Competition and Offshoring

I present a model of offshoring decisions with heterogeneous firms, random adjustment costs, and endogenous markups. The model shows an inverted-U relationship between firm-level productivity and the probability of offshoring; hence, the most productive firms are less likely to offshore than some lower-productivity firms. A tougher competitive environment has two opposing effects on firm-level offshoring likelihood: a Schumpeterian effect--accounting for the negative effect of competition on offshoring profits--and an escape-competition effect--accounting for the effect of competition on the incremental profits from offshoring. A productivity level separates non-offshoring firms according to the dominant effect, with the Schumpeterian effect dominating for the least productive firms.