Offshore Production and Business Cycle Dynamics with Heterogeneous Firms

43 Pages Posted: 7 Sep 2017 Last revised: 18 Mar 2022

See all articles by Andrei Zlate

Andrei Zlate

Board of Governors of the Federal Reserve System

Date Written: February, 2016

Abstract

To examine the effect of offshoring through vertical FDI on the international transmission of business cycles, I propose a two-country model in which firms endogenously choose the location of their production plants over the business cycle. Firms face a sunk cost to enter the domestic market and an additional fixed cost to produce offshore. As such, the offshoring decision depends on the firm-specific productivity and on fluctuations in the relative cost of effective labor. The model generates a procyclical pattern of offshoring and dynamics along its extensive margin that are consistent with data from Mexico's maquiladora sector. The extensive margin enhances the procyclical response of the value added offshore to expansions in the home economy, as the number of offshoring firms mirrors the dynamics of firm entry at home. As a result, offshoring increases the comovement of output across economies, in line with the empirical evidence.

Keywords: Offshore production, extensive margin, heterogeneous firms, firm entry, business cycle dynamics, terms of labor

JEL Classification: F23, F41

Suggested Citation

Zlate, Andrei, Offshore Production and Business Cycle Dynamics with Heterogeneous Firms (February, 2016). FRB Boston Risk and Policy Analysis Unit Paper No. RPA 16-1, Available at SSRN: https://ssrn.com/abstract=3033350

Andrei Zlate (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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