Trade liberalization, outsourcing, and the hold-up problem |
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Authors: | Emanuel Ornelas John L. Turner |
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Affiliation: | a Department of Economics, Terry College of Business, University of Georgia, Brooks Hall Fifth Floor, Athens, GA 30602-6254, United States b Ibmec-RJ, Brazil |
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Abstract: | This paper shows that, in a bilateral relationship where a foreign supplier has to make a relationship-specific investment but cannot enforce a complete contract, the standard hold-up problem of underinvestment is aggravated when trade incurs a tariff. In this context, we identify two new channels through which trade liberalization enhances international trade. First, lower tariffs increase the incentives of foreign suppliers to undertake cost-reducing investments. Second, lower tariffs may prompt vertical multinational integration. These indirect effects imply that responses of trade volumes to trade liberalization are greater than standard trade models suggest and help explain current trends toward foreign outsourcing and intra-firm trade. |
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Keywords: | International trade Outsourcing Hold-up problem Vertical integration Investment effect |
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