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Offshoring and the New Zealand Balance of Payments

1. Summary

Outsourcing of business operations by resident entities overseas (offshoring) is within the scope of New Zealand's Balance of Payments (BoP) statistics. A number of New Zealand companies are already engaging in offshoring, and it is likely that more companies will follow suit in the future.

An initial investigation has identified three major types of arrangements that New Zealand companies have entered into. These include:

  • shifting manufacturing operations or services activities to an affiliate entity overseas (either to an existing entity or to a newly set-up entity) 
  • contracting manufacturing or service activity for a fee to an unrelated party overseas 
  • ceasing manufacturing in New Zealand and buying goods directly from a contracted manufacturer overseas.

An assessment of the data implications for BoP from offshoring shows that: 

  • there is an undercoverage of some exports and imports of goods as these flows are outside the current data sources and therefore they are not captured. 
  • there is a probable undercoverage of services because the current collection vehicle does not adequately capture transactions (e.g. fees for contract manufacturing) arising from offshoring. 
  • the likely non-inclusion of some companies engaged in such activity in the sample population.

The measurement of offshoring needs to improve to better reflect this activity in BoP and other macroeconomic statistics.

2. Background

This paper focuses mostly on the implications of offshoring for BoP statistics. Issues to do with changes to the structure of New Zealand industry (i.e. companies changing their industrial classification, ANZSIC), employment, industry production etc arising from offshoring are not discussed in this paper. The next phase of this project which is currently unfunded was intended to have a much wider focus than just implications for BoP statistics.

3. Introduction

International competition and an adverse exchange rate in recent years have compelled a number of New Zealand manufacturers to shift some part of, if not all, of their production overseas. In addition, the global efforts to liberalise international trade and investment is encouraging other companies to consider the cost effectiveness of some of their non-core business operations in New Zealand. The geographic location of New Zealand means that the cost of importing raw materials and turning them into finished products and then exporting these goods to markets abroad, make goods produced here uncompetitive compared to goods produced overseas that are closer to raw materials and final consumers.

Like the manufacturing sector, companies in the service sector are either already engaging or are looking into outsourcing some of their services activities (such as call centre operation, data processing, software development etc) to specialised providers in low cost economies. While much of the surge in outsourcing services activities by New Zealand companies has involved shifting work to low cost centres abroad, there are some instances where a New Zealand companies are the recipients of outsourcing activities from foreign firms.

4. Concept and definition

The Balance of Payments statistical framework does not specifically define offshoring or recommend any separate identification or recording of such activities. It does, however, denote that some cross-border transactions in goods, services, income and investment flows may arise as a result of offshoring. The OECD handbook on Economic Globalisation Indicators identifies outsourcing and offshoring in the context of international subcontracting under the topic Trade Globalisation. The handbook recommends a set of indicators for international subcontracting of manufacturing and services.

Defining offshoring is difficult as the phenomenon is often muddled with outsourcing leading to confusion and ambiguity. Outsourcing means the purchase by an enterprise of goods and services that could be produced in-house from another enterprise. This can occur within an economy where the enterprise is located (domestic outsourcing) or abroad (international outsourcing).

Offshoring is used to designate outsourcing abroad and covers the following situations: 

  • The production of goods or services that are transferred abroad within the enterprise group (international insourcing) i.e. transfer of some of its activities to a foreign affiliate (either to an already existing one or a newly created one). 
  • The partial or total transfer of the production of goods or services abroad to a non-affiliated enterprise (international outsourcing). This situation could be described as subcontracting abroad.

The concepts are illustrated in Diagram 1 below. The cross-border aspect is the distinguishing feature of offshoring. Note that outsourcing takes place on a much larger scale domestically.

While offshoring represents a type of service import, not all service imports can be counted as offshoring. It is impossible to distinguish which part of it should be counted as offshoring. It is also not possible to determine what share of foreign direct investment (FDI) is directly related to offshoring.

Sourcing between firms and within firms.

The definition attributed to offshoring in this paper is applicable in the widest context possible. The definition does not specify whether the country that provides the offshored service is a developing or an advanced economy. The definition also makes no distinction whether the shifting of the manufacturing or the services activity displaces any workers in the economy which is seeking to offshore.

5. Offshoring arrangements

In order to assess the likely impact on BoP statistics (such as coverage, classification and measurement issues), it was necessary to get an understanding of the offshoring arrangements that New Zealand companies have entered into with foreign parties. A sample of the companies identified as engaging in offshoring was contacted to gather this information. The investigation revealed that there are three major types of arrangement that New Zealand companies have undertaken to outsource manufacturing and commercial services activities with non-residents. These are illustrated in Table 1 below.

Table 1: Offshoring Arrangements

Offshoring arrangements Description of arrangement
Case 1
Manufacturing or services activity undertaken via an affiliate overseas i.e. Direct investment abroad

 A New Zealand company closes its manufacturing facility in New Zealand and either opens up a new production facility overseas or shifts production to an existing facility abroad (may or may not be in a low cost economy).
The raw materials needed for production are sourced from a combination of the following: 

  • within the country where the production facility is located 
  • sent from New Zealand 
  • sourced from a third country.

The goods produced are: 

  • sold within the country where the production facility is located 
  • sold in other markets overseas 
  • imported in small proportion into New Zealand for the domestic market.

An entity (subsidiary or a branch) is often set up in the overseas country to ensure ownership of the production facility. In the BoP framework, the overseas entity is designated as being resident of the economy of its new location.

 Case 2
Contract manufacturing or service activity

 A New Zealand company contracts a manufacturing company in a low cost economy to manufacture its products.
The New Zealand company supplies the raw materials. These are sourced from: 

  •  New Zealand 
  •  the country of the manufacturer 
  •  a third country

The New Zealand company specifies the design and quality standards to the overseas manufacturer. A fee is paid by the New Zealand company to the manufacturer.
The finished goods are shipped from the country of manufacture to markets overseas. Some goods are imported into New Zealand for the domestic market.
At all times the New Zealand company retains the ownership of the raw materials and the finished goods.

 Case 3
Merchanting
 A New Zealand manufacturer contracts manufacturing to a company in a low cost economy. The New Zealand company specifies design and quality standards to the overseas manufacturer.
The overseas manufacturer buys all the raw materials needed and produces the final goods as specified. The New Zealand company pays the overseas manufacturer for the goods (this includes payment for raw materials and for the manufacturing service) and takes ownership of the goods.
The New Zealand company sells the goods to markets overseas. A small proportion of the goods are imported into New Zealand for the domestic market.

It is important to note that the arrangements described in Cases 2 and 3 are often fluid and subject to change over time. Once a New Zealand company gains experience of offshoring, it may opt to take direct control of the production process by setting up a subsidiary or a branch in a low cost economy (Case 1). Note that the arrangement described in Case 3 results in a structural change within the New Zealand economy where an entity changes from being a manufacturer to a wholesaler.

The offshoring of non-manufacturing services (such as accounting, call centre, data processing etc) do not involve any movement of goods and as such Case 3 above does not apply to services. The majority of services offshoring is to independent third parties abroad (Case 2), i.e. to companies that specialise in the provision of services.

6. Data collection and measurement issues

A combination of survey and administrative data sources are used to capture BoP data. The various cross-border transactions that arise as a result of offshoring of manufacturing and services fall within the following data collections:

  • Merchandise Trade Statistics – collects data on export of raw materials to related or unrelated parties abroad (for inputs into manufacturing) and the import of finished goods (into New Zealand for the domestic market). 
  • Quarterly International Trade in Services and Royalties Survey (ITSS) – collects data on the receipts and payments of various commercial services including merchanting, research and development and payments and receipts on royalties. 
  • Quarterly International Investment Survey (QIIS) – collects data on the flow of investment and investment income from related and unrelated parties abroad.

Table 2 below provides an illustration of the data implications of the different offshoring arrangements highlighted in Section 5.

Table 2: BOP Data Implications of Offshoring

Arrangement types  Implication for BOP data
Case 1
Manufacturing or services activity undertaken via an affiliate overseas
 The re-location of production overseas results in a fall in New Zealand’s exports statistics. Services offshoring with affiliated parties result in an increase in imports of services.
Note that since the all production activity is attributed to the overseas entity (subsidiary/branch), the export of final products from the overseas entity to markets abroad is included in the Merchandise Export Statistics of the country where the entity located.
The direct investment and investment income data in BoP record the relevant investment and investment income flows between the New Zealand parent and the overseas entity.
 Case 2
Contract manufacturing or service activity

The impact on BoP statistics from contract manufacturing and services are as follows: 

  • The undercoverage of New Zealand’s import statistics of the raw materials sourced from a third country (e.g. Italy) and sent to the overseas manufacturer (e.g. China) as a component into the production process. 
  • The undercoverage of New Zealand’s export statistics of the final goods that are sold to markets abroad (e.g. USA, UK etc) from the manufacturing country (e.g. China). 
  • The undercoverage of transportation and freight services associated with the delivery of the raw materials and the final goods mentioned above. 
  • The possible undercoverage of manufacturing and other commercial services imported from abroad.
Case 3
Merchanting
The shift from manufacturing to wholesaling in general results in a substitution effect with a reduction in New Zealand’s exports of goods and an increase in exports of services.
Data on merchanting is captured on a gross basis in the quarterly ITSS survey. The key concern here is that it is difficult to identify entities engaged in this activity for inclusion in the sample population.

7. Conclusion

As technology develops further and New Zealand’s integration into the global economy deepens, offshoring is likely to generate a more noticeable effect on the economy. The real impact of offshoring for a given economy can only be measured by combining macroeconomics statistics (such as foreign direct investment, goods and services trade, industry production, employment, research and development etc) with micro analysis of the firms that are engaged in such activities.

To overcome some of the data requirements, an improvement has already been made to Statistics New Zealand’s Business Frame Update Survey to better identify New Zealand entities engaged in offshoring activities. Improvements to the various BoP data collections will be made once resources become available.

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