Task offshoring and organizational form: Theory and evidence from China

This paper examines why heterogeneous tasks are offshored in different organizational forms, that is, offshored to multinational subsidiaries (“foreign insourcing”) or to subcontractors (“foreign outsourcing”). We develop a model in which multinational subsidiaries benefit from lower communication costs despite having to pay for an efficiency wage premium compared with subcontractors. The model predicts that offshoring cost reductions increase foreign insourcing shares for industries that have communication intensity levels above a certain threshold, but decrease the shares otherwise. To test this theoretical prediction, we examine how reductions in offshoring costs that are attributed to the establishment of export processing zones affect the organization of Chinese offshoring. This study presents strong evidence supporting the model's prediction.