Princeton University 50 Outsourcing versus FDI in Industry Equilibrium by Gene M. Grossman Princeton University and Elhanan Helpman Harvard University,Tel Aviv University, and CIAR Discussion Paper #219 December 2002 Discussion Papers in Economics Woodrow Wilson School of Public and International Affairs Outsourcing versus FDI in Industry Equilibrium?byGene M. GrossmanPrinceton UniversityandElhanan HelpmanHarvard University, Tel Aviv University, and CIARDecember 2002AbstractWe study the determinants of the extent of outsourcing and of directforeign investment in an industry in which producers need -ponents. Potential suppliers must make a relationship-speci?cinvestmentin order to serve each prospective customer. Such investments are governedby imperfect contracts. A?nal-good producer can ponentsfor itself, but the per-unit cost is higher than for specialized suppliers. Weconsider how the size of the cost di?erential, the extent of contractual pleteness,thesizeoftheindustry,andtherelativewageratea?ect anization of industry Classi?cation:F12, F23, L22, D23Keywords:outsourcing, direct foreign investment, multinational cor-porations, imperfect contracting, intra-industry trade?We thank the National Science Foundation for?nancial IntroductionInternational outsourcing and FDI (foreign direct investment) have been growingaround the globe. Firms outsource an expanding range of activities, such as theproduction of intermediate inputs and after-sale services. Audet (1996), Campa andGoldberg (1997), Feenstra (1998), Hummelset al. (2001) and Yeats (2001) have doc-umented this phenomenon. Firms also expand foreign direct investment. Althoughthe debate on whether most FDI is horizontal or vertical has not been settled, it isevident that the production of inputs is an important activity of foreign subsidiaries,and that this activity has been growing fast. Hanson, Mataloni, Jr. and Slaughter(2001) provide evidence of this expansion for . based? gr
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