the state are not being replaced by other high earners at the same rate. California’s top earners are particularly mobile, showing the highest rates of departure around tax policy changes such as Proposition 30 in 2012 and the Tax Cut and Jobs Act (TCJA) of 2017 as well as the COVID-19 pandemic in 2020. Consequently, potential net outflows of taxable income spiked to nearly $4 billion in the year TCJA was implemented and $10.7 billion around COVID-19. High-earning movers have been consistently more likely to leave California for zero-income tax states since 2012, and those who experienced larger tax increases under TCJA were more likely to depart….”

Paper: “…Using microdata from the California Franchise Tax Board (FTB) on the universe of California tax filings from 2000 to 2020, we observe the resident status, county or state of residence, taxable income, and taxes paid for all California filers around two major policy changes, California Proposition 30 and the US Tax Cut and Jobs Act (TCJA) of 2017, as well as the onset of the COVID-19 pandemic. This paper, therefore, makes three main contributions….”

“…First, this paper extends the findings of Rauh and Shyu (2022) on Proposition 30 to also consider taxable income and revenue impacts of out-migration. In 2012, California voters passed ballot initiative Proposition 30 to increase the marginal income tax rates for high-income earners by one to three percentage points, up from 9.3 percent (California Legislative Analyst’s Office, 2012).2 According to Rauh and Shyu (2022), the Proposition 30 tax increases resulted in significantly higher departure rates among California’s high income earners. I find that the calculation of total taxable income of out-movers exceeded that of in-movers around the year of Proposition 30 by $1.2 billion, which translates into a net loss of about $135 million in tax liability, an arguably permanent annual loss. Were it not for the net in-migration of a high number of earners in the bottom tax bracket, these figures would be approximately 2.2 times as large…”

“…Second, this paper studies the consequences of TCJA for California’s taxable income and tax revenue. TCJA instituted a $10,000 cap on the state and local tax (SALT) deduction.3 For many California taxpayers, this cap more than offset the impact of TCJA’s lower federal tax rates, leading to a net federal tax increase.4 Even for taxpayers who saw a net federal tax cut under TCJA, TCJA dramatically increased the spread in total tax paid by most California taxpayers and what they would pay if they were in a much lower-tax state. We investigate departures from the state, changes in taxable income, and potential revenue effects in the years surrounding the implementation of TCJA and the SALT deduction cap. Total taxable income of out-movers between 2017 and 2018 exceeded that of in-movers by nearly $4 billion, jumping up from roughly zero in the previous year. This translated into a net loss of about $368 million in tax liability, again an arguably permanent annual loss. These effects largely repeated themselves between 2018 and 2019, with $3.44 billion n taxable income and $314 million in annual tax revenue lost on net. Net in-migration of mlower-income earners was considerably less helpful during this episode, exerting an effect half as large as it was in 2012….”

“….Third, most recently in 2020, the COVID-19 pandemic spread across the United States with the first case diagnosed in California in January 2020. While the pandemic did not impact tax policy in the same way as Prop 30 or TCJA, Californians saw a marked decline in public services during COVID-19, particularly in the early months of its spread. A statewide emergency was declared by Governor Gavin Newsom on March 4, 2020 followed promptly by a statewide shelter-in-place order taking effect on March 19, 2020. This resulted in the closure or major scale back of services at public schools, courthouses, DMV offices, and almost all businesses.5 In fact, schools throughout the state were required to be closed for in-person instruction in California for 290 days in 2020, amongst the longest closure in the nation (Hale et al., 2021). COVID-19 restrictions and shutdowns were not unique to California during this period, but taxpayers in the state continued to pay a premium for services that were largely unavailable while many employers likely no longer required workers to be stationed in California. For families with dependents, the share of California taxpayers who left and moved to a given state was higher in 2020 by an average of half a percentage point for every 10 percent fewer days of school closures in the destination state. Total taxable income of people who moved out-of-state in 2020 surpassed that of those who moved into California in the same year by $10.7 billion. This is reflected in a potentially permanent annual net loss of about $1.17 billion in tax liability….”

“…Based on our analysis, we find that the departure rates of high-income taxpayers appear highly responsive to tax policy changes like Proposition 30 and the TCJA as well as more large-scale changes like those prompted by the COVID-19 pandemic, while outmigration for low- and middle-income earners has been gradually increasing over time with in-migration not keeping pace for most income tax brackets. Similarly, the amount of income tax liability of high-income out-movers prior to their move has consistently not been replaced in full by that of in-movers at the same level, meaning the state loses revenue due to out-migration from the top bracket. We also see that a large share of emigrants relo- cate to zero- and low-income tax states during our time period. Finally, our analysis shows that Southern California saw a larger share of out-of-state departures during the Proposition 30 episode, while Northern California saw high levels of these departures around TCJA and COVID-19. As California’s tax revenues have become increasingly dependent on high-income earners in the top bracket, the loss of taxpayers from net out-migration, no matter the cause, poses long-term challenges the state’s fiscal stability…”

“…While much of the literature suggests that migration effects do not have substantial impacts on government revenues (Agrawal and Foremny, 2019; Martinez, 2021), none of the aforementioned studies explore the impact migration may have on economic prosperity generally. As noted by Rauh and Kearney (2021), a more holistic approach to studying ncome taxation would consider the rate at which the productive output of a society is maximized, not simply the rate at which the government can collect the most revenue….”

FACTOIDS

“…Lavelle and Kepner (2022) use data from United Van Lines to compare trends in migration before the pandemic in 2018 and 2019 and after the pandemic started in 2020 and 2021. They find that even prior to the pandemic, California accounted for the second largest outbound share of total interstate moves in the country, with over 56 percent of movers in the US originating in California in 2018 and 2019. This trend continued after the pandemic began with California’s share of outbound movers increasing to nearly 60 percent of movers nationwide…”

“…Figure 7 displays the total amount of income tax revenue generated within the state over time, broken down by tax bracket. From 2003 to 2019, income tax revenues about tripled, increasing from $32.1 billion to $94.7 billion in 2015 dollars. At the same time, income tax revenues as a share of total revenues grew from 31 percent in 2003 to 57 percent in 2019 according to the US Census Bureau. Over the same period, the state has become increasingly reliant on the top income tax bracket for these revenues, and particularly on the highest earners within that bracket (those earning more than $5 million a year), as is displayed in Figure 8. In 2003, the top 1 percent of income earners (those earning more than $681,342 annually in 2015 dollars) generated more than 42 percent of all of California’s income tax revenues. In 2012, this share jumped to 50 percent of total income tax liability. As of 2020, those making over $5 million contributed more than 25 percent of total income tax revenue. This means that only 25,000 households – 0.1 percent of the income tax-paying population – paid over a quarter the state’s total income tax revenues in that year. Meanwhile the 9.3 percent tax bracket’s share of total tax liabilities decreased from 49.3 percent in 2003 to 36.8 percent in 2020….”

“…We find that high-income earners appear to be very responsive to tax policy changes, with spikes in departure rates of these taxpayers in 2012 and 2017 following the enactment of Proposition 30 and the TCJA’s $10,000 cap on the state and local tax deduction. Further, we find that particularly for the highest-income earners, the rate of out-migration outweighs the average rate of in-migration by over 0.5 percentage point from 2001 to 2018, and spikes to over 1.5 percentage points for the very highest earners around the tax events we study. These spikes, however, paled in comparison to those related to the COVID-19 pandemic. Departure rates for filers making over $5 million rose to 3.75 percent, swamping the in-migration rate of 0.42 percent for filers at the same income level. This departure rate was more than 2 percentage points higher than the income-weighted baseline of 1.6 percent from 2001 to 2018. The economic implications of these increases in out-migration are significant for the state. With high-earning individuals moving out, so too does a large portion of their income. This represents a loss of economic activity and tax revenues. We estimate that in 2019 alone, nearly $30 billion in taxable income was earned by taxpayers who moved out of California in the next year while just $19 billion was earned by those moving in, resulting in a net outflow of nearly $11 billion that could have been taxed by the state. This loss is compounded over time as the income growth of movers occurs in an emigrant’s destination state, rather than in California….” Joshua Rauh, “Taxes, Revenues, and Net Migration in California,” Stanford University, December 2022, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4037764