Outsourcing and Trade in a Spatial World

Abstract

This paper provides an analysis of outsourcing and trade in a spatial model à la Hotelling. In this setting, we discuss the trade-off between transport cost related disadvantages and outsourcing-induced production cost advantages of a large economy. The model gives a rich picture of possible trade and welfare effects of a movement towards free trade. For example, if there is international outsourcing, both countries may gain from free trade, independently of who exports the consumption good. However, if specialized input production only occurs in the large economy and the small country exports the final good, overall world welfare may even decline, when moving towards free trade.International outsourcing; International trade; Spatial competition