Offshoring Brains? Evidence on the Complementarity between Manufacturing and R&D in Danish Firms*

• DOI: http://doi.org/10.1111/sjoe.12388
• Published date: 01 October 2020
• Date: 01 October 2020

Scand. J. of Economics 122(4), 1315–1342, 2020

DOI: 10.1111/sjoe.12388

Offshoring Brains? Evidence on the

Complementarity between Manufacturing

and R&D in Danish Firms*

Svend Greniman Andersen†

University of Copenhagen, DK-1353 Copenhagen K, Denmark

greniman@gmail.com

Abstract

By employing a firm-level linked employer–employee dataset for Danish manufacturing firms,

this paper investigates whether offshoring is complementary to, or a substitute for,research and

development(R&D) activities. Offshoring is instrumented with world export supply to circumvent

the inherent endogenous nature of the firm’sdecision to offshore. Results suggest that firms with

increased offshoring do in fact tend to engage in further R&D activities at home. Moreover,they

also tend to reallocate R&D resources toward product R&D, possibly at the expense of process

R&D.

Keywords: Imports; innovation; intermediate inputs; offshoring; R&D

JEL classification:F10; F14; O30; O33

I. Introduction

“Over the past few decades it became conventional wisdom that

factory jobs could be done cheaply in some far-flung corner of

the world but more important innovation work should stay in-

house in high-cost countries. Manufacturing was seen as just

a cost centre, so it was often offshored. Now many companies

reckon that production makes a big contribution to the success

of research and development, and that innovation is more likely

to happen when R&D and manufacturing are in the same

place, so increasingly they want to bring manufacturing back

in-house.”1

Much concern has been raised recently by politicians and policymakers

in advanced economies as to whether domestic manufacturing activities are

*Viewsand conclusions expressed are my ownand do not necessarily represent those of Danmarks

Nationalbank. I would like to thank the EPRN for financial support and participants at DIEW

Aarhus, NOITS Oslo, UCPH seminars and colleagues at Danmarks Nationalbank for helpful

comments and encouragement.

†Also affiliated with Danmarks Nationalbank.

1Quote taken from the article “Herd Instinct” in The Economist, 17 January 2013.

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The editors of The Scandinavian Journal of Economics 2019.

1316 Complementarity between manufacturing and R&D in Danish firms

a prerequisite for more knowledge-based activities at home.2This is seen in

light of the rapid rise in offshoring3over the past two decades, coupled with

a substantial decline in domestic manufacturing jobs. Because knowledge-

based activities are often coupled with technological and technical advances,

this debate also concerns the determinants of long-run growth in general.

When concerned about domestic labor markets and their ability to sustain

high-skilled jobs, it therefore becomes of interest to assess whether globally

oriented firms take offshoring and high-skilled inputs as substitutes or

complements in the production process. In this paper, the focus is on

research and development (R&D) activities as an important high-skilled

input for domestic firms.

On the one hand, R&D and offshoring can be substitutes if the

development of new products and processes is performed with better

synergies when production is carried out at home next to the laboratory

instead of abroad. On the other hand, relocating production to a foreign

country might mean freeing up resources to increase R&D spending at

home where the comparative advantage is present, thus rendering R&D

and offshoring complements. The literature so far offers no clear, explicit

answer to this question.

This paper therefore seeks to fill this gap by asking the following

question. Is offshoring complementary to, or a substitute for, R&D at the

firm level? By employing a rich firm-level dataset on R&D activities and

intermediate imports, as well as looking at exogenous offshoring shocks, I

am able to focus on the channel running from offshoring to domestic R&D,

which is of considerable concern to public policy.

Focusing on the relationship between trade and innovation, a number

of papers offer useful theoretical frameworks. One example is Bloom etal.

(2013) where some production factors are assumed to be “trapped” within

firms in the shorter run. After a trade shock reduces the price for one

of the goods that the firm had been producing, the opportunity cost goes

down for inputs that are trapped within the firm. The firm carries out more

innovation, not because of an increase in the value of a newly designed

good, but rather because of a fall in the opportunity cost of the inputs used

to design and produce new goods.

Naghavi and Ottaviano (2009) suggest an endogenous growth model

with offshoring. The model features an R&D sector supplying blueprints

2The above quote is just one example of many related statements. For an example from the

business literature, see Pisano and Shih (2012).

3I shall refer to “offshoring” throughout the paper as the relocation of intermediate inputs from

domestic to foreign suppliers, those suppliers being either within or outside the boundaries of the

firm. In practice, I measure offshoring at the firm level as the total value of imports, and I do not

distinguish between imports from firms within the same business group and other foreign firms.

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The editors of The Scandinavian Journal of Economics 2019.