Innovation and Manufacturing Offshoring with Fully Endogenous Productivity Growth

This paper investigates the relationship between net offshoring patterns for innovation and manufacturing and fully endogenous productivity growth in a two-country model. The occupational choice of skill-differentiated workers into low-skilled employment in production and high-skilled employment in innova- tion determines labor market allocations, and perfect investment mobility allows firms to shift innovation and manufacturing independently between countries. These mechanisms generate a tension between access to technical knowledge and low-cost high-skilled labor in the location decision for innovation, which results in innovation and manufacturing tending to concentrate in the asset-wealthy (asset-poor) country when trade costs are high (low). The model exhibits a positive relationship between innovation costs and the concentration of industry and innovation, ensuring that a rise in knowledge diffusion between countries coincides with increases in net offshoring flows in innovation and manufacturing from the asset-wealthy country to the asset-poor country, and a faster rate of productivity growth, when the asset-wealthy country has larger shares of innovation and production.