DP8614 Global Sourcing of a Complex Good

Author(s): Johannes Van Biesebroeck, Lijun Zhang
Publication Date: October 2011
Keyword(s): FDI, Outsourcing, property rights
JEL(s): D23, F12, L23
Programme Areas: Industrial Organization, International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=8614

We analyze a firm that produces a final good from multiple intermediates that can each be sourced domestically or from a low-wage country. The model explicitly incorporates that sourcing decisions of intermediates are interdependent. Equilibrium predictions depend crucially on a key modeling assumption--the nature of the trade friction that foreign production has to overcome. If production abroad involves a fixed cost, offshoring one intermediate unambiguously facilitates offshoring of other intermediates. However, if production abroad involves incomplete contracts, offshoring one intermediate almost always makes it more difficult to offshore others. We illustrate that the pattern in prices at which successive automotive parts are imported into the U.S. accords better with the predictions of the incomplete contracting model, except for a few countries with the best governance indicators.