Relocating the value chain: offshoring & agglomeration in

the global economy

Richard BaldwinTony Venables

4 February 2011RIETI, Tokyo

The 1st & 2nd unbundlings1st unbundling: Spatial separation of production & consumption.

2nd unbundling:2.1 Factories.

2.2 Offices.

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Clusters&uneven unbundling (death of distance mistake)Unbundling 2.1: Factory Asia

Growing Automobile Agglomeration in Pearl River Delta

Nissan

Honda 1

Honda 2

Toyota

Unbundling 2.1: Factory Asia

2nd Unbundling : “New paradigm”

• Conceptual framework• Grossman & Rossi-Hansberg

– Simple model of ‘tasks trade’.• Baldwin & Robert-Nicoud

– Integrates tasks trade into Hecksher-Ohlin & monopolistic competition trade theory.

– Offshoring as ‘shadow migration’ on quantity side and technological change on price side.

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This paper• Study the process of 2nd unbundling taking

seriously engineering details of supply chain.

Part 1

Part 2

Part 3

Component 1

Final assembly

Part 4

Part 5Component 2 Domestic sales

Part 6

Part 7 Part 8

Export sales

Spider & Snake

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Assembly

Part 1 Part 2 Part 3Part 4

“spider”

AssemblyPart 1 Part 2 Part 3 Part 4

“snake”

Basic assumptions• Perfect competition, constant returns.• All final consumption in North• Shipping costs of final good t.

– Traditional trade costs• Offshoring cost of a part, (i)

– Costs that explain why factories bundled spatially even within nations.

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Specifically• Parts are indexed by type y ε Y• Unit production cost in S is b(y); unit costs of all

parts normalised to 1 in N.• Low b parts can be produced more cheaply in S

– refer to low b parts as ‘labour-intensive’• Assembly of parts: aN, aS in N & S. • Per-unit off-shoring costs is tθ(y) if not

produced in region of assembly (shipping & coordination costs).

• If assembly in S then tα is paid to ship to N consumers. 9

Spider

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bbN = 1 + θ

bS = 1 - θ

N

S

NS

b

b

1

Part’s relative cost in S

Part’s Offshoring cost

Threshold part; assembly in S

Threshold part; assembly in N

Spider

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bbN = 1 + θ

bS = 1 - θ

N

S

NS

b

b

1

Part’s relative cost in S

Part’s Offshoring cost

Each part is a point in b, space.-3 sets of parts, N, NS, S-N is set always cheapest in N & S in S.-NS, cheapest location of part depends upon location of assembly.

Single agent cost minimisation• Assembly in S iff

• is greater than

• NB: – if t=0, then NS disappears => pure comparative

advantage for parts & assembly.– If t=, trade costs dominate; all parts made in N &

assemble in North.– For intermediate, get tension trade costs vs

comparative advantage.12

dyyytybdyyayyN

SNSN

)()()()(

dyyybdyyyttayyS

NSSN

)()()()(1

(1)

.

Cost minimising location• Focus on comparative advantage;

- Assume all offshoring costs equal for all parts, soo horizontal axis now “t” , not theta

• Start with assembly in North; assume aS<aN.

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2/)( bbtA 2/)( bbtR

2/)( bbtA 2/)( bbtR

Result: Offshoring “overshooting” of parts

Assembly in S tAssembly in N

b = 1

N

S

NS

Another example• S’pose S has strong c.a. in parts, but N has c.a.

in assembly aS>aN.

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)(tA 2/)( bbtR

tbOS 1

tbON 1

b

btAssembly in S Assembly in N

b = 1

tA

Assembly in N

tA

2/)( bbtA )(tR

Nash in parts location• Multiple eq’m arise:

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Figure 5: Equilibrium locations, low cost assembly in S (aS < aN)

t

b

b = 1

2/)( bbtA

tbOS 1

tbON 1

b

Assembly in S

Assembly in N Ω

Snake

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Assembly

Part 1 Part 2 Part 3Part 4

“spider”

AssemblyPart 1 Part 2 Part 3 Part 4

“snake”

Basic assumptions• Stages of produciton continuum; z (0,1)

– z = 0 the most upstream• Each stage combines primary factors with the

output of the previous stage. • In general factor intensity need not vary

continuously with z, but we assume this. • Factor cost in S is c[z]; normalised to 1 in N.

– Low c[z] = “very L-intensive”• Off-shoring costs z]t;

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Snake: General issues• More difficult as cannot freely re-order the parts

by comparative advantage.• Parts vary by c.a. and by offshoring costs

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D

2z2z1zz

13z

A B C1

c(z)

τ(z)t

0

Relative cost in S

OS cost if stage done in S

Snake: General issues• If stages 0 to z1 in S

– Save area A on factor cost, but pay ([0]+[z1])t in offshoring costs.

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D

2z2z1zz

13z

A B C1

c(z)

τ(z)t

0

General results• Won’t get infinitely small segments of supply

chain offshored; cluster tendency• Offshore overshooting again; if one stage is

offshored already, trade costs favours production of immediate up and down stream stage in S.– In multiple S world, suggests agglomeration.

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Example 1: Upstream offshoring• S’pose c[z] increase (i.e. upstream parts are

most L-intense and so c.a. in S).– Single break in supply chain, z-hat.

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dztzdzzczUzz

z 1

ˆ

ˆ

0)ˆ()()(:]1,0(ˆ

c=1

z

c[z]

z'

Upstream offshoring• Factor cost savings vs OS’ing costs

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$

Z-hat

Total cost saving (z-hat)

z'

Shipping cost (z-hat)

[z]t

Labour mkt implications• Baldwin & Robert-Nicoud insight• Start with standard HO 2x2x2 model with free

trade in goods but no offshoring.• Assume N has Hicks neutral tech advantage.

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1 * 11*

w wr p r p

-1 -1T TA A

* *1* *

X L X LY K Y K

-1 -1A A

Allow offshoring• N can combine its superior tech with lower

prices S labour and re-import that stage.• Means N can produce same output with fewer

resources, i.e. shadow migration.

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Offshoring : Equilibrium• Full-employment conditions (‘o’ offshoring)

→ “Shadow migration”

→Offshoring in L-intensive sector tends to shift N towards L-int production

1* 1; (1 )O O O w

OO O O

L X XL L L LL L LK Y YK K K

A A 0

*

1 1*( ) ,O OO

O OO

X XL L* XY YK K* Y

A A A A

Home Foreign

11 1

LXI LYI

KX KY

a aa a

A

• Pricing conditions

→Cost saving technical progress (Stolper-Samuelson)

→Wage effects depends upon cost savings by sector, not nature of cost-savings per se.

* *

1* *

1 1X O XO O O

Y O O O YO O O

S w Sw w wS p r p Sr r r

T T TA A A

Offshoring : Equilibrium (ctd.)

* *

1 1 * *

1 1( ) O O O

O O OO O

w w wp r pr r

T T T TA A A A

Home Foreign (no change)

Conclusion• Early stage in theory development.• Theory needs guidance from facts on

unbundling in specific industries.• Please see:

www.VoxEU.org

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