City University of Hong Kong, Hong Kong.
The organization of production and trade
Article first published online: 28 MAY 2012
International Journal of Economic Theory
Special Issue: The Legacy of Lionel W. McKenzie: Special Issue 2
Volume 8, Issue 2, pages 179–195, June 2012
How to Cite
Lu, C.-H., Peng, S.-K. and Wang, P. (2012), The organization of production and trade. International Journal of Economic Theory, 8: 179–195. doi: 10.1111/j.1742-7363.2012.00185.x
We are grateful for valuable comments and suggestions from Pol Antràs, Marcus Berliant, Michele Boldrin, Rick Bond, Jiahua Che, Ron Jones, Bruce Petersen, Ray Riezman, Jacques Thisse and seminar participants at Academia Sinica, Chinese University of Hong Kong, Hong Kong University of Science and Technology, National Taiwan University, National Tsinghua University, University of Tokyo, as well as at the Kyoto International Conference on General Equilibrium, Trade and Complex Dynamics in Memory of Professor Lionel McKenzie, the Midwest Economic Theory and International Trade Meetings, and Society for Advanced Economic Theory Conference. Financial support from Academia Sinica, the City University of Hong Kong, the National Science Council (NSC 98-2911-H-001-001) and the Weidenbaum Center on the Economy, Government, and Public Policy to enable this international collaboration is gratefully acknowledged.
- Issue published online: 28 MAY 2012
- Article first published online: 28 MAY 2012
- Accepted 30 August 2011
- middle-product trade;
- vertical mergers;
- global sourcing
We construct a unified framework to study under what conditions one of the three frequently observed organizational structures of international middle-product production may arise in equilibrium: (i) separation of upstream and downstream firms with middle-product trade, (ii) vertical integration of upstream and downstream firms, and (iii) global sourcing with upstream firms internalizing design and marketing tasks while only outsourcing the final good production to subcontractors. We examine how conventional comparative advantage (search, communication, trade and diversification costs) and the concern of the product-defect risk arising from outsourcing jointly determine the organization of production and trade. We show that the potential availability of one organizational structure can change the trade-off of the other two structures, thereby making simple pairwise comparison invalid.