Modularity and the Organization of International Production

In many globalized industries, vertical outsourcing seems to co-evolve with horizontal integration in the component sector. In order to account for this phenomenon, I incorporate modularity into an industry-equilibrium model with monopolistic competition and perfect contracts that allows the organization of the firm to be endogenous in both the vertical and horizontal dimensions of production. The model illustrates that the co-evolution is most likely to occur in industries with modular product architectures and high increasing returns to scale in the intermediate good sector. This paper also provides a theoretical legitimation of Stigler's contentious conjecture that firm production structures become vertically disintegrated as an industry expands.