Vertical Integration Versus Outsourcing in Industry Equilibrium

We study the determinants of the extent of in-house vertical integration and of outsourcing in foreign countries. Potential suppliers must make a relationship-specific investment in order to serve each prospective customer. Such investments are governed by imperfect contracts. A final-good producer can manufacture components for it, but the per-unit cost is higher than for specialized suppliers. We consider how the size of the cost differential, the trade costs of components, the relative costs of searching in south country for final producers, the relative cost of customizing inputs affect the organization of industry protection.