Relocating the value chain: off-shoring and agglomeration in the global economy*

Fragmentation of stages of the production process is determined by international cost differences and by the benefits of co-location of related stages. The interaction between these forces depends on the technological relationships between these stages. This paper looks at both cost minimising and equilibrium fragmentation under different technological configurations. Reductions in trade costs beyond a threshold can result in discontinuous changes in location, with relocation of a wide range of production stages. There can be overshooting (offshoring that is reversed as costs fall further) and equilibrium may involve less offshoring than is efficient.