A North–South model of outsourcing and growth

• Author: Yuki Saito
• DOI: http://doi.org/10.1111/rode.12382
• Date: 01 August 2018
• Published date: 01 August 2018

REGULAR ARTICLE

A North–South model of outsourcing and growth

Yuki Saito

Graduate School of Economics, Osaka

University, 1-7 Machikaneyama,

Toyonaka, Osaka, 560-0043, Japan

Correspondence

Yuki Saito, Graduate School of

Economics, Osaka University, 1-7

Machikaneyama, Toyonaka, Osaka 560-

0043, Japan.

Email: yuki.saito.r@gmail.com

Funding information

Japan Society for the Promotion of

Science (JSPS), Grant/Award Number:

JP16J02242

Abstract

In this paper, I formulate a simple North–South R&D-based

growth model where final goods firms in the North endoge-

nously determine the range of international outsourcing of

intermediate goods to the South. I show that a fall in the

trade cost (through trade liberalization) of intermediate

goods in the North: (i) reduces the wage of the North relative

to that of the South; (ii) increases the outsourced variety of

intermediate goods in the North; and (iii) stimulates North-

ern R&D activity and economic growth in both countries.

By conducting welfareanalysis, I also show that a decline in

the trade cost of intermediate goods in the North improves

welfareintheSouthmorethanintheNorth.

1

|

INTRODUCTION

Because of a decline in trade costs (e.g., costs of communication, search, and transportation) in

recent decades, the environment for the production of final goods has changed. In particular, many

final goods firms have outsourced the production of some intermediate goods (or some production

tasks) needed to produce final goods. If the price of an intermediate good in a foreign country is

cheaper than in the home country, final goods firms will then purchase the intermediate good from

the foreign country to minimize their overall production cost. Consequently, final goods firms

determine whether they purchase an intermediate good from their home country or a foreign coun-

try. For example, Feenstra and Jensen (2012) show that imported intermediate inputs as a share of

total intermediate inputs in the US manufacturing sector rose from about 6% in 1980 to abou t 27%

in 2006.

1

Furthermore, outsourcing the production of intermediate goods has an important impact

on research and development (R&D) activity. By importing some varieties of intermediate goods

from a foreign country, firms can reallocate workers from the production sector to R&D within

those countries in which they operate. Therefore, it is possible to shift from production to R&D in

the country from which firms outsource.

DOI: 10.1111/rode.12382

e16

|

©2018 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/rode Rev Dev Econ. 2018;22:e16–e35.

In this paper, I construct a simple North–South R&D-based growth model in which final goods

firms in the North endogenously determine the extent of international outsourcing of intermediate

goods to the South and the South engages only in the production of intermediate goods. To endoge-

nize the extent of outsourcing in each firm, I incorporate Dornbusch, Fischer, and Samuelson’s

(1977) continuum-good Ricardian model into Grossman and Helpman’s (1991) quality-ladder

model.

2

Using this model, I examine the impact of a decline in the trade cost (or trade liberalization)

of intermediate goods in the North. I then show that a fall in the trade cost of intermediate goods in

the North: (i) reduces the wage of the North relative to that of the South; (ii) increases the outsourced

variety of intermediate goods in the North; and (iii) stimulates Northern R&D activity and economic

growth in both countries.

3

The second of these results is consistent with the following relationship. In

recent years, the cost of trade (mainly the costs of transportation and communication) has declined,

and at the same time, the volume of outsourcing has increased in most developed countries.

4

The third

of these results arises from the reallocation of Northern labor from production to R&D as a conse-

quence of outsourcing. By conducting welfare analysis, I show that a fall in the trade cost of interme-

diate goods in the North improves welfare in both the North and the South, and that the positive

impact of a fall in the trade cost of intermediate goods in the North on welfare in the South is larger

than that in the North.

Many existing studies employ an R&D-based growth model to investigate fragmentation

issues such as outsourcing and offshoring. For example, Glass and Saggi (2001) and Glass

(2004) detail a North–South product-cycle model with outsourcing.

5

In a North–South endoge-

nous growth model with offshoring, Naghavi and Ottaviano (2009a, 2009b) analyze the effect

of contracts in relation to offshoring. Elsewhere, Morita (2010, 2012) investigates not only the

steady state but also the transition of an economy using a North–South endogenous growth

model with outsourcing. Rodr

ıguez-Clare (2010) analyzes the effect of offshoring on relative

wages in Eaton and Kortum’s (2001, 2002) models with offshoring. Impullitti (2016) analyzes

the effect of foreign technological competition on the skill premium and residual wage inequal-

ity in a two-region quality-ladder growth model with offshoring. Importantly, in all of these

studies, the range of outsourcing or offshoring within a firm’s total use of inputs is an exoge-

nous constant. Accordingly, they necessarily focus on the decision to outsource or on the

effects of outsourcing and offshoring. In practice, firms decide the range of outsourcing within

the total use of intermediate goods. In a North–South model of directed technical change, Ace-

moglu, Gancia, and Zilibotti (2015) and Chu, Cozzi, and Furukawa (2015) investigate the effects

of offshoring on skill-biased technical change. Hashimoto (2015) analyzes the impact of tariffs in

a two-country model with offshoring and labor market imperfections. In these models, the share

of outsourcing or offshoring within total inputs is endogenously determined.

6

However, none of

these studies conduct welfare analysis.

7

In contrast to this literature, I assume the range of out-

sourcing within a firm’s total use is endogenously determined and analytically conduct welfare

analysis. I also explore a different set of research questions.

The present analysis most relates to Gao (2007) and Naito (2012), both of which explor e

the effect of trade liberalization in an endogenous growth model. Gao (2007) constructs a

North–South R&D-based growth model in which the production locations of intermediate goods

are endogenously determined, and shows that a reduction in trade cost increases the number of

intermediate goods produced in the South and the growth rate of the world by expanding the

supply of labor to the Northern R&D sector. Because in Gao’s (2007) model location shifts of

intermediate goods production from the North to the South can be interpreted as international

outsourcing by the North, the results and mechanisms of the present paper in relation to inter-

national outsourcing and growth are similar to those in Gao (2007). However, Gao (2007) does

SAITO

|

e17