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Vertical FDI versus Outsourcing: A Welfare Comparison from the Perspective of the Host Country

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  • Arti Grover
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    Abstract

    The theory on organization of offshore production is most often viewed through the lens of a source country. Moreover, internalization literature in a vertical production transfer context is divorced from its welfare consequences. That is, the decision to “make or buy” offshore input is usually not connected with the welfare effect of each alternative organizational mode. In this paper we recognize the importance of the mode of organization of fragmented production for the host country. Whether production sharing arrangement is internalized by the parent firm in the form of a vertical foreign direct investment (VFDI) relationship or transacted externally through outsourcing contracts, affects the welfare of the host country in a significant way. Using a Grossman-Helpman quality ladders model and Vernon’s product cycle set up, we compare the welfare derived by the host country in the two alternative regimes of production sharing arrangements in the host country. The ability to maximize welfare in the alternative regimes is found to be contingent on the absorptive capacity of the host country. If the host country's absorptive capacity is above a threshold level, outsourcing is more welfare enhancing vis-à-vis VFDI; while even with an absorptive capacity lower than this threshold, outsourcing being welfare improving over VFDI cannot be ruled out.

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    Bibliographic Info

    Paper provided by DEGIT, Dynamics, Economic Growth, and International Trade in its series DEGIT Conference Papers with number c013_009.

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    Length: 15 pages
    Date of creation: Nov 2008
    Date of revision:
    Handle: RePEc:deg:conpap:c013_009

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    Related research

    Keywords: outsourcing; foreign direct investment; absorptive capacity;

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    References

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    1. Antras, Pol & Helpman, Elhanan, 2004. "Global Sourcing," Scholarly Articles 3196327, Harvard University Department of Economics.
    2. Jocelyn Glass, Amy & Saggi, Kamal, 2002. "Licensing versus direct investment: implications for economic growth," Journal of International Economics, Elsevier, vol. 56(1), pages 131-153, January.
    3. Pack, Howard & Saggi, Kamal, 1997. "Inflows of Foreign Technology and Indigenous Technological Development," Review of Development Economics, Wiley Blackwell, vol. 1(1), pages 81-98, February.
    4. Mary Amiti & Shang-Jin Wei, 2006. "Service Offshoring and Productivity: Evidence from the United States," NBER Working Papers 11926, National Bureau of Economic Research, Inc.
    5. Beaulieu, Eugene & Benarroch, Michael & Gaisford, James, 2004. "Trade barriers and wage inequality in a North-South model with technology-driven intra-industry trade," Journal of Development Economics, Elsevier, vol. 75(1), pages 113-136, October.
    6. Glass, Amy Jocelyn & Saggi, Kamal, 2001. "Innovation and wage effects of international outsourcing," European Economic Review, Elsevier, vol. 45(1), pages 67-86, January.
    7. Balcao Reis, Ana, 2001. "On the welfare effects of foreign investment," Journal of International Economics, Elsevier, vol. 54(2), pages 411-427, August.
    8. Gorg, Holger & Hanley, Aoife, 2005. "International outsourcing and productivity: evidence from the Irish electronics industry," The North American Journal of Economics and Finance, Elsevier, vol. 16(2), pages 255-269, August.
    9. Saggi, Kamal, 1999. "Foreign Direct Investment, Licensing, and Incentives for Innovation," Review of International Economics, Wiley Blackwell, vol. 7(4), pages 699-714, November.
    10. Gianmarco I. P. Ottaviano & Alessandro Turrini, 2007. "Distance and Foreign Direct Investment when Contracts are Incomplete," Journal of the European Economic Association, MIT Press, vol. 5(4), pages 796-822, 06.
    11. Glass, Amy Jocelyn & Saggi, Kamal, 1999. "FDI policies under shared factor markets," Journal of International Economics, Elsevier, vol. 49(2), pages 309-332, December.
    12. Saggi, Kamal, 1996. "Entry into a Foreign Market: Foreign Direct Investment versus Licensing," Review of International Economics, Wiley Blackwell, vol. 4(1), pages 99-104, February.
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