An increasingly complex pattern of cross-border activities and transactions characterizes the international economic system, distinguishing it from the earlier predominance of arms length trade in raw materials and finished goods. Over time, technological changes have enabled producers to divide their operations into ever finer segments, allowing greater specialization and efficiencies in each one. As the activities of production are further distinguished and segmented, it becomes increasingly possible to separate them geographically. "Globalization" may be defined as the process by which segments of the production process are carried out in several or many different countries. Globalization encompasses a variety of different organizational arrangements, including the 'outsourcing' of various components in arms-length relations with unrelated producers (trade), the establishment of foreign subsidiaries to undertake activities such as assembly and marketing (direct foreign investment), the entry into long-term and possibly exclusive contractual agreements with foreign entities who might produce under license or distribute a firms' products, and the establishment of joint ventures for R&D and/or production. Research is needed to bring these organizational choices into the corpus of international trade and investment theory. This project develops models of international trade and foreign investment that are underpinned by a richer and more complete theory of the firm. Such models allow them to investigate when firms will decide to undertake activities 'in-house' and when they will 'outsource,' when the in-house activities will be performed locally versus in foreign locations, and when the outsourcing will be domestic and when through foreign trade. A model of trade with a more complete theory of the firm will also allow exploration of other organizational forms, such as long-term contracts, keiretsu relationships, licensing arrangements, and joint ventures. The investigators intend to draw heavily on recent advances in contract theory. By investigating the trade-off between the greater efficiency that arises when each party maintains control of its own special assets and the loss of efficiency that can result from dulled investment incentives in the face of imperfect contracting, contract theorists have developed a framework for investigating the determinants of the boundaries of the firm. Rarely, however, have these tools been applied to study vertical relations in the context of market equilibrium.
After introducing a richer theory of the firm into the corpus of general-equilibrium trade theory, the investigators will address a number of important questions. First, why has trade grown so much faster than income in the post-war period, and why has trade in components and producer services grown especially fast? Second, has globalization contributed to the declining relative wage of unskilled workers in the United States and elsewhere? Third, does the internationalization of economic activity hamper governments' ability to regulate industry? Finally, what are the economic motivations for the long-term supplier relationships seen in Japan, and to what extent do these relationships act as an implicit barrier to trade?
