Effects of Outsourcing in the Ricardian Model

1
Effects of Outsourcing in the Ricardian Model

• Andrés Rodríguez-Clare
• PSU

2
Basic Assumptions

• Two goods computers and shoes
• Two countries US and India
• One factor labor
• Productivity (MPL) in shoes is 1 in both
  countries
• Productivity in computers is A gt 1 in US and 1 in
  India

3
Equilibrium without Outsourcing

• US specializes in computers and India in shoes
• Relative price of computers (price in terms of
  shoes), p, must be between 1/A and 1
• The wage (in terms of shoes) in India is 1
• The wage in the US is pA (w VMPL in computers)
• Note that since p gt 1/A then pA gt 1, which
  implies that the wage in US gt than in India

4
Introducing Outsourcing

• Computers are produced from two activities, 1
  and 2 (e.g. production and customer support)
• USs superior productivity in computers comes 1
  and not 2
• For concreteness, assume that productivity in
  activity 2 is the same in US and India
• There is an incentive for US producers to
  outsource activity 2 to India cost savings
• This becomes possible thanks to the IT revolution
  lower communication costs

5
Effect of Outsourcing

• As US firms start outsourcing, they can
  effectively use Indian labor to produce more
  computers
• The increased supply of computers leads to a fall
  in the international price p
• This leads to a decline in the US wage, pA
• If communication barriers fall significantly,
  then can have pA fall to 1, at which point wages
  are equalized across US and India!