Offshoring under uncertainty

We develop a theoretical framework explaining firms’ offshoring decisions in the presence of uncertainty. Our model highlights the role of labor market institutions in shaping a firm’s ability to effectively react to future shocks, yielding a sharp prediction on the prevalence of offshoring in a given industry: The propensity of firms to source intermediate inputs from foreign rather than domestic suppliers decreases in the foreign country’s labor market rigidity, and this effect is particularly pronounced in industries with higher volatility. Combining industry-level data on the U.S. offshoring intensity with measures of labor market rigidity and industry volatility, we find empirical evidence strongly supportive of the model’s predictions.