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Contracting Frictions in Global Sourcing: Implications for Welfare

1 December 2021
2:00 pm

Contracting frictions affect firm sourcing decisions, but how much do such frictions — that firms encounter in their interactions with suppliers around the world — matter for trade patterns and country welfare? We develop a model of firm global sourcing in the presence of contracting frictions, that we embed into a quantitative general-equilibrium trade setting. At the micro level, each firm identifies a set of suppliers for its customized inputs, where these interactions are subject to a bilateral holdup problem, following the Grossman-Hart-Moore property-rights approach to the theory of the firm. These firm-level decisions aggregate into a gravity equation for bilateral trade flows by industry and organizational mode (i.e., whether to source from within or outside firm boundaries), and hence yield a structural expression for the intrafirm trade share. We further derive an expression for welfare changes that nests the Arkolakis, Costinot and Rodriguez-Clare (AER 2012) formula, making clear how contracting frictions affect welfare relative to that benchmark. After associating key contracting-related parameters in the model to observables (specifically, to country and input industry characteristics), we structurally estimate the model using U.S. data on intrafirm trade shares. We demonstrate through a series of counterfactual exercises how and how much such contracting frictions affect country welfare and the pattern of trade.

Joint work with Lin Ma (Singapore Management University)


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Davin Chor - Dartmouth College