Threatening to Offshore in a Search Model of the Labor Market

We develop a two-country labor search model in which a multinational firm engages in production sharing by hiring both domestic and foreign labor to produce a final good. A key innovation to the model is the sequential nature of labor markets which allows the ability of the multinational to shift production oversees to enter into its outside option in domestic wage negotiations. This feature allows us to articulate the threat effect is a very tractable way. Using this framework, we derive a model-based estimate of the effect that the threat of offshoring has on global wages and labor market allocations. In the short run, when firm entry and the capital stock are both impeded from fully adjusting to an increase in globalization, we find that the threat has sizable effects: domestic wages are lower, jobs are reallocated abroad, and the unemployment rate is higher. In contrast, when entry and adjustment of the capital stock are free to adjust, we find that the threat of offshoring has a minimal impact. These results highlight the importance of taking into account transition dynamics when evaluating the effects of changes in trade policy.