DP3629 Why is a Flexible World More Insecure? The Way Outsourcing Amplifies Uncertainty

Author(s): David Thesmar, Mathias Thoenig
Publication Date: October 2002
Keyword(s): flexibility, fragmentation, outsourcing, uncertainty
JEL(s): D20, D80, F40, L22
Programme Areas: Industrial Organization, International Trade and Regional Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3629

This Paper presents a macroeconomic model where firms may endogenously outsource part of their production process. We start from the premise that adaptation to uncertainty cannot be contracted upon in the worker - employer relationship. Outsourcing decisions then balance flexibility gains against hold-up costs of opportunistic behaviour by outside contractors. In equilibrium, the degree of outsourcing is shown to depend on the degree of product market competition, contractor's bargaining power, and the volatility of demand shocks. Our main result is that an increase in the degree of outsourcing amplifies the volatility of firm sales and employment; it does not, however, amplify aggregate uncertainty. This theory is therefore a good candidate in explaining the rise in firm level uncertainty witnessed in the US over the past 30 years. It also provides valuable insights on the relation between globalization, technical change, firm level uncertainty and job instability. Finally, we bring our theory's implications to the test. Evidence from firm level data is shown to be largely consistent with the main implications of our theory.