During the past decade, offshoring has become an established business practice. Hill, Cronk and Wickramasekera (2011) refer offshoring as a type of outsourcing where a task previously carried out in one country is now being undertaken overseas. For a business, this can be shifting product manufacturing, service centres or operations to a different country. Offshoring has gone on to such a level that it is estimated that around 40% of US imports are produced by US companies, many of them in China (Financial Times, 2007 as cited by Hamilton & Webster, 2009). Gyorki (2009) mentions that, companies are leveraging the comparative advantage of other nations via offshoring. For example, China’s advantage is low cost and abundant labour whereas US’s is creativity, technology and marketing (Gyorki, 2009). Great companies use both of these advantages well. Offshoring enables them to obtain market share as well as helps grow the total market by innovation and introducing new products (Gyorki, 2009).
This paper will identify how appreciation of local currency affects offshoring of manufacturing operations. The discussion will be associated with some examples. The other part of the paper will point out the arguments why firms do not engage in offshoring even though their domestic currency’s value is strong over their trading partners’. Finally, the discussion will be concluded with a brief analysis of future trends in offshoring.
Currency appreciation is simply the surge in value of a currency in relation to another foreign currency. For example, if one US Dollar is worth 3.3 Malaysian Ringgit yesterday and today it has a currency increase to 3.5 Malaysian Ringgit to the US Dollar, a currency appreciation has occurred. It shows that yesterday’s US Dollar 1 can buy RM 3.3 but today’s US Dollar 1 can buy RM 3.5. Therefore, USD dollar appreciates against Ringgit Malaysia. According to Hamilton and Webster (2009), currency appreciation will encourage the shifting of manufacturing operations to other countries which have relatively cheaper production factors. Madura and Fox (2011) assert that, firms usually prefer to direct their investment to establish their operations in a country while that country’s currency is comparatively cheap or weak.
Based on the research done by Ekholm, Moxnes and Karen (2008), it is identified that an increase in the relative cost of US inputs due to an appreciation of the US dollar will lead to an increase in offshoring. Moreover, Ekholm et al (2008) point out that, sharp appreciation of the Norwegian Kroner in early 2000’s induced firms’ offshoring decisions and increased offshoring, for the manufacturing sector as a whole, by about 1.5%. Rise in the cost of inputs for instance cost of raw materials will cause the cost of production to surge (Ekholm et al, 2008). Due to this, companies are unable to manufacture goods at a lower cost as they did previously and therefore, they need to hike up the selling price of those products to cover the cost. When the products are exported to country which has a lower currency value it will be expensive for the consumers to purchase them. Therefore, the demand for such goods may well decrease and the value of exports will decline (Madura & Fox, 2011). Betts (2007) states that, appreciation of Euro against the Yen and Yuan in 2002 has accelerated the trend of European companies offshoring manufacturing, led to sharp losses in export market share. However, Madura and Fox (2011) argue that, firms find it cheaper to invest abroad when their local currency appreciates. What they need to do is to shift their manufacturing operations to countries that have relatively cheaper production factors and produce their goods there at lower cost. For example, appreciation of Korean Won against US dollar and other currencies in mid-2000s made Hyundai Motor Company to offshore their manufacturing operations abroad (Hill et al, 2011). Hill...