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Firm Heterogeneity, Contract Enforcement, and the Industry Dynamics of Offshoring

Alireza Naghavi and Gianmarco Ottaviano
The Scandinavian Journal of Economics
Vol. 111, No. 4, Heterogeneous Firms and International Trade (December 2009), pp. 629-653
Published by: Wiley on behalf of The Scandinavian Journal of Economics
Stable URL: http://www.jstor.org/stable/40587807
Page Count: 25
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Firm Heterogeneity, Contract Enforcement, and the Industry Dynamics of Offshoring
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Abstract

We develop an endogenous growth model with R&D spillovers to study the long-run consequences of offshoring with firm heterogeneity and incomplete contracts. In so doing, we model offshoring as the geographical fragmentation of a firm's production chain between a home upstream division and a foreign downstream division. While there is always a positive correlation between upstream bargaining weight and offshoring activities, there is an inverted U-shaped relationship between these and growth. Whether offshoring with incomplete contracts also increases consumption depends on firm heterogeneity. As for welfare, whereas with complete contracts an R&D subsidy is enough to solve the inefficiency due to R&D spillovers, with incomplete contracts a production subsidy is also needed.

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