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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.

Suggested Citation

  • Thomas J. Holmes & Julia Thornton Snider, 2009. "A Theory of Outsourcing and Wage Decline," NBER Working Papers 14856, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:14856
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    Cited by:

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    2. 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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    More about this item

    JEL classification:

    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production

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