Productivity, outsourcing and exit: the case of Australian manufacturing

Abstract

This paper uses a panel of small and medium manufacturing firms in Australia and studies the relationship between productivity and outsourcing accounting for the possibility of inefficient firms self-selecting into exit instead of outsourcing to domestic suppliers. Estimating a propensity model on an unbalanced panel of firms and correcting for the selection bias when firms opt for exit shows that the impact of productivity on the outsourcing decision could be much larger than estimated so far. The paper further explores the impact of outsourcing on a firm’s future performance and finds that the effect is non-uniform and productivity dependent, and outsourcing mostly brings improvements to firms that initially had low productivities. The most productive firms seem to outsource for other reasons such as focusing on innovation and exports with an eye on longer-term returns.