Trade liberalization, outsourcing, and the hold-up problem

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 t...

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Bibliographic Details
Published in:Journal of international economics 2008, Vol.74 (1), p.225-241
Main Authors: Ornelas, Emanuel, Turner, John L.
Format: Article
Language:English
Subjects:
Economic models
Hold-up problem
International trade
Investment
Investment effect
Outsourcing
Studies
Subcontracting
Tariffs
Trade liberalization
Vertical integration
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Summary: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.
ISSN:0022-1996
1873-0353
DOI:10.1016/j.jinteco.2007.02.005