DP5925 Outsourcing, Complementary Innovations and Growth

Author(s): Alireza Naghavi, Gianmarco Ottaviano
Publication Date: November 2006
Keyword(s): complementary innovations, growth, incomplete contracts, organization of firms, outsourcing, welfare
JEL(s): D91, L14, L23, O32
Programme Areas: International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=5925

This paper analyzes the organization of firms in a dynamic setting with endogenous growth to shed light on the link between economic growth and the parallel creation and adoption of complementary innovations by independent labs and plants. 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 into innovation and growth. Our dynamic perspective reveals a tension between the static and dynamic effects of outsourcing. The reason is that firms make their organizational choices weighting the higher searching and contracting costs of outsourcing against the higher entry and foregone specialization costs of vertical integration. In so doing, they neglect the effects of their choices on innovation and growth. Hence, when outsourcing is selected, the static gains from specialized production may at times be associated with relevant dynamic losses for consumers.