Ebook Contractual Frictions and Global Sourcing
Insights from neoclassical trade theory and new trade theory have improved our understanding of the structure of foreign trade and investment. Recent developments in the world economy have sparked, however, an increased interest in new theoretical approaches designed to better understand the evidence about firms that organize production on a global scale. These developments include the growing role of multinational corporations in the global economy, their engagement in more complex integration strategies, and the growing share of intermediate inputs in trade flows.
Although traditional theories allow for trade in intermediate inputs and for the emergence of international production networks, they cannot explain some newly observed phenomena. First, while the traditional approaches assume that firms are (for the most part) symmetrically structured within industries, the data exhibit substantial within-industry heterogeneity, both in the size distribution of firms and in their participation in foreign trade. Second, in developing global sourcing strategies firms decide on where to locate the production of different parts of their value chains and also on the extent of their control over these activities. Which activities should they locate in the home country and which should they offshore? If they choose to offshore, should they engage in foreign direct investment (FDI) and import intermediate inputs within their boundaries or should they outsource the production of intermediates to independent foreign suppliers? As is well known from the work of Coase (1937), Williamson (1975, 1985), and Grossman and Hart (1986), these questions cannot be answered in a complete-contracting framework of the type used in traditional theories of international trade.
In Antràs and Helpman (2004) we developed a simple two-country Ricardian model of international trade in order to address some of these issues. In our model, firms in the North develop differentiated products. Then they decide whether to integrate the production of intermediates or outsource them. In either case firms have to decide in which country to source these inputs, in the high-cost North or the low-cost South.
Production entails relationship-specific investments by both the final-good producers (or product developers) and their suppliers, and we assumed that the nature of these investments does not enable the parties to specify them in an enforceable contract. As in the work of Grossman and Hart (1986), we envisioned a world in which incomplete contracting creates inefficiencies even when the production of intermediate inputs is carried out by integrated suppliers. The key difference between integration and outsourcing is that only the former gives the final-good producer property rights over the fruits of the relationship-specific investments.
Our model focused on the choices between integration and outsourcing and between domestic sourcing and foreign sourcing. In particular, we described an equilibrium in which firms with different productivity levels choose among the four feasible organizational modes: domestic outsourcing, domestic integration, foreign outsourcing (and thus imports of intermediate inputs at arm’s length), and foreign integration (and thus FDI and intrafirm imports of inputs). We then studied the effects of variations in country and industry characteristics on the relative prevalence of these organizational forms.
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