On Offshoring and Trade Deficit

• DOI: http://doi.org/10.1111/rode.12100
• Published date: 01 August 2014
• Date: 01 August 2014
• Author: Hamid Beladi,Reza Oladi

On Offshoring and Trade Deficit

Hamid Beladi and Reza Oladi*

Abstract

The paper constructs a general equilibrium model of North–South trade with nontraded goods, real

exchange rate, and a continuum of components that North partly offshores to South. It is shown that a

protectionary policy which restricts offshoring may have the unintended consequence of widening the trade

deficit.

1. Introduction

International outsourcing or offshoring is often defined as international fragmentation

of production, whereby a firm outsources the production of some fragments (compo-

nents) to foreign firms. Although it has been used for a long time,1the extent of this

practice (especially offshoring to low-wage developing countries) has been increasing

so rapidly that it has caused alarm in the public policy circles and academic

community.

Apart from the often heated public debates on offshoring that we have witnessed,

economists have intensely studied various aspects of this issue in the literature.

Some authors have explored the determinants of international outsourcing or

offshoring (e.g., see Grossman and Helpman 2005; and more recently, Choi and

Choi, 2013; Oladi et al., 2014), while others considered the effects of international

outsourcing on factor rewards, in particular wages (see Jones, 2005; Batra and

Beladi, 2010a,b).2

The purpose of the present paper is to study the effect of protectionary policies vis-

à-vis offshoring on trade deficit. Notwithstanding the intense research on offshoring

the in past few years, the question we address in this paper has been ignored in the lit-

erature. To answer the question, we construct a general equilibrium model of a pro-

duction economy with two finished goods (a non traded good and a traded good) and

a continuum of components. The non traded good sector uses the continuum of com-

ponents (some of which being imported) as inputs in production of the finished non

traded good. The inclusion of the nontraded good allows us to introduce the real

exchange rate in our general equilibrium model. Aside from the crucial role the

nontraded good plays in our model in facilitating the definition of the real exchange

rate, the inclusion of nontraded good is paramount on its own merits. Nowadays, a

significant share of gross domestic product (GDP) in any developed economy consists

of nontraded goods. For example, GDP share of nontraded goods for the US

economy was about 41% in 2005.3

Much of the international trade literature assumes balanced trade, with a few

exceptions (e.g., see Batra and Beladi, 1996; Chao and Yu, 1998).4However, the

* Beladi, Department of Economics, University of Texas at San Antonio, One UTSA Circle, San Antonio,

TX 78249-0633, USA. Tel: +210-458-7038, Fax: +210-458-7040; E-mail: hamid.beladi@utsa.edu. Oladi:

Department of Applied Economics, Utah State University, Logan, UT 84322, USA. Reza Oladi acknowl-

edges financial support from Utah Agricultural Experiment Station and Hamid Beladi thanks IBC Bank.

Review of Development Economics, 18(3), 517–523, 2014

DOI:10.1111/rode.12100

© 2014 John Wiley & Sons Ltd