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Vertical FDI versus Outsourcing: The Role of Host Country Human Capital

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  • Arti Grover

Abstract

The decision to make or buy” an input is usually studied with reference to the home country. However, since the offshored input is produced in a host country, there is a strong reason to believe that the host country factors would also influence the organization decision of offshore production. In this paper, we modify the Antràs (2005) model to explore the affect of the host country human capital on the organization of offshore production. We propose that the offshored input cannot be produced in a host country without incurring training cost on the host country labor. This training cost would in turn depend on the human capital gap between the home and the host country. We find that: 1. For low-tech goods, where the likelihood of outsourcing is higher in the Antràs model, vertical FDI is a possibility when the human capital gap between the home and the host country is low, 2. For high-tech goods, where the likelihood of vertical FDI is higher in the Antràs model, international outsourcing is also possible, especially when the human capital gap between the home and the host country is large. Our model also has policy suggestions for host countries which aspire to maximize their benefits from the exploding global production sharing phenomenon. As the wage gap between the source and the host country falls, offshoring for simply cost considerations falls. To keep this cost pressure from dampening offshoring activity, a host country must necessarily make investment in education to lower the human gap between the home and the host.

Suggested Citation

  • Arti Grover, 2009. "Vertical FDI versus Outsourcing: The Role of Host Country Human Capital," DEGIT Conference Papers c014_048, DEGIT, Dynamics, Economic Growth, and International Trade.
  • Handle: RePEc:deg:conpap:c014_048
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    File URL: http://degit.sam.sdu.dk/papers/degit_14/c014_048.pdf
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    References listed on IDEAS

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    1. Bartel, Ann P & Lach, Saul & Sicherman, Nachum, 2005. "Outsourcing and Technological Change," CEPR Discussion Papers 5082, C.E.P.R. Discussion Papers.
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    Cited by:

    1. Goswami, Arti Grover, 2013. "Vertical FDI versus outsourcing: The role of technology transfer costs," The North American Journal of Economics and Finance, Elsevier, vol. 25(C), pages 1-21.

    More about this item

    Keywords

    Outsourcing; Foreign Direct Investment; Training; Human Capital Gap;

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • 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
    • L33 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Comparison of Public and Private Enterprise and Nonprofit Institutions; Privatization; Contracting Out

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