May 2014

IZA DP No. 8164: Low-Skill Offshoring: Labor Market Policies and Welfare Effects

published as 'Low-skill offshoring and welfare compensation policies' in: Economic Modelling, 2016, 52, part B, 408 - 426

We analyze the effect of low-skill workers offshoring on the welfare of the economy. In the context of a matching model with different possible equilibria, we discuss two policies that could potentially outweigh the negative welfare effects of offshoring, namely, an increase of the unemployment benefits and the flexibilization of the labor market. Our results suggest that, while both policy instruments can theoretically bring the economy back to previous welfare levels, careful thought should be given to the practicability of either measure. In particular, while it would require a significant increase in the unemployment benefits to compensate for the negative welfare effects of offshoring, it would only take a small reduction in the vacancy cost to achieve the same outcome. Not only will this last measure be more financially advantageous, but it will avoid the strong disincentives to work that come with the adoption of the alternative.