Temporary Shocks and Offshoring: The Role of External Economies and Firm Heterogeneity

33 Pages Posted: 21 Jun 2007  

Devashish Mitra

Syracuse University - Department of Economics; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Priya Ranjan

University of California, Irvine - Department of Economics

Date Written: May 2007

Abstract

We construct a model of offshoring with externalities and firm heterogeneity. Due to the presence of externalities, temporary shocks like the Y2K problem can have permanent effects, i.e., they can permanently raise the extent of offshoring in an industry. Also, the initial advantage of a country as a potential host for outsourcing activities can create a lock in effect, whereby late movers have a comparative disadvantage. Furthermore, the existence of firm heterogeneity along with externalities can help explain the dynamic process of offshoring, where the most productive firms offshore first and the others follow later. Finally, we work out some unexpected welfare implications which show that net industry profits can be lower in an outsourcing equilibrium than in a regime of no outsourcing. Consumer welfare rises, and under fairly plausible conditions this effect can offset the negative impact on profits.

Keywords: offshoring, outsourcing, Y2K, complementarity

JEL Classification: F12, F23, O19

Suggested Citation

Mitra, Devashish and Ranjan, Priya, Temporary Shocks and Offshoring: The Role of External Economies and Firm Heterogeneity (May 2007). IZA Discussion Paper No. 2811. Available at SSRN: https://ssrn.com/abstract=995490 or http://dx.doi.org/10.2139/ssrn.995490

Devashish Mitra (Contact Author)

Syracuse University - Department of Economics ( email )

The Maxwell School of Citizenship & Public Affairs
133 Eggers Hall
Syracuse, NY 13244-1020
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Priya Ranjan

University of California, Irvine - Department of Economics ( email )

3151 Social Science Plaza
Irvine, CA 92697-5100
United States

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