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A Theory of Outsourcing and Wage Decline

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  • Thomas J. Holmes
  • Julia Thornton Snider

Abstract

We develop a theory of outsourcing in which there is market power in one factor market (labor) and no market power in a second factor market (capital). There are two intermediate goods: one labor-intensive and the other capital-intensive. We show there is always outsourcing in the market allocation when a friction limiting outsourcing is not too big. The key factor underlying the result is that labor demand is more elastic, the greater the labor share. Integrated plants pay higher wages than the specialist producers of labor-intensive intermediates. We derive conditions under which there are multiple equilibria that vary in the degree of outsourcing. Across these equilibria, wages are lower the greater the degree of outsourcing. Wages fall when outsourcing increases in response to a decline in the outsourcing friction.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14856.

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Date of creation: Apr 2009
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Publication status: published as 5 "A Theory of Outsourcing and Wage Decline." American Economic Journal: Microeconomics , 3(2), May 2011: 38–59, with Julia Thornton Snider
Handle: RePEc:nbr:nberwo:14856

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Cited by:
  1. Richard B. Freeman, 2010. "What Does Global Expansion of Higher Education Mean for the United States?," NBER Chapters, in: American Universities in a Global Market, pages 373-404 National Bureau of Economic Research, Inc.

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