Outsourcing and productivity growth in services

Outsourcing from manufacturing firms has fueled some of the service sector's rapid growth. We model the firm's decision to outsource and show that increases in outsourcing may explain part of the increase in the divergence in productivity growth between manufacturing and services. We also analyze the implications of outsourcing for output and productivity growth of service industries. Our findings indicate that it has reduced service sector productivity in the short run. In contrast to earlier work on services (Baumol, W.J., 1967. American Economic Review 57, 415-426. Baumol, W.J., Blackman, A.B., Wolff, E.N., 1985. American Economic Review 75, 806-817), we project that productivity growth in services is likely to increase, once demand growth from manufacturing due to outsourcing subsides.