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Why do they JUST DO IT? A Theory of Outsourcing and Working Conditions

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Abstract

Nike and other brand companies have long been criticized for outsourcing their production to contract factories with dismal working conditions. Despite the overwhelming amount of interest, there exists no theory for studying this topic. The current paper fills this gap. The framework embeds a compensating-wage-differentials model into the global sourcing model of Antràs and Helpman (2004). In the model, the most productive firms in the North make high profits and outsource their manufacturing production to contract factories in the South. Manufacturing production is inherently dangerous. The level of working conditions depends on their provision cost and on the country’s labor productivity. To attract workers, factories pay wages that can compensate for poor working conditions. Despite being higher, factory wages might not meet workers’ basic needs, but the reason is that the country’s labor productivity is too low. In the benchmark model, the only source of comparative advantage between the two countries is the difference in their labor productivities. Thus, a low-productivity country can attract more outsourcing contracts since its factories can produce at lower costs. The paper also studies an extension in which factory workers misperceive the true level of working conditions and in which factories might not comply with local legal standards. Under this extension, factory workers are not appropriately compensated for inferior working conditions. Moreover, differences in the degree of workers’ misperception and of factory noncompliance can be additional sources of comparative advantage between the countries.

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Notes

  1. See more details in Locke (2003) and Nike (2019).

  2. See, e.g., Moran (2002), Rosen (2002), and Sluiter (2009).

  3. See, e.g., Antràs and Helpman (2004, 2008), Grossman and Helpman (2004), and Grossman, et al. (2005).

  4. The literature on offshoring is also somewhat connected to this first strand. The seminal paper is Grossman and Rossi-Hansberg (2008). Other important papers include Bergin et al. 2009; Crinò 2010; Rodriguez-Clare 2010; Wright 2014; and Goel 2017. This literature has studied the impact of offshoring on wages and on employment but has completely ignored the connection to working conditions. The current paper fills this gap.

  5. See Rosen (1987) for a summary.

  6. This literature is summarized in Brown (2000), Basu et al. (2003), and Donado and Wälde (2015).

  7. As it will be clear along the paper, individuals in the North (i = N) can work in one of five different types of occupations. They can either provide headquarter services (j = h), manufacturing services (j = m), fixed costs services (j = f), entry costs services (j = e), or produce the homogeneous good (j = y). In the South (i = S), individuals can only work in one of two occupations. They can either provide manufacturing services (j = m) or produce the homogeneous good (j = y).

  8. Empirical support for this assumption can be found in Fletcher et al. (2011), Cottini and Lucifora (2013), and Barnay (2014).

  9. See, e.g., Permanyer (2014) and the references therein.

  10. Note that setting \(u_{\min \limits }=0\) does not change the results of this paper in any significant way. The only point of introducing \(u_{\min \limits }>0\) in Eq. 2 is to capture the recurrent idea from the nonacademic literature that factory workers might not be able to meet their basic needs. Allowing for \(u_{\min \limits }>0\) also simplifies the presentation and discussion of the model’s main predictions below.

  11. The other reason is that only the North has the knowledge to produce final manufacturing goods (see below).

  12. Since all manufacturing firms are always located in the North, the superscript i on the variables directly associated with those manufacturing firms (hi, pi, qi, ri, πi, fi) only denotes the country in which they outsource their manufacturing stage m.

  13. See also Antràs (2016, ch. 4) and Antràs and Yeaple (2014, sect. 5.3). This assumption is typically made to abstract from the horizontal (FDI) dimension in which firms might replicate the same production process in another country to save on transportation costs or tariffs.

  14. See also Antràs 2016, ch. 4.

  15. See Chen and Chan (1999), Markkanen (2009: 23-28), and Conradi and Portich (2011).

  16. This can be seen after plugging Eq. 6 in Eq. 18.

  17. AMRC and HKCIC (1997). See also Chen and Chan (1999).

  18. In reality, factory owners might not have perfect knowledge on some working conditions either. For example, some occupational diseases might take several years to manifest, and even employers might not be aware of the causal link between a particular disease and factory production. However, what is important for the argument is that factory owners have more knowledge than workers. To simplify the model, the paper assumes that factory owners perceive working conditions as they truly are, while workers underperceive them.

  19. AMRC and HKCIC (1997). See also Chen and Chan (1999).

  20. I am especially thankful to two anonymous referees who suggested most of the ideas discussed in this section.

  21. See, e.g., Glass and Saggi (2001), Naghavi and Ottaviano (2008), Rodríguez-Clare (2010), Bøler et al. 2015, and Goel (2017).

  22. See, e.g., Edmonds and Pavcnik (2005) and Levine and Rothman (2006).

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  1. Department of Economics, Frankfurt School of Finance & Management, Adickesallee 32-34, 60322, Frankfurt am Main, Germany

    Alejandro Donado

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The author would like to thank two anonymous referees for their helpful comments and suggestions.

I would like to thank two anonymous referees, Hartmut Egger, Thomas Eife, and participants at several workshops and conferences for helpful comments and suggestions.

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Donado, A. Why do they JUST DO IT? A Theory of Outsourcing and Working Conditions. Open Econ Rev 32, 559–586 (2021). https://doi.org/10.1007/s11079-020-09609-z

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