Offshore Production and Business Cycle Dynamics with Heterogeneous Firms

43 Pages Posted: 7 Sep 2017

See all articles by Andrei Zlate

Andrei Zlate

Federal Reserve Banks - Federal Reserve Bank of Boston

Date Written: 2016-02-17

Abstract

To examine the effect of offshoring through vertical FDI on the international transmission of business cycles, I propose a two-country model in which firms endogenously choose the location of their production plants over the business cycle. Firms face a sunk cost to enter the domestic market and an additional fixed cost to produce offshore. As such, the offshoring decision depends on the firm-specific productivity and on fluctuations in the relative cost of effective labor. The model generates a procyclical pattern of offshoring and dynamics along its extensive margin that are consistent with data from Mexico's maquiladora sector. The extensive margin enhances the procyclical response of the value added offshore to expansions in the home economy, as the number of offshoring firms mirrors the dynamics of firm entry at home. As a result, offshoring increases the comovement of output across economies, in line with the empirical evidence.

Keywords: Offshore production, extensive margin, heterogeneous firms, firm entry, business cycle dynamics, terms of labor.

JEL Classification: F23, F41

Suggested Citation

Zlate, Andrei, Offshore Production and Business Cycle Dynamics with Heterogeneous Firms (2016-02-17). FRB Boston Risk and Policy Analysis Unit Paper No. RPA 16-1. Available at SSRN: https://ssrn.com/abstract=3033350

Andrei Zlate (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Boston ( email )

600 Atlantic Avenue
Boston, MA 02210
United States

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