Lecture 5
October 11, 2022 10:56 AM
Title: VFDI & Outsourcing/offshoring
WI the motivation for • Vertical FDI: produce elsewhere because of cheaper production costs
VFDI?
WI the short-coming • Melitz assumes that firms differ in productivity… Helpman et al. extended the model by
of HMY? including HFDI as the only alternative international option.
• Challenges:
○ What about trade in intermediate outputs (outsourcing)?
▪ Paper 1 (Corcos et al. 2013) focuses on ownership (should a firm…):
□ Offshore?
Outsource foreign (buying from another firm abroad)
Vertical FDI (owning a subsidiary abroad)
○ Paper 2 focuses on the role of technology in outsourcing/offshoring
• Bottomline of this week's papers:
• Corcos et al (2013) on the intra-firm imports by French firms: vertical FDI (vs
arm’s length imports)
○ Foreign outsourcing vs VFDI depends on:
Acc. Corcos et al. WD
the decision of a ▪ The firm's:
firm to do VFDI □ factor intensity
depend on? (3 things) □ Productivity
▪ Host country's: institutions
• Fort (2017) on role of technology in production fragmentation (= domestic
Acc. Fort, how does outsourcing or offshoring):
technology mediate
fragmentation of a ○ Firms with more technology are more likely to fragment.
firm? ▪ The effect of technology depends on the industry:
WD the industry □ Industries with more codifiability have higher fragmentation.
influence this? Technology lowers coordination costs, but more for
domestic outsourcing than for foreign.
WI the relationship ▪ There are complementarities between technology and worker skills.
between human capital □ Firms that are more technology intensive are more likely to
and technology? outsource to high skilled countries (SBTC).
Intro to 1st paper
• Simple textbook case: VFDI is efficiency seeking (or resource seeking)
WI the main reason to
do VFDI? • Efficiency seeking: lower wages in China make it profitable to produce there:
○ “slicing up the value chain” or international fragmentation of production
process
Is VFDI a substitute
or a complement of ○ VFDI assumes that trade and offshoring are complements (as it focuses on
trade? intermediate inputs)
• Types of fragmentation:
• Domestic: outsource domestically (NOT DISCUSSED BY THIS PAPER, ONLY BY
FORT (2017))
• Foreign (Offshoring): discussed by Corcos et al.
WR the two types of • Foreign outsourcing: subcontracting and importing.
fragmentation in ▪ This paper calls it arm-lengths trade
Corcos et al.?
• Vertical FDI: owned subsidiary.
▪ This paper calls it intrafirm trade
FDI Page 53
, •
• Production function of offshoring: The MC that matters includes transport costs
Graph production
function of exports (importing the foreign production) because the inputs are either:
vs VFDI… a. subcontracted (arm-length imports)
(graph price*output, b. produced by owned plant abroad (intrafirm imports or VFDI)
incl.: D, AC, MC, MR,
t as VC, profits)
WD both production
functions include?
Why?
•
• Corcos et al.'s samples the imports by French firms in these 2 sourcing modes (a + b).
They want to find what determines the firm's choice.
WR the 4 empirical
predictions of • 4 key predictions of determining factors (VFDI):
determinants for FDI? 1. Input intensity (+): Capital- and skill-intensive firms are more likely to
engage in intrafirm trade (=VDFI).
2. Productivity (+): More productive firms are more likely to engage in
intrafirm trade.
3. Capital stock in host-country (+): Intrafirm imports are more likely to
originate from capital-abundant countries.
4. Quality of institutions (+): More productive firms are more likely to import
intrafirm from countries with good contract enforcement
W motivates these • Motivation of predictions:
predictions? • Hold-up problem: the risk of incompleteness of contracts (trust, property
rights, timeliness) and relation-specific investments motivate VFDI.
WI the hold-up ▪ Problem: Risk of hold-up after production stage (ex-post) leads to
problem? underinvestment (ex-ante)
▪ Solution: VFDI gives more control over production (HQ in France
HD VFDI solve it?
decides) via ownership (property rights approach).
▪ Comes from International Economics.
WR the 2 alternative • OLI (Ownership, Location and Internationalization) paradigm.
approaches to study
firms' int'l ▪ Comes from International Business.
strategy? (IB vs IE) • VFDI demands higher investments, so only more productive firms (more
profitable) should choose VFDI over foreign outsourcing because they want
Y would more
productive firms do to have higher degree of control.
VFDI?
• Preliminary evidence:
• Key dependent variable is 1 if firm imports product from country
via foreign affliate (=VDFI!) and 0 otherwise.
• Having a foreign affiliate , as opposed to foreign outsourcing, is
positively correlated with
WR the main findings ▪
of the paper about ▪
determinants of FDI?
(3-4 determinants) ▪
• The distribution of firms' triple ( ) suggests a link with firm's
productivity…
FDI Page 54
October 11, 2022 10:56 AM
Title: VFDI & Outsourcing/offshoring
WI the motivation for • Vertical FDI: produce elsewhere because of cheaper production costs
VFDI?
WI the short-coming • Melitz assumes that firms differ in productivity… Helpman et al. extended the model by
of HMY? including HFDI as the only alternative international option.
• Challenges:
○ What about trade in intermediate outputs (outsourcing)?
▪ Paper 1 (Corcos et al. 2013) focuses on ownership (should a firm…):
□ Offshore?
Outsource foreign (buying from another firm abroad)
Vertical FDI (owning a subsidiary abroad)
○ Paper 2 focuses on the role of technology in outsourcing/offshoring
• Bottomline of this week's papers:
• Corcos et al (2013) on the intra-firm imports by French firms: vertical FDI (vs
arm’s length imports)
○ Foreign outsourcing vs VFDI depends on:
Acc. Corcos et al. WD
the decision of a ▪ The firm's:
firm to do VFDI □ factor intensity
depend on? (3 things) □ Productivity
▪ Host country's: institutions
• Fort (2017) on role of technology in production fragmentation (= domestic
Acc. Fort, how does outsourcing or offshoring):
technology mediate
fragmentation of a ○ Firms with more technology are more likely to fragment.
firm? ▪ The effect of technology depends on the industry:
WD the industry □ Industries with more codifiability have higher fragmentation.
influence this? Technology lowers coordination costs, but more for
domestic outsourcing than for foreign.
WI the relationship ▪ There are complementarities between technology and worker skills.
between human capital □ Firms that are more technology intensive are more likely to
and technology? outsource to high skilled countries (SBTC).
Intro to 1st paper
• Simple textbook case: VFDI is efficiency seeking (or resource seeking)
WI the main reason to
do VFDI? • Efficiency seeking: lower wages in China make it profitable to produce there:
○ “slicing up the value chain” or international fragmentation of production
process
Is VFDI a substitute
or a complement of ○ VFDI assumes that trade and offshoring are complements (as it focuses on
trade? intermediate inputs)
• Types of fragmentation:
• Domestic: outsource domestically (NOT DISCUSSED BY THIS PAPER, ONLY BY
FORT (2017))
• Foreign (Offshoring): discussed by Corcos et al.
WR the two types of • Foreign outsourcing: subcontracting and importing.
fragmentation in ▪ This paper calls it arm-lengths trade
Corcos et al.?
• Vertical FDI: owned subsidiary.
▪ This paper calls it intrafirm trade
FDI Page 53
, •
• Production function of offshoring: The MC that matters includes transport costs
Graph production
function of exports (importing the foreign production) because the inputs are either:
vs VFDI… a. subcontracted (arm-length imports)
(graph price*output, b. produced by owned plant abroad (intrafirm imports or VFDI)
incl.: D, AC, MC, MR,
t as VC, profits)
WD both production
functions include?
Why?
•
• Corcos et al.'s samples the imports by French firms in these 2 sourcing modes (a + b).
They want to find what determines the firm's choice.
WR the 4 empirical
predictions of • 4 key predictions of determining factors (VFDI):
determinants for FDI? 1. Input intensity (+): Capital- and skill-intensive firms are more likely to
engage in intrafirm trade (=VDFI).
2. Productivity (+): More productive firms are more likely to engage in
intrafirm trade.
3. Capital stock in host-country (+): Intrafirm imports are more likely to
originate from capital-abundant countries.
4. Quality of institutions (+): More productive firms are more likely to import
intrafirm from countries with good contract enforcement
W motivates these • Motivation of predictions:
predictions? • Hold-up problem: the risk of incompleteness of contracts (trust, property
rights, timeliness) and relation-specific investments motivate VFDI.
WI the hold-up ▪ Problem: Risk of hold-up after production stage (ex-post) leads to
problem? underinvestment (ex-ante)
▪ Solution: VFDI gives more control over production (HQ in France
HD VFDI solve it?
decides) via ownership (property rights approach).
▪ Comes from International Economics.
WR the 2 alternative • OLI (Ownership, Location and Internationalization) paradigm.
approaches to study
firms' int'l ▪ Comes from International Business.
strategy? (IB vs IE) • VFDI demands higher investments, so only more productive firms (more
profitable) should choose VFDI over foreign outsourcing because they want
Y would more
productive firms do to have higher degree of control.
VFDI?
• Preliminary evidence:
• Key dependent variable is 1 if firm imports product from country
via foreign affliate (=VDFI!) and 0 otherwise.
• Having a foreign affiliate , as opposed to foreign outsourcing, is
positively correlated with
WR the main findings ▪
of the paper about ▪
determinants of FDI?
(3-4 determinants) ▪
• The distribution of firms' triple ( ) suggests a link with firm's
productivity…
FDI Page 54
