andrei to lohn or not to lohn

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 To Lohn or Not to Lohn: A Puzzle in Subcontracting Arrangements (November 2007) Simona Andrei  Abstract In the last two decades we have witnessed a dramatic fragmentation and globalization of the production process. While there is now a large and growing theoretical literature seeking to understand international outsourcing and the choices involved, a lot is still left to be explained. One feature that the vast majority of works on the new organization of production share is that they analyze the determinants of decisions by outsourcing firms, but ignore the firms production is outsourced to. The present paper works to bridge this gap in the literature by studying outsourcing decisions not from the point of view of the outsourcing firm alone, but rather, as a joint process, in which the firm outsourcing goes to is actively involved. I focus on a particular form of international outsourcing, also known as the lohn system, in which the outsourcing firm provides the manufacturer with all the inputs needed to produce and then re-imports the final goods. Using an incomplete contracts framework, I show that the lohn system is more likely to be adopted the lower the manufacturer’s efficiency in finding low-cost inputs; the lower the bargaining power of the manufacturer; and the lower the degree of relationship-specificity. Keywords: Export Processing, Lohn system, Outsourcing, Incomplete Contracts. JEL codes: F23, L14, L22, L23, P14 Department of Economics, University of Maryland, College Park, MD 20742 (e-mail: [email protected]). I am indebted to my advisors Roger Betancourt, Ginger Jin, and Razvan Vlaicu for their guidance and support throughout the project. I thank Piyush Chandra, Cindy Clement, Jacques Crémer, and seminar participants at the University of Maryland for many helpful comments and suggestions, and Ioan Goreac and Vergil Voineagu from the National Institute of Statistics in Romania for providing the data for the project. Financial support from the Department of Economics, University of Maryland to obtain the data is gratefully acknowledged. All remaining errors and omissions are my own.

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