Monitoring Costs and Offshoring with Heterogeneous Firms

We present a model in which monitoring costs determine firms’ outsourcing and offshoring decisions. We predict that the most productive firms outsource in the South, while the least productive produce in-house in the North. Within the range of intermediate productivities, firms with lower productivity outsource in the North, and those with higher productivity perform in-house production in the South. Offshoring gives rise to higher average world productivity, but an overall loss of variety. Exit of Southern firms following offshoring is sufficient to offset any change in the number of Northern firms producing ex post. Inequality between Northern entrepreneurs and Northern workers rises, while that between Northern workers and Southern workers falls. Inequality between Northern entrepreneurs and everyone else rises. ∗Nuffield College and Department of Economics, University of Oxford. Email: [email protected]. I am extremely grateful to Peter Neary for helpful comments, suggestions and encouragement. I also wish to thank participants at the Merton-Oxcarre Seminar in International Trade at Oxford, and participants on the 2008 Columbia University/Manchester University Advanced Graduate Workshop on Poverty, Globalization and Development. All errors remain my own. Comments, criticisms and suggestions most welcome; please email me at the above address.