RIETI Report February 2017

Uncertainty and firms' global sourcing patterns

Global sourcing by multinational firms has changed international trade as evident by the substantial increase of cross-border transactions of intermediate inputs in recent decades. While the determinants of intrafirm trade are becoming apparent, it is difficult to identify their causal effect on international fragmentation. Little is known about how firms alter their global sourcing pattern when facing uncertainty, or negative shocks, as in the case of the Great East Japan Earthquake in 2011. In the February issue of the RIETI Report, we present the column "Uncertainty and firms' global sourcing patterns" by Waseda University Assistant Professor Lianming Zhu, RIETI Consulting Fellow Koji Ito, and RIETI Faculty Fellow Eiichi Tomiura.

Zhu et. al look at the negative shock from the Great East Japan Earthquake and its effect on global sourcing patterns of Japanese firms in the affected areas. They find that the earthquake increased total offshoring by 2.3% on average, which equates to an annual increase of 0.8%. They also show that there was a significantly positive effect on manufacturing offshoring in 2011, indicating that the effect of the earthquake was one-off, and that firms adjusted their offshoring activities immediately after the earthquake. As production costs in Japan continue to rise and manufacturing technology in other countries continue to improve, along with the frequent occurrence of earthquakes, offshoring by Japanese manufacturing firms will steadily increase. Policies to facilitate offshoring, such as tariff reductions on intermediate goods and support for the legal system in developing countries, will support these emergency responses.

This month's featured article

Uncertainty and firms' global sourcing patterns

Lianming ZHUAssistant Professor, Waseda University

ITO KojiConsulting Fellow, RIETI

TOMIURA EiichiFaculty Fellow, RIETI

Global sourcing by multinational firms has changed international trade. Cross-border transactions of intermediate inputs have increased substantially in recent decades. Hummels et al. (2001) collected data for ten OECD and four emerging market countries that trade in intermediate goods. This trade accounts for about 21% exports from these countries. In a recent study, Johnson and Noguera (2014) use data for 52 countries between 1970 and 2009, and find that international fragmentation had increased by about 10%.

The rapid growth of global sourcing has received plenty of attention from academics. Antràs and Helpman (2004) document the importance of contractual frictions in determining firms' organisation choices. In their theoretical model, they show that firms with higher productivity are more likely to engage in intrafirm trade, that capital- and skill-intensive firms are more likely to have intrafirm trade, and that capital-intensive countries or countries with better institutional quality are more likely to engage in intrafirm trade. The theoretical findings were tested by Tomiura (2007), Corcos et al. (2013), Defever and Toubal (2013), Nunn and Trefler (2013), and others. Antràs and Chor (2013) consider how firms choose their organisational structures when their production required more than one sequential stage. They show that the choice depended on the relationships among production stages, and the location on the production chain.

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