Local Spillovers, Production Technology and the Choice to Make and/or Buy: Empirical Evidence from Emilia Romagna Mechanical Industry

Abstract

By exploiting a new rich firm-level dataset, this paper investigates the decision to subcontract production activities (outsourcing) with respect to vertically integrate them. In particular, we aim at identifying the main factors underlying the decision to either fully or partially decentralise production activities by mechanical firms located in Emilia Romagna (Italy). In so doing, we first account for firm characteristics, such as size, age and the skill composition of the labour force, then we focus on labour costs per employee, product diversity and the presence of the firm on international markets. Finally, and differently from previous research, we include in the analysis both the qualitative composition of the production process, as given by the single stages of production developed by the firm, and the industrial composition of the local market, as evidenced by the agglomeration economies identified in the literature: specialisation economies, variety and urbanisation economies. Our estimates show that production activities, workforce skill intensity and spatial agglomeration are important factors related to both the propensity and the frequency of outsourcing. Once controlled for the phase-composition of the production process, the choice to fully outsource is positively related to the exporting activity of firms and to unit labour cost. The positioning on international markets and the need to save on labour costs can be interpreted as a 'search-for-efficiency' strategy in the production of high-quality products. Once the decision is taken, however, outsourcing seems to be related to a smaller size of the firm, a younger age, a higher skill intensity, a lower average labour cost and, more interestingly, a higher degree of related variety. Finally, we distinguish between final and subcontracting firms and we find that their outsourcing strategies are related to different variables. In particular, final firms committed to outsourcing seem to be older and larger and relatively less based on labour cost saving objectives.