Preference Bias and Outsourcing to Market: A Steady-State Analysis

We analyze a model that focuses on the export/outsource decision. Outsourcing has the advantage of providing better information about local preferences. The disadvantage is that producing in the host country also means using the inferior technology embodied in the local capital. The decision of whether to o¤er an outsourcing contract weighs these two e¤ects against each other. The host country accepts the outsourcing contract if the higher price they pay for the outsourced good is worth the bene…t of consuming a manufactured good closer to their ideal variety. These results suggest that as low income countries develop they become a more attractive destination for outsourcing because their capital grows to meet production needs and the local market is more lucrative. In addition, the developing low income country …nds the outsourcing contract more attractive since their increased demand for the correct variety of the manufactured good increases. This suggests that preference based outsourcing is more likely to occur with higher income host countries. Keywords: Outsourcing, Multinational Firms, Foreign Direct Investment JEL Classi…cation Numbers: F20, F21, F23 Acknowledgment: We would like to dedicate this paper to the memory of our dear friend and colleague Koji Shimomura whose stimulating work in trade and growth has inspired all of us. We are grateful for comments and suggestions by Eric Bond, Ronald Jones, Murray Kemp, an anonymous referee, and participants of the Kobe Conference in memory of Koji Shimomura, the CESifo Area Conference on Global Economy, and the Midwest International Trade Meeting. Correspondence: Raymond Riezman, Department of Economics, University of Iowa, Iowa City, IA 52242; 319-335-1956 (Fax); [email protected] (E-mail).