This paper examines the make-or-buy decision with regard to location (North and South) and productivity (firm heterogeneity) in a complete contracting model. In contrast to the usual incomplete contracting approach to outsourcing, this paper considers the situation in which outsourcing can be governed by contracts, although contract enforcement is imperfect. It shows that a firm's productivity and regional differences in wage rates, fixed costs for vertical integration, fixed costs for outsourcing and degrees of contract enforcement jointly determine whether the firm will choose vertical integration or outsourcing, and whether they will locate in the North or the South.
Bibliographical noteFinancial support from the Research Grants Council of Hong Kong (HKUST6428/05H).
- vertical integration
- contract enforcement
- international trade