Relocation of jobs in the Danish financial sector. Consequences for employees, companies and the society

Relocation of jobs in the Danish financial sector Consequences for employees, companies and the society Finansforbundet 08 September 2017

Authors: Sigurd Næss-Schmidt Dr Palle Sørensen Dr Christian Heebøll

Preface By Finansforbundet In recent years, the financial sector has become more and more international, not least due to the digitalisation of products and processes, which has made work more moveable - also across borders. Finansforbundet (the Financial Services Union Denmark) believes that globalisation is the new reality for our members, their employers and for us as a union. Financial services and businesses are not limited by borders. The members of Finansforbundet have felt this development at first hand in the sense that they have more foreign colleagues in Denmark, and some work in global teams across borders. Some members see their jobs disappearing out of the country, and for the individual member this is, of course, a huge personal loss. Here, we as Finansforbundet is focused on helping our members in new employment in the best possible way. We believe, however, that the responsibility of ensuring finance employees the relevant skills and competences now and in the future is a joint task of both finance companies and the union. It is clear to us, that the internationalisation of functions and jobs has implications for our members, the financial sector and the society in general. The actual extent and proportion for the financial sector along with the consequences for the Danish economy has not been fully disclosed and analysed. This knowledge base is necessary to address the issues and problems and to take advantage of the opportunities. Finansforbundet has, therefore, asked Copenhagen Economics to analyse the movements of finance/it jobs across the Danish border to have a factual understanding of the issue of international division of work in the Danish financial sector. More specifically, we have asked CE to analyse two specific elements of the subject: Mapping outflows and inflows of workers in Denmark linked to production of financial services. Analysing causes and consequences for Danish workers and the Danish economy.

Table of contents Executive summary 4 1 Introduction and background 8 2 Mapping the relocations of job functions in the Danish finance and IT sectors 12 2.1 Offshoring to countries with lower-paid workers: the overall picture 12 2.2 Offshoring by services and functions 20 2.3 Employment for foreign workers in the financial and IT sector 22 3 Causes and consequences for Danish workers and the Danish economy 31 3.1 A driving force being the rapidly changing financial sector 31 3.2 The structural drivers of offshoring 32 3.3 The level of competition in the financial sector is expected to keep rising 36 3.4 Offshoring benefits some employees, but hurts others 38 3.5 Jobs at risk in coming years from increase in skill gap and higher rate for wage taxes 40 References 42

List of figures Figure 1 Danish import and export of financial and IT services... 8 Figure 2 GVA per employee and share of employees in sectors, 2014... 10 Figure 3 Types of offshoring and total jobs offshored on a cumulative basis, 2005-2016... 13 Figure 4 Estimated directly offshored jobs in the financial sector, 2010 and 2016... 15 Figure 5 Destinations of direct offshoring over time, cumulative numbers... 16 Figure 6 Estimated indirectly offshored jobs from the financial sector, 2010 and 2016... 18 Figure 7 Destinations of indirect offshoring over time,... 19 Figure 8 Offshoring by sub-branch to countries with a lower wage... 21 Figure 9 Offshoring by function, 2017... 22 Figure 10 Share of employed foreigners in chosen services, 2015... 23 Figure 11 Foreign employees working in the Danish financial sector... 24 Figure 12 Country of origin of foreign employees in the financial sector... 25 Figure 13 Functions of foreign employees and natives working... 26 Figure 14 Foreign employees in sub-sectors as a share of the total employees in the sub-sector... 27 Figure 15 Foreign employees in the IT sector as a whole... 28 Figure 16 Country of origin of foreign employees working in the IT sector... 29 Figure 17 Sector division of employees on Forskerskatteordning... 30 Figure 18 Changes in the production of financial services in several stages... 32

Figure 19 Increasing lack of labour... 34 Figure 20 Wage tax as an extra tax on jobs in the Danish financial sector... 35 Figure 21 The estimated effect on employment in the Danish banking sector if the wage tax was kept at 12 per cent from 2015-2020... 36 Figure 22 A large increase in the share of jobs in the financial sector being exposed to competition... 37 Figure 23 Wage consequences... 39 Figure 24 Potential job losses from higher wage tax and skill gap... 41

List of boxes Box 1 Definition of Danish offshoring... 14 Box 2 Some facts about individual banks... 17 Box 3 Forskerskatteordningen 2017... 29

Executive summary A still more international financial sector Denmark has a fairly large and well-functioning financial sector. It employs approximately 3 per cent of all employees in Denmark, but looking at the economic activity measured by gross value added (GVA), the sector accounts for significantly more than that; 106 bn. DKK which is about 6 per cent of national GVA, reflecting a highly productive sector with several areas of competences, where Denmark has an international leading position. The global sector is also becoming increasingly internationalised and digitalised. At the national level, this is seen from the increasing international trade in financial services where Danish import and export of financial services have risen by 60 and 74 per cent from 2005 to 2016, respectively. It is worth noticing that the Danish financial sector has become an important exporter with export growing more rapidly than import of financial services during the same period. At the same time, we are observing both more offshoring of activities to other countries and more inflow of workers to Denmark, often in specialized positions. However, the ability of the sector to contribute to a high level of jobs and productivity in Denmark is conditioned on well-designed framework conditions. In this context, the study evaluates the extent and drivers of outsourcing from Denmark and discusses some of the tax and educational policies that may have an impact on the future tendencies for offshoring in the sector. Digitalisation as a driver of outsourcing in the financial sector Financial services become more and more digitalised and mobile, which enables financial companies to produce their services more cheaply and effectively using international labour and global chains of production. This happens both between industrialised countries, through offshoring to low-cost countries and through influx of labour from abroad. This has also led to an increasing degree of relocation of jobs in and out of Denmark: several of the major Danish banks have already offshored parts of their labour to low-cost countries, and more foreign employees are working in the Danish financial sector. Today, more than 3,700 jobs related to the Danish financial sector are offshored to countries with lower-paid workers. The tendency for offshoring seemed to start slowly in the early 2000s, after 2010 it picked up speed, and from 2012 to 2014 the number of offshored jobs almost doubled. Still, when looking at the large reduction in the number of employees in the banking sector in recent years, digitalisation and other factors still play a larger role than offshoring to lowcost countries. These tendencies are clearly seen from the increasing import and export of financial and IT services to the Danish financial sector, which especially increased a lot after 2005. Early in the period, most of the offshoring happened indirectly through long-run contracts with large IT subsidiaries, having IT centres in distant low-cost countries such as India. 4

This typically involved computer programming and IT infrastructure in banks and insurance companies. Most recently, the direct offshoring has increased much faster, partly at the expense of indirect offshoring. Here both large and mid-sized banks started near-shoring, opening back office centres in the new EU countries (typically Poland and the Baltics). Offshoring benefits some employees but hurts others When jobs are moved out of Denmark, it typically has negative consequences for Danish production staff in low-knowledge areas. It is primarily employees, who are exposed to competition that get dismissed and replaced by labour abroad and, for many of these employees, finding a new job with the same wage levels will take time. Specifically, we find that unemployment results in a 10 per cent wage decrease in the following year for employees who do find new employment. Five years after a spell of unemployment, wages are approximately 3 per cent lower than would have been the case if the employment had continued. One of the drivers is that only around 40 per cent find new jobs in the highly productive financial sector, and hence people do not necessarily get a job that aligns completely with their skill set. On top of this, on average 38 per cent do not find new employment quickly after losing their job. The scenario is the inverse for highly educated employees working in knowledge-intensive areas of Danish finance and IT companies. These employees become a part of the efficiency improvements taking place in the companies and, hence, experience an improvement of their wages when jobs are being offshored. Highly specialized jobs being offshored The offshoring of Danish jobs resembles the relocations experienced in the industrial sector, where the companies initially offshored production staff with low or medium educational attainment. Within the IT sector, these are jobs like web design and programming, whereas for the financial sector these would be back office functions or standard IT functions. These types of jobs have mainly been offshored to new EU countries including the Baltics, but also to countries like India where the labour market functions relatively well, but the wages are significantly lower than in Denmark. More recently, offshoring also includes the development of new products and services related to high competence and more specialized functions. Specifically, IT development accounts for approximately 47 per cent of all offshoring related to the financial sector. Our analysis further suggests that compliance work related to avoiding money laundering as well as payment service specialists account for approximately 10 per cent of Danish offshoring, design services account for 3 per cent, and project management and IT service management account for 4 and 7 per cent respectively. 5

An increased influx of labour The influx of labour has been increasing in the financial and IT sectors over the past eight years especially in the IT and banking sector. In total, the financial and IT sectors employed 6,600 foreign workers in 2008; today this number is around 7,700, where 2,700 work in the financial sector. The influx of labour is mainly within areas where Denmark has a competence cluster e.g. asset management and areas where the Danish labour market is in short supply. When looking at where we import labour from, the picture is more scattered, but most foreign employees come from other EU countries, other industrialised countries and developing countries such as India and Pakistan. Compared to many other knowledge-intensive industries, the IT sector is generally ahead in the matter of influx of foreign labour. Concretely speaking, 11 per cent of people working in the IT sector are currently foreigners. The financial sector is lagging behind with only 4 per cent foreign workers, while other knowledge-intensive sectors, e.g. architects and pharmaceuticals, employ 9 and 10 per cent foreign workers, respectively. The financial sector, however, employs relatively more highly skilled foreign employees especially in the most recent years and especially when it comes to people from other old industrialised countries. Specific Danish drivers of offshoring In this study, we have focused on two potential drivers of offshoring in the Danish broader financial sector that may push the tendencies for further offshoring in the coming years: 1. Lack of qualified labour. 2. The Danish wage tax on staff in the financial sector. The lack of qualified labour in the IT sector is a major factor. A recent study found that Denmark will experience a shortage of an additional 19,000 IT specialists by 2030. As the financial industry employs a significant share of all current Danish IT specialists, the overall skill gap related to the financial sector alone may lead to a job loss of 1,500 by 2020. This should be seen in the context of financial services becoming extremely IT intensive. Furthermore, it will put an upward pressure on wages in the IT sector in Denmark as several industries compete for scarce IT resources. Higher influx of labour from abroad is contingent on legal constraints and could be an option to close skills gaps, but this option is likely to be costly. The already decided increase of the wage tax (lønsumsafgift) is also a factor. It is a type of tax only existing in Denmark and a few other countries, including France and Norway. As a consequence, it will be a factor when companies consider where to locate jobs, with Denmark being a more costly option. Given the expected continuing ability to shift production away from the location of consumers to the lowest cost location of production, the wage tax will have an increasing impact on offshoring. It has been decided to raise the tax rate from 12.2 per cent in 2015 to 15.3 per cent in 2021. We find that approximately 1,100 jobs may be lost in the financial sector as result of that. 6

Summing up Denmark has a strong and productive financial sector accounting for 6 per cent of GVA. The sector is increasingly exposed to international competition in all value chains of production and products. Both import and export of financial services are increasing. The digitalisation, which is a main driver of these tendencies, has also resulted in increasing tendencies of offshoring as well as influx of workers from abroad. As a whole, this has been beneficial for the sector and its customers. However, for the sector to thrive in the coming years, supporting framework policies is crucial. In this context, it will be important to address the skill gap of IT specialists in the Danish educational system and find a replacement for the Danish wage tax on employees in the financial sector. Potentially over 3,000 jobs are at risk, and Denmark risks losing some of its international leading positions in different areas of the financial industry. 7

Chapter 1 Introduction and background The Danish financial sector is becoming increasingly internationalised, digitalised and new technology implies a higher mobility of jobs in the financial sector. This leads to an increasing degree of relocation of jobs in and out of Denmark: several of the major Danish banks have already offshored parts of their labour to low-cost countries, and more foreign employees are working in the Danish financial sector. At the national level, this is seen from the increasing international trade in financial services. From 2005 to 2016, Danish import of financial services rose from 4.3 to 7.0 bn. DKK, while Danish export of financial services rose from 3.8 to 6.9 bn. DKK: see Figure 1a. This corresponds to an increase of 60 and 74 per cent, respectively. It is worth noticing that the Danish financial sector has become an important exporter with export growing more rapidly than import of financial services during the same period. Figure 1 Danish import and export of financial and IT services a) Danish national import and export of financial services b) Import of IT and financial services in the Danish financial sector Import and export, million. DKK, 2015-8.000 7.000 6.000 5.000 4.000 3.000 2.000 1.000 - Import Export Import Export 2005 2016 Import, bn. DKK, 2015-prices 2,5 2 1,5 1 0,5 0 1990 1995 2000 2005 2010 2015 IT and information services Financial services Note: Financial services here also include insurance services. Panel a) shows the total import and export of financial services in the Danish economy, while panel b) shows the total import of IT and financial services, from input-output tables, for the IT and financial sector, respectively. Source: Statistics Denmark Further, we see increasing imports of financial and IT services to the Danish financial sector: from 1990 to 2005, imports of financial services to the sector have been more or less stable after this there was a significant increase, and in 2015 imports were more than double those in 2005: see Figure 1b. For direct imports of IT to the Danish financial sector, the numbers are significantly lower, but here the increase already began in the late 1990s. Because of this trend, the Danish financial sector is also exposed to increased competition and the need for operational optimisation and specialisation. For Danish financial firms, this has changed the international division of labour through three main channels: 8

1. International division of labour between industrialised countries: The large banks (Danske Bank and Nordea) have reorganised and centralised their production of financial services in expert centres some are in Denmark and others can be found in other Nordic countries. There is also a trend towards collaboration and outsourcing of service production to specialized international banks. 2. Direct offshoring to countries with lower-paid workers: Especially in recent years, Danish banks and to some extent supporting financial companies have started to move the production of financial services to countries with lower-wage workers. The direct offshoring can be through the purchasing of consultancy services from external foreign companies or by establishing internal divisions of subsidiaries in other countries. 3. Indirect offshoring to countries with lower-wage workers: The core IT infrastructure of financial companies has, for many years, been outsourced and produced by IT companies. Other IT services have been outsourced as well (some insourced again in recent years). The IT sector is generally ahead of the financial sector in terms of international division of labour and so a significant share of offshoring from the financial sector happens indirectly. In the next chapter, we will focus on both offshoring to countries with lower-wage employees, both directly and indirectly (point 2 and 3 above) and the inflow of jobs from abroad to the Danish financial sector. Healthy and unhealthy developments The jobs that disappear in Denmark are only to some extent replaced by new jobs higher up in the value chain. Part of this happens as a consequent of sound international division of labour. In particularly, non-core finance jobs are outsourced, and less demanding financial jobs are relocated to countries where production is cheaper. It ensures competitive prices for Danish companies and households, growth and prosperity in Denmark. Another part is unhealthy for the Danish economy and heavily influenced by weak framework conditions in Denmark; inappropriately high taxation of labour in the Danish financial sector, insufficient focus on educating enough IT and financial specialists, and poor conditions when it comes to attracting international specialized labour. Hereby jobs are relocated for the wrong reasons, namely because Danish financial companies are unable to recruit the right employees even though their willingness to pay is not lower than in other countries. At this point, special national taxes such as the Danish payroll tax are very distorting in an international sector and job market and are undoubtedly contributing to the relocation of jobs, we see today. The payroll tax was introduced in the 1980s, where the job mobility in the sector was much lower. Nevertheless, the payroll tax rate is still increasing. In chapter three, we will go more into details about how the Danish payroll tax, a lack of specialized labour and other factors are driving the tendencies for offshoring the financial sector. 9

Denmark has a lot to lose Denmark has a lot to lose from such unsuitable and uncompetitive framework conditions. The sector ensures essential functions in society; a well-functioning payment system, households' terms on mortgages, pension savings and, perhaps even more important, that Danish companies have the right access to capital, risk hedging, etc. As such, the whole economy benefits from a well-functioning financial sector. Denmark has a fairly large and well-functioning financial sector. Nationally, it employs approximately 3 per cent of all employees in Denmark, but looking at the economic activity measured by gross value added (GVA), the sector accounts for significantly more than that; 106 bn. DKK which is about 6 per cent of national GVA. Hence, in comparison with other sectors, the financial sector has the absolute highest GVA per employee, see Figure 2. This illustrates how important the value-creation of employees in the sector is for the rest of the economy. Figure 2 GVA per employee and share of employees in sectors, 2014 Note: Others include 1) agriculture, 2) real estate, 3) culture, leisure and other services. Source: Sector-divided national accounts. Compared to other countries, the strength of the Danish financial sector is to a large extent driven by our large pension wealth of about 3,500 billion DKK. It gives rise to extensive investment activity and the need for associated services from lawyers, auditors and other advisers. At the same time, we are currently developing a number of new innovative technologies for financial services (Fintech), which underlines the current opportunities for the Danish financial sector. For the sector to keep developing these areas, the framework conditions are crucial and dependent on international competition. 10

Paradoxically, sound international division of labour helps the Danish financial sector to sustain and create new jobs higher up in the value chain, while unhealthy developments may imply that Denmark will lose its leading positions in certain areas of finance. In the last part of chapter three, we will discuss the cost of unhealthy international division of labour for the Danish economy. 11

Chapter 2 Mapping the relocations of job functions in the Danish finance and IT sectors International division of labour is an increasingly common phenomenon in most industrialised countries and has been so since the beginning of the 1980s. In this chapter, we analyse the offshoring and outsourcing in the financial sector during the last decade. We start by analysing how Danish jobs are being offshored to a number of low income countries (Section 1.2). Further, we look at how offshoring happens broadly across services for a broad range of specialized areas (Section 1.3). Finally, job markets are becoming more mobile and Danish financial institutions have a greater influx of foreign employees. This will be analysed in the last section (Section 1.4). 2.1 Offshoring to countries with lower-paid workers: the overall picture When analysing the number of jobs offshored, it is important to have a clear definition of the concept. Offshoring from the Danish financial sector is defined as employees working in countries with lower wages but serving Danish customers of financial companies domiciled in Denmark: see Box 1. This may both happen through local branches and subsidiaries as seen lately for the larger banks in the Baltics and Poland and through local subcontractors and consultancy firms as is more typical for smaller banks and operations in distant countries (India especially). Using a number of different sources, we find that more than 3,700 potential Danish jobs are currently being directly and indirectly offshored to countries with lower-paid workers: see Figure 3a 1. The offshoring trend seems to have started slowly in the early 2000s, while growing rather slowly in the years from 2007 to 2010. Thereafter, it increases quite fast especially from 2012 to 2014 where the number of offshored jobs almost doubles. These are even quite conservative estimates. A large part of the increase in offshoring over the period is driven by direct offshoring, especially related to large banks and supporting financial companies (BEC, NETS etc.). The indirect offshoring grows much slower over the period, and for some years it even decreases. This mostly relates to the financial sectors core IT infrastructure, offshored through sub-contractors, typically being larger IT companies, not specifically related to finance (IBM, CSC, NNIT etc.). This trend for outsourcing started back in the 1970s, but in some cases, this trend has been reversed as some larger banks are insourcing functions, but locating them in low-cost countries. 1 See Box 2 for estimation techniques and data sources 12

Figure 3 Types of offshoring and total jobs offshored on a cumulative basis, 2005-2016 a) Types of offshoring of financial services b) Jobs in the Danish financial sector relative to jobs offshored Total jobs offshored 4.500 4.000 3.500 3.000 2.500 2.000 1.500 1.000 500 0 Total number of jobs 100.000 90.000 1% 80.000 1% 70.000 60.000 50.000 40.000 30.000 20.000 10.000 0 1% Share of jobs offshored 2% 3% 4% Indirect offshoring Direct offshoring Total offshoring Other financial services Pension and insurance Credit institutions Banks Total Danish jobs Total jobs including offshoring Note: Figure 2a) shows a rough estimate of the accumulated number of jobs offshored based on a number of data sources. For Nordea and Danske Bank, we assume that 30 and 65 per cent of the banks activities, respectively, are related to Denmark. The numbers are quite uncertain, especially the indirect offshoring and the numbers from before 2009. In Figure 2b) other financial services include different types of supporting companies, capital and investment funds and other services. Source: Panel a): Register data on foreign service trade, yearly accounts of a number of banks, an interview study and Oxford Research (2012). Panel b): Statistics Denmark Today, the total offshoring from the financial sector relates to about 4 per cent of the total employment in the Danish financial sector: see Figure 3b. The increasing tendencies for offshoring kicks in at the same time as the number of employees in the Danish financial sector decreases relatively fast. However, the offshoring tendencies only add up to a minor share of the overall decrease in employees in the Danish financial sector. The increasing digitalisation may explain a significantly larger share. 13

Box 1 Definition of Danish offshoring In this study, we define jobs offshored from Denmark as jobs set up in countries with lowerpaid workers to serve Danish customers of financial companies domiciled in Denmark. Importantly, for the large international banks, the Danish market is only a share of their business and, hence, only a part of their employees in countries with lower-wage workers serve their Danish consumers. Based on turnover, we assume that 65 per cent of Danske Bank and 30 per cent of Nordea is related to Danish customers. These are conservative estimates. The jobs offshored may not correspond to business functions previously handled by Danish employees. For example, as a result of increasing use of internet banking and mobile apps, several banks have opened new IT centres in India, Poland and other countries. The jobs in these centres do not correspond to previous business functions in Denmark, but they are still serving Danish consumers of Danish banks. Had the banks not offshored these, and if the supply of IT skills was there, these jobs could potentially have been set up in Denmark. Our distinction between direct and indirect offshoring is based on whether the offshoring occurs directly in a Danish financial company (defined by their branch codes in Statistics Denmark s registers) or through a Danish IT company delivering services to the financial sector. However, the distinction between what is part of the financial sector and what is IT is not clear-cut. For example, companies like NETS, SDC and Bankdata are part of the financial sector (supporting financial services), while JN Data is part of the IT sector. In this study, we generally do not distinguish between intercompany job relocation, where a Danish company establishes a branch or subsidiary in a country with lower wages, and situations where Danish companies buy services from a sub-contractor set up in a country with lower wages (on a consultancy basis). Source: Copenhagen Economics Direct offshoring from the financial sector We find that so far, a little over 3,000 jobs have been directly offshored from the financial sectors. A relatively large number of these have been offshored to India, and this has been the case for many years, whereas Lithuania and Poland have also become popular destinations for offshoring more recently: see Figure 4 and Figure 5. 14

Figure 4 Estimated directly offshored jobs in the financial sector, 2010 and 2016 Note: The numbers used are approximate, rounded up and quite uncertain. The numbers only relate to the Danish market: see Box 1 Source: Appendix A Direct offshoring of IT in the banking sector A large part of direct offshoring is driven by the banking sector and, in particular, by the large banks. Nordea, Danske Bank and Nykredit all started offshoring IT jobs to India in the early to mid-2000s, and Jyske Bank from 2008: see more details in Box 2. In the early phase this was only done through Danish and international consultancy companies, while Danske Bank has started to in-source their Indian IT employees in recent years. Today, Danske Bank has the largest IT back office in India (among the Danish banks) with more than 800 people (where it is estimated that around 65 per cent are serving Danish customers). Later, some of the smaller and regional banks, i.e. SEB Denmark, Spar Nord, and Saxo Bank also started offshoring IT functions to India. As far as we know, all these banks still offshore IT to India today. Nearshoring of both IT and back office functions in the banking sector Nordea also had some IT activities in Poland in the mid-2000s, but (as far as we know) had not established an actual IT centre and were not very successful. Nykredit started a pilot project in Poland in 2005. However, from around 2009, Nordea and Danske Bank both started nearshoring more systematically. Danske Bank started offshoring to Vilnius in Lithuania where they already had a relatively large retail bank and good experience with the job market. In the first year, the process happened relatively slowly this is possibly because Dansk Bank first needed to 15

know the Lithuanian market better and how to work in global teams. In 2012 they established a back-office centre; Danske Bank Global Services Lithuania (GSL), and in 2014 an IT centre; Danske Bank Global IT Lithuania (DGITL). Both centres grew quickly in the first couple of years. Nordea has an operation centre in Lodz, Poland and IT departments in Gdansk and Gdynia, where they previously also had a large retail department (now sold off to the Polish PKO bank). For both banks, the number of employees in the new EU countries increased slowly at first but have increased more quickly in recent years, especially from around 2012: see Figure 5. Nykredit established an IT centre in Warsaw, Poland, but given the smaller size of Nykredit compared to Nordea and Danske Bank, this centre was also much smaller in scale. Figure 5 Destinations of direct offshoring over time, cumulative numbers Jobs offshored 3.500 3.000 2.500 2.000 1.500 1.000 500 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Lithuania India Other new EU countries Direct offshoring, total Poland Other Baltics Pakistan, Ukraine and Gibraltar Note: The figure shows our rough estimates based on a number of data sources. For Nordea and Danske Bank, we assume that 30 and 65 per cent of the banks' activities, respectively, are related to Denmark. These are conservative estimates. Source: See appendix A Banks offshoring to other destinations We also see some degree of offshoring to other countries: We saw a relatively large degree of offshoring to the Czech Republic, Slovenia and Slovakia in 2010-12, but this has since decreased, which may indicate that this was on a shorter-term consultancy basis. For the other two Baltic countries, there has been an increasing degree of offshoring from 2013. To our knowledge, this is partly related to Danske Bank, which has some global back-office functions in Lithuania. Nordea has also established a call centre in Estonia, mostly to serve their Finnish customers. We also see a trend in offshoring to Cyprus and Malta, equivalent to around 30-60 employees after 2009. 16

Jyske Bank and Nordea have some operations on Gibraltar, especially the former. Jyske Bank has around 100 employees there, but not all of them serve the Danish market. Box 2 Some facts about individual banks Danske Bank: Early on, Danske Bank established a consultancy-based centre in Bangalore, India, through a company called ITC Infotech. In 2006 they had 40 employees working for Danske Bank in India. However, in recent years Danske Bank started insourcing the Indian consultants, and today most of their operations are managed internally in Danske Bank. Originally, Danske Bank started in India because of lack of resources in Denmark, but later scaling and cost efficiency have also become large factors. In 2009, Danske Bank started a back office and IT centre in Vilnius, Lithuania. This was mostly developed from 2012 and onwards. Danske Bank has their IT infrastructure outsourced partly to IBM and partly to NNIT. Since IBM have many employees in India and NNIT has some in China, the Philippines and the Czech Republic, this probably involved a large share of indirect offshoring. Nordea: Nordea started an operation centre in Lodz, Poland in 2010. In the beginning this was part of Nordea s local bank in Poland. The local bank was sold off to PKO Bank in 2014, but Nordea has kept and expanded their operation centre in Poland. Today, Nordea also has an IT department in Gdansk and Gdynia, Poland. Nordea has also established a call centre in Estonia, mostly to serve their Finnish customers. In 2006 Nordea outsourced large IT projects to an external IT company, Capgemini, where much of the production happened in Mumbai, India. From 2003 to 2014, Nordea s IT infrastructure was managed by a joint venture company with IBM: Nordic Processor. Since IBM has many employees in India, this probably involved a large share of indirect offshoring. However, from 2014 Nordea started insourcing their IT infrastructure in order to gain full control of their IT, to have better synergy in their IT services and shorten delivery times. Jyske Bank: Jyske Bank has a branch in Gibraltar with approximately 100 employees. Some of them serve local bank customers, but most of them serve Danish consumers. In spring 2008, Jyske Bank established an IT development centre in India (in Gurgau, near Delhi), starting with 10 employees. This was done on a consultancy basis through the company 7N. Before 2008, Jyske Bank also saw IT development in Poland. Their move to India was mostly done to cut costs compared to Poland. Nykredit: Nykredit started offshoring IT functions to India in the early 2000s, but later on they started nearshoring to an IT development centre in Warsaw, Poland, in 2005 at first with 5-10 employees, then around 15 in 2012. By 2014 they had 60 consultants. Source: See Appendix A 17

Offshoring of other financial IT services Other supporting financial services such as NETS, Bankdata and SDC have also undertaken direct offshoring in the financial sector. In total, our estimates suggest that they have a little over 500 employees offshored, primarily to India, Romania and Poland. Indirect offshoring to countries with lower-paid workers For indirect offshoring from the financial sector, the destinations are more widespread and distant, and here we find a total of around 700 jobs offshored indirectly in 2016, see Figure 6. The amount of indirect offshoring has been decreasing in recent years, partly at the expense of more direct offshoring. That said, given the indirect characteristics, the numbers are very uncertain: see estimation methods in Appendix A. Figure 6 Estimated indirectly offshored jobs from the financial sector, 2010 and 2016 Note: The numbers used are roughly rounded up and insecure Source: Appendix A Indirect offshoring through large IT companies For many years, the IT infrastructure for banks and other financial companies has been outsourced to IT consultants or combined financial-it houses. Offshoring to India and other countries has been going on for many years, especially for large international IT consultants. This is also why the indirect offshoring from the financial sector takes up a much larger share early in the period and has been more stable over the years compared to direct offshoring: see Figure 7. 18

Nordea and Danske Bank both started large agreements with IBM from 2003 and 2004. Nordea did this by establishing a joint venture company together with IBM (Nordic Processor APS), but Nordea has recently in-sourced their IT infrastructure. Danske Bank has extended part of their agreement with IBM and started another contract with NNIT. Indirect offshoring through joint venture with smaller banks Jyske Bank and Nykredit established a joint venture IT company together in 2003 called JN Data. Bankdata is another joint venture IT company. Other banks and insurance companies have used CSC and KMD. Figure 7 Destinations of indirect offshoring over time, cumulative numbers Jobs offshored 900 800 700 600 500 400 300 200 100 0 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Other countries Poland Indirect offshoring, total Balticum and other new EU countries India Note: The figure shows our rough estimates based on a number of data sources. For Nordea and Danske Bank, we assume that 30 and 65 per cent of the banks activities, respectively, are related to Denmark Source: Register data on foreign service trade, yearly accounts of a number of banks, interview study and Oxford Research (2012) 19

Key findings from Section 2.1: Today, more than 3,700 potential Danish jobs are offshored to lower-cost countries, mostly directly through the banking sector. The tendency for offshoring seems to start slowly in the early 2000s. After 2010 it picks up speed, and from 2012 to 2014 the number of offshored jobs almost doubles. Early in the period most of the offshoring happened indirectly through large IT subsidiaries, having large IT centres in distant low cost countries such as India. More recently, the direct offshoring has increased much faster and partly at the expense of indirect offshoring. Here large banks have started IT and other back office centres, typically much closer in the new EU countries. When looking at the large reduction in the number of employees in the banking sector in recent year, digitalisation and other factors still play a larger role than offshoring to low-cost countries. 2.2 Offshoring by services and functions Generally, there has been large changes in the types of jobs offshored in the mid-2000s as compared to today, both in the IT and financial sector. Earlier, low-cost countries were mostly used for less demanding and specialized jobs, while today offshoring happens across many different services and functions. Offshoring in the IT sector is mostly related to computer programming but is also related to many other services Within the IT sector, most offshoring is related to computer programming: see Figure 8. The share of offshoring of consultancy services related to information technology between 2005 and 2010 increased in the period from 2011 to 2015. Meanwhile firms working in computer facility management were offshoring to a much larger extent from 2005 to 2010 compared with the period between 2011 and 2015. In the financial sector it is mostly banks that have been offshoring From 2005 to 2010 banks were responsible for 20 per cent of total offshoring, and more recently 58 per cent from 2011 to 2015. The pension and insurance companies seem to have slowed down their offshoring activities. Specifically, the pension and insurance firms made up 25 per cent of total offshoring from 2005-2010, compared to only 5 per cent from 2011 to 2015. 20

Figure 8 Offshoring by sub-branch to countries with a lower wage Offshoring by sub-branch within the IT sector 2005-2010 7% 4% 2011-2015 3% 9% 31% 49% 14% 43% 32% 9% Computer programming Consultancy services for information technology Computer facility management Other IT services Data handling, webhosting and similar services Computer programming Consultancy services for information technology Computer facility management Other IT services Data handling, webhosting and similar services Offshoring by sub-branch within the financial sector 2005-2010 5% 2011-2015 1% 20% 32% 29% 58% 7% 29% 14% 5% Other Other credit services Other Other credit services Pension and insurance Banks Pension and insurance Banks Mortgage banks Mortgage banks Note: The figures are based on offshoring to countries with lower wages. Other includes different types of supporting companies, capital and investment funds and other services. Source: Copenhagen Economics based on register data from Statistics Denmark Today highly specialized jobs are being offshored IT development accounts for approximately 47 per cent of all offshoring: see Figure 9. Our analysis further suggests that compliance staff employed to avoid money laundering and payment service specialists account for approximately 10 per cent of Danish offshoring and design services for 3 per cent. Furthermore, project management and IT service management account for 4 and 7 per cent, respectively. We generally observe that the composition of IT functions abroad looks very similar to the functions in Denmark, yet with small differences, e.g. slightly more project management in Denmark. 21

Figure 9 Offshoring by function, 2017 3% 1% 2% 3% 7% 4% 3% 8% 8% 4% 9% 47% Specialists in payment services Money laundering specialists Business Development IT Operations IT Service Management Test Management Design IT Development Project Management Architects Infrastructure Security Source: Copenhagen Economics Traditionally, jobs further down the value chain were offshored As the financial services are becoming more and more digital, administrative tasks that were traditionally made manually are quickly becoming IT-driven. So, when financial institutions offshore administrative tasks, they are at the same time becoming automated. This implies that jobs that were labour intensive are now better characterised as IT tasks. It is these jobs that have been traditionally offshored. Today competences play a larger role Today the picture is different and financial institutions are now also offshoring highly specialized processes: see e.g. Figure 9. Our interview study reveals that it is increasingly difficult to find the right specialists in Denmark and highly productive jobs are being offshored or created abroad. Examples include JAVA developers, payment service specialists and money laundering experts. Key findings from Section 2.2: Today, most of the offshoring in the financial sector is related to banks, while for the IT sector it is related to computer programming. Compared to the mid-2000s where offshoring mostly related to standardized back office functions, it is now also related to the high competence and more specialized functions. 2.3 Employment for foreign workers in the financial and IT sector Compared to many other knowledge-intensive industries, the IT sector is generally ahead in the influx of foreign labour: see Figure 10. This is particularly due to the lack of supply 22

of IT skills in Denmark. The financial sector is also behind compared to architects and pharmaceuticals both knowledge-intensive sectors where Denmark has a leading role. Figure 10 Share of employed foreigners in chosen services, 2015 Share 16% 14% 12% 10% 8% 6% 4% 2% 0% Source: Statistics Denmark and Copenhagen Economics An increased influx of labour in the financial sector Foreign employees account for a rather small but increasing share of the jobs in the financial sector. In 2015, there were about 2,700 foreign employees working in the financial sector, equal to around 3.5 per cent of the total employment in the sector. The number of foreign employees working in the sector has steadily increased by around 3.5 per cent per year since 2009, even though the total number of employees in the financial sector has decreased over the period: see Figure 11. Highest influx of employees from EU countries When we look at country of origin, almost 43 per cent of the foreign employees come from other old industrialised countries, 18 per cent come from new EU countries (including Russia and Ukraine), while about 39 per cent come from emerging markets. Figure 12 shows a more detailed distribution. 23

2008 2009 2010 2011 2012 2013 2014 2015 Figure 11 Foreign employees working in the Danish financial sector a) Number of foreign employees employed b) Share of total foreign employees in the working sector, 2015 Number of foreign employees 3.000 2.500 2.000 1.500 1.000 500-2.424 2.8% 2.227 2.296 2.7% Source: Statistics Denmark 2.9% 2.583 2.728 3.3% 3.5% Old industrialised countries New EU countries, Russia and Ukraine Emerging markets 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Over 54, 8% 45-54, 19% 30-44, 53% Under 30, 21% Age Men, 51% Women, 49% Gender Most foreign employees are middle-aged Most foreign employees in 2015 are between 30 and 54 years old, while another 21 per cent are younger than 30: see Figure 11b. When we exclude foreign employees from conflict zones and non-industrialised countries, this share under 30 years old is even lower. This may indicate, that most foreign employees employed today come with some work experience from their home country. This trend has changed to some degree. In 2008, the share of foreign employees employed under 30 years old was nearly 30 per cent. The gender distribution is close to 50-50. There are slightly more men when we exclude foreign employees from conflict zones and non-industrialised countries, but only slightly. This has also remained constant over the years. All groups have grown since 2009, and the new EU countries have grown more substantially (at around 4.7 per cent per year). This mostly relates to the Baltics as well as Bulgaria and Romania. In the emerging markets, especially the number of foreign employees from India has increased a lot (part of other emerging markets in Figure 12). For most other countries, the share has remained almost unchanged. 24

Figure 12 Country of origin of foreign employees in the financial sector 2008 Other industrialised countries, 13% Germany and UK, 16% Other new EU countries, 2% Russia and Ukraine, 5% Poland, 8% Baltics, 2% Other, 37 % Bosnien-Hercegovina, 4% Iran and Irak, 7% Other conflict zones, 5% Parkistan and Turkey, 7% China, 4% Other emerging markets, 11% Scandinavia, 17% 2015 Other new EU countries, 3% Poland, 7% Baltics, 3% Other industrialised countries, 13% Germany and UK, 13% Russia and Ukraine, 5% Other, 39 % Bosnien- Hercegovina, 4% Iran and Irak, 7% Other conflict zones, 5% Parkistan and Turkey, 7% China, 4% Other emerging markets, 12% Scandinavia, 17% Source: Statistics Denmark Foreigners hold high-level positions Unsurprisingly, significantly more foreign employees from old industrialised countries occupy high-level jobs and chief executive positions (over 50 per cent in 2015): see Figure 13. Foreign employees from emerging markets and new EU countries mostly occupy ground and middle-level jobs and almost no chief executive positions. This may indicate that foreign employees from other industrialised countries often are headhunted by Danish companies and move to Denmark only because of the specific position. This is far from always the case for other foreign employees. 25

Figure 13 Functions of foreign employees and natives working in the financial sector, 2008 vs. 2015 Share of foreign employees with working in sector 100% 80% 60% 40% 20% 0% 2008 2015 Other Ground level Middel level High level Chief executive Note: Old industrialised countries include France, Germany, United Kingdom, Netherlands, Italy, Spain, Sweden, Norway, Island, Hungary and USA. Source: Statistics Denmark Compared to 2009, foreign employees are significantly more likely to occupy high-level jobs. In 2008, only 10 to 15 per cent of foreign employees occupied high-level jobs, while in 2015 the number is more than 40 per cent. First, this indicates how digitalisation and increasing offshoring means that, in general, jobs in the Danish financial sector are now more high-level and specialized. Many previously routine jobs are either digitalised or moved to countries with lower-paid workers. In some areas, especially in IT, Danish financial companies have a hard time finding the right qualified native Danish employees and, therefore, have to employ people from abroad. A significant increase in the number of high-level jobs happened just after the economic crisis (from 2008 to 2010). This may be due to the rather sudden increase in financial regulation (CRD 4 etc.), whereby banks and credit institutions were forced to hire experts in risk analysis. From the interviews, banks report that the availability of risk experts was very low in Denmark at this point, which is why they had to find people with the skills elsewhere. Where in the financial sector? In the financial sector, other financial services (such as capital and investment funds and different supporting companies) is the sub-sector with the highest share of foreign employees; around 7 per cent in 2015 (almost equally distributed between Western and non-western countries): see Figure 14. Banks, other credit institutions, pensions and insurance all have around a 4 per cent foreign employee workforce (also nearly equally distributed between Western and non-western countries). Since 2008, banks, other credit institutions 26

and other financial services have seen some increase in the share of foreign employees (between 0.7 and 0.9 per cent). Figure 14 Foreign employees in sub-sectors as a share of the total employees in the sub-sector Share of total imployees 8% 7% 2008 2015 6% 5% 4% 3,3% 3,6% 3% 2% 1% 0% 1,8% 2,1% 1,6% 1,3% 1,6% 1,7% 2,9% 2,5% 2,5% 1,6% 1,6% 1,9% 2,1% 3,4% Non-western countries Western countries Note: Other financial services include different types of supporting companies, capital and investment funds and other services. Source: Statistics Denmark Also an increased influx of labour in the IT sector The number of foreign employees in the IT sector is significantly higher than for the financial sector, even though the sector is significantly smaller. In 2015, more than 5,000 foreign employees were working in the IT sector, which equals about 9 per cent of the total number employed: see Figure 15. Similar countries of origin in both the IT and finance sector When we look at country of origin, the overall picture is not much different from the financial sector. Although, when we look at the details, other emerging markets take up a particularly large share (32 per cent in 2015): see Figure 15, panel a. This mostly indicates that a large share of foreign employees is from India, which is the single country with by far the biggest immigration share. See Figure 16 for a more detailed picture. All groups have increased since 2009, but especially the share from the Baltics. Other new EU countries and India have increased a lot, and especially in the most recent years. From 2013 to 2015, the number of foreign employees working in the IT sector from new EU countries increased by 20 per cent per year, while the number from India increased by 16 per cent per year. 27

Figure 15 Foreign employees in the IT sector as a whole a) Number of foreign employees b) Share of total foreign employees, 2015 6.000 100% Over 54, 5% 5.000 5.055 90% 9.1% 80% 4.273 45-54, 13% 4.000 8.0% 3.558 70% Men, 3.084 3.137 6.9% 71% 3.000 6.2% 6.4% 60% 30-44, 51% 50% 2.000 40% 1.000 30% 0 2008 2009 2010 2011 2012 2013 2014 2015 Old industrialised countries New EU countries, Russia and Ukrain Emerging markets 20% 10% 0% Under 30, 31% Age Woman, 29% Gender Note: Compared to Figure 6 and Figure 7, this figure includes the whole IT sector in Denmark not only the part related to the financial sector. As a rough estimate using input-output tables, suggest that a bit over 10 per cent of the IT services produced in Denmark is sold to the Danish financial sector. Source: Statistics Denmark Compared to the financial sector, the IT sector employs more people under the age of 30 and mostly men (as it is for the IT sector in general): see Figure 15b. More than half of all foreign employees hold high-level jobs When we look at job functions, the IT sector is ahead of the curve compared to the financial sector. In 2008, a little over half of all foreign employees in the IT sectors were hired in high-level jobs, and this was the same picture for all countries of origin (emerging, new EU and old industrialised). In 2015, the picture has in fact shifted as compared to the financial sector, such that emerging markets and new EU countries have an even higher share of high-level jobs (65 per cent and 56 per cent, respectively), while the share is unchanged for old industrialised countries. Compared to the financial sector, this indicates a clear lack of the right IT competences in Denmark, as has been pointed out in earlier studies, as discussed below. Furthermore, this may also explain much of the offshoring in the IT sector that we have seen. When companies in Denmark have to import a very large share of their employees, which is made difficult by high Danish taxation, it may be easier and cheaper to offshore. 28

Figure 16 Country of origin of foreign employees working in the IT sector 2008 Other new EU countries, 3% Russia and Ukraine, 3% Poland, 6% Baltics, 1% Other industrialised countries, 19% Germany and UK, 16% Scandinavia, 12% Other, 41% Bosnien-Hercegovina, 3% Iran and Irak, 6% Other conflict zones, 2% Parkistan and Turkey, 6% China, 5% Other emerging markets, 19% 2015 Other new EU countries, 7% Poland, 5% Baltics, 3% Other industrialised countries, 18% Russia and Ukraine, 4% Other, 39 % Bosnien-Hercegovina, 3% Iran and Irak, 5% Other conflict zones, 3% Parkistan and Turkey, 4% China, 4% Other emerging markets, 20% Germany and UK, 14% Scandinavia, 10% Source: Statistics Denmark Still a large share of foreign employees in key positions in the financial sector The financial sector employs a large share of employees on the so-called Forskerskatteordning a reduced income tax scheme for well-paid, specialized foreign employees. The financial sector employees 10 per cent of all employees using the scheme: see Figure 17. This is a large share given that the financial sector only makes up 6 per cent of the Danish economy. Box 3 Forskerskatteordningen 2017 Facts on Forskerskatteordning: Researchers and high-wage employees recruited abroad can under certain conditions reduce taxes to 26 per cent for up to 5 years. The reductions can be used by employees in every sector and by both foreign and Danish employees as long as they have not received income in Denmark for the past 10 years In order to be included in Forskerskatteordning, the high-wage employee must have an average monthly wage of 63,700 DKK or more. Source: SKAT 29

Figure 17 Sector division of employees on Forskerskatteordning Administrative services and help services, 11%; 396 Other* Mining and quarrying, 10%; 387 Liberal, scientific and technical services, 19%; 719 Manufacturing, 25%; 922 Financial services, 10%; 384 Information and communication, 06%; 231 Wholesale and retail trade, 14%; 522 Note: The numbers exclude scientists working in education. *) Since employees can work in more than one sector at the same time the category other is not the simple residual. Source: Skatteministeriet: http://www.skm.dk/skattetal/statistik/generel-skattestatistik/bruttoskatteordningen-for-forskere-og-noeglemedarbejdere-fakta-og-statistik Key findings from Section 2.3: The IT sector is generally in the lead when it comes to import of foreign labour. The import of foreign labour to the finance and IT sector sums up to around 2,700 and 5,000, respectively, and the employees come from both close to distant countries, within and outside of the EU. Accounting for the part of IT services sold to the financial sector, this seems almost as large as the financial sectors' offshoring to low-cost countries. This tendency for foreign workers has increased quite a lot in recent years -- especially in the IT and banking sector and especially workers from India, the Baltics and other new EU countries. Foreign workers often occupy highly qualified jobs -- especially in the most recent years and especially when it comes to people from other old industrialised countries working in the financial sector. The financial sector occupies a large share of all foreign workers on the Danish "forskerskatteordning". 30

Chapter 3 Causes and consequences for Danish workers and the Danish economy The increasing international division of labour is driven by a rapidly changing financial sector that is becoming increasingly digitalised. This creates an opportunity to move production to minimise costs and compensate for the lack of qualified domestic labour. We start by discussing how the financial sector is changing and how this change has been a driving force for offshoring (Section 2.2). Next, we analyse why financial institutions are offshoring (Section 2.3). We find two prominent drivers of offshoring and analyse them in detail, namely the lack of qualified labour and the so-called wage tax. This should be seen in the light of increasing offshoring in the financial sector going forward (Section 2.6). Next, we analyse the consequences for employees who become unemployed (Section 2.7) and end by giving some rough estimates of the consequences for the Danish economy (Section 2.8). 3.1 A driving force being the rapidly changing financial sector The structures of the financial sector are changing. The rapidly growing digitalisation of the financial sector, sometimes led by FinTech startups, is changing the incumbent financial sector with alternative digital services in almost every domain of the traditional sector. This is everything from money transfer, raising equity, lending activity, trading platforms, financial advice, etc. These digital advances have the potential to change the whole value chain of the financial sector. Digitalisation and centralisation have been the driving force The changing value chain is making offshoring more beneficial and has happened in multiple steps starting from centralising administrative tasks and ending up with core services being offshored, cf. Figure 18. To begin with it has made financial institutions gather their production in headquarters, close regional branches and outsource IT tasks to subcontractors. In the early 2000s, many newly created IT jobs in the financial sector were outsourced to Danish subsidiaries. In other words, digitalisation transformed traditional banking services into digital services that were primarily handled by Danish IT consultants and then later offshored. More recently, the trend is toward insourcing, where Danish financial institutions have started to create subdivisions abroad to ensure a more stable flow of services and ensure that employees have the right skill sets. A prime example is Danske Bank s activities in India and Lithuania. Danske Bank has bought IT services from India for decades, but traditionally used external consultants organised by large IT consultancies (like L&T Technology 31

Services or TCS). However, more recently, as IT services are becoming specialized, Danske Bank have chosen to have IT services made in-house in Danske Bank s own subsidiary in India in order to have a more consistent flow of services and make sure that Indian employees have the right skill set for the challenges faced by the bank. A similar in-sourcing trend can also be observed in Danske Bank Group IT in Lithuania where the help desk and IT services related to internet banking have been in-sourced from IBM. Figure 18 Changes in the production of financial services in several stages Administrative tasks are centralised at headquarters Outsourcing of non-core activities to subsiduaries Core services are streamlined, digitalised and centralised, and branches are closed Core financial services that do not require direct customer contact are outsourced or offshored Source: Copenhagen Economics Today, many customers prefer digital solutions like internet banking which are often presumed to be less time consuming and more efficient. It is this trend in preferences that are driving the ability of financial institutions to offshore jobs as physical contact is no longer needed. However, some jobs still require face-to-face customer interactions, not least among Danish IT suppliers. Our interviews reveal that one of the main barriers for outsourcing is customer contact, i.e., the more customer contact, the less likely it is that the job will be offshored. Key findings from Section 3.1: The structures of the financial services are changing, becoming more digital, less dependent on face-to-face contact and local branches, and no longer purely produced by the established domestic financial sector. This has changed the production of financial services in several stages, where a large part of the services today is produced in large centres, often across borders. 3.2 The structural drivers of offshoring If a company relocates job functions it is essentially due to the belief that it can serve its present or prospective customers at a lower cost and/or better attract employees with the right competences abroad. A key factor for many sectors, including the financial sector, is that gross wage costs are often lower in regions chosen for offshoring. 32