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Incomplete Contracts and the Impact of Globalization on Consumer Welfare

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  • Fabrice Defever

Abstract

We embed a North-South trade model into an incomplete contracts setting where the production of heterogeneous firms can be geographically separated. When a Northern headquarter contracts with a Southern supplier instead of a Northern supplier, the presence of international incomplete contracts may lead to a higher price. As a result, trade liberalization, that induces offshoring, is not necessarily welfare-enhancing for consumers, despite the lower cost of labor in the South. In addition, firms which use the supplier's component intensively, offshore their supplier in the South using outsourcing. As trade costs fall, less componentintensive firms also offshore, but by vertically integrating their supplier. We argue that this organizational change increases production-shifting in the South, implying that a larger number of varieties will be produced in the South where contracts are incomplete. We show that, this may reduce consumer welfare in both countries.

Suggested Citation

  • Fabrice Defever, 2011. "Incomplete Contracts and the Impact of Globalization on Consumer Welfare," CEP Discussion Papers dp1057, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp1057
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    Cited by:

    1. Defever, Fabrice & Toubal, Farid, 2013. "Productivity, relationship-specific inputs and the sourcing modes of multinationals," Journal of Economic Behavior & Organization, Elsevier, vol. 94(C), pages 345-357.

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    More about this item

    Keywords

    Consumer Welfare; Incomplete Contracts; hold-up problem;
    All these keywords.

    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • R3 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location

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