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The International Organization of Production in the Regulatory Void

Philipp Herkenhoff and Sebastian Krautheim

No 6922, CESifo Working Paper Series from CESifo Group Munich

Abstract: In recent decades, NGOs and consumers have heavily criticized a large number of leading firms and their suppliers in a diverse set of industries for exploiting cross-country differences in regulation to cut costs at the expense of workers and the environment. In line with a wide range of examples, our explorative empirical analysis links these features of globalization to the international organization of production: a high cost advantage of ‘unethical’ production in an industry favors international outsourcing (as opposed to vertical integration) and most strongly so for sourcing from low-regulation countries. We rationalize this pattern by introducing a cost-saving ‘unethical’ technology, consumer boycotts, and advocacy NGOs into a standard property-rights model of the international organization of production. Contracts are incomplete, limiting a firm’s control over both investment and (un)ethical technology choices of integrated as well as independent suppliers. We identify and analyze a novel unethical outsourcing incentive, which - in line with the empirical findings - links outsourcing to unethical production. We also contribute to the modeling of NGO-firm interactions by providing a microfounded model of investment and pricing under incomplete contracts and monopolistic competition when the production technology is a credence attribute of the final good.

Keywords: multinational firms; international outsourcing; property rights theory of the firm; ethical production; labor standards; pollution; consumer boycotts; credence goods; NGOs (search for similar items in EconPapers)
JEL-codes: D21 D23 F12 F23 F61 J81 L22 L23 L31 L50 Q53 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-com, nep-cta, nep-hme, nep-int and nep-lab
Date: 2018
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