The relation between productivity level and the mode of organi zation remains on unsolved puzzle in international trade theory. As pointed out by Antras and Helpman (2004), while some studies indicate that low productivity firms choose to outsource, other studies have derived results to the contrary. This paper attempts to solve the puzzle by taking into account the imperfections of financial markets. If the enforcement level of the financial market in the South country is low, only low productivity firms choose outsourcing in the South. On the other hand, if the enforcement level is sufficiently high in the South country, high productivity firms choose outsourcing in the South and low productivity firms choose integration in the North country. Thus, we demonstrate that the difference in the empirical results of previous studies arises from the different degrees of financial imperfections in the host country. Furtheremore, we extend this model to a multi-country model.
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