This paper exploits a direct measure of offshoring to study how the movement of production abroad affects the composition of firms’ domestic employment and production, as well as their innovative activities. After offshoring begins, firms increase their imports of domestically produced goods, and retain – rather than abandon – domestic production of those goods. We define a new measure of offshoring based on this relationship that enables us both to distinguish it from import competition and to identify new production cost saving opportunities in foreign countries. In response to such new offshoring opportunities, firms reallocate labor from production work to technology and innovation-related occupations. This reallocation of workers is accompanied by increases in offshoring firms’ product development and R&D spending. The results suggest a link between offshoring and domestic innovation.

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