DP5681 Outsourcing, Contracts and Innovation Networks

Author(s): Alireza Naghavi, Gianmarco Ottaviano
Publication Date: May 2006
Keyword(s): incomplete contracts, innovation, outsourcing
JEL(s): F12, F23
Programme Areas: International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=5681

We study the decision of firms between vertical integration and outsourcing in a dynamic setting with product innovation. In so doing, we model an industry in which R&D is performed by independent research labs and outsourcing production requires complementary upstream and downstream inventions. In the presence of search friction and incomplete outsourcing contracts, we show that the ex-post bargaining power of upstream and downstream parties at the production stage feeds back to R&D incentives, thus affecting the emergence and the performance of labs specialized in complementary inventions.