Relationship-Speci…c Investments and Intellectual Property
Rights Enforcement with Heterogeneous Suppliers
Alireza Naghaviy

Shin-Kun Pengz

Yingyi Tsaix

Abstract
This paper examines the impact of intellectual property rights (IPR) enforcement on multinationals’choice of input suppliers and industry pro…ts in a host economy. The framework consistsof suppliers with heterogeneous capabilities who must engage in a relation-speci…c investment
to customize intermediate inputs upon a transfer payment by …nal producers. An outsourcing
contract with better technologically-endowed suppliers requires a lower transfer and generates ahigher surplus. Stronger IPR enforcement leads …rms to self-select into better quality supplierson average by reducing their outside option. Weak legal institutions instead make it possible
for a larger range of suppliers, including the less capable ones, to form partnerships by granting
them a larger outside option. A better IPR environment is more likely to harm lagging countries
where the technology distribution is characterized by less capable suppliers.

J.E.L. Classi…cation: O34; L24; F21; F23; O32; L22; D23.
Keywords: International outsourcing; Supplier heterogeneity; Relation-speci…c investment; Intellectual property rights enforcement; Outside option; Customization; Technological capability.
We are grateful to two anonymous referees for their valuable feedback and insights which greatly helped us to
improve the paper. We are also indebted to James Rauch, Yi-Fan Cheng and Katsunori Yamada for very helpful suggestions. We would like to thank the audience at the APJAE Symposium on Industrial Organization and Global Value
Chains (Hong Kong), the Asian Meeting of the Econometric Society (Singapore), the Society for the Advancement of
Economic Theory conference (Tokyo) and the seminar participants at Academia Sinica, Taiwan. Financial support
provided by Academia Sinica, the National Science Council (NSC-102-2410-H-001-001-MY3), and the Ministry of Science and Technology (MOST 103-2923-H-390-001-MY2) in Taiwan, and by MIUR (PRIN project Institutions, Social
Dynamics, and Economic Development) in Italy to enable this international collaboration is gratefully acknowledged.
y University of Bologna, Department of Economics. Email : alireza.naghavi@unibo.it.
z Institute of Economics, Academia Sinica, Taipei, Taiwan. E-mail: speng@econ.sinica.edu.tw.
x Corresponding author: National University of Kaohsiung, Department of Applied Economics, 700 Kaohsiung
University Road, Nan-Tze 811, Kaohsiung, Taiwan. Phone: +886-7-5919189, Fax: +886-7-216 9365. Email : yytsai@nuk.edu.tw.

1

1

Introduction

The organization of production and innovation in global supply chains has been subject to recent
intense research among trade economists.1 The complex contractual relationships between the upstream and downstream …rms in international markets have particularly been under the spotlight instudying the organizational decisions of …rms, relation-speci…c investments, and consequences for the
economy. A good example used to study supply arrangements has been the Keiretsu models in theJapanese industries, where suppliers undertake relation-speci…c investments directed at customizing
a product to make it more valuable to a particular partner, but not to other potential (rival) buyers.
Applications of the Keiretsu models have been brought into the ambit of international trade by Qiu
and Spencer (2001,2002). This type of relationship between assemblers and suppliers is especiallyprevalent in the Japanese automotive sector (Ahmadijan and Oxley, 2006, 2013).
This paper constitutes one of the …rst attempts to introduce supplier heterogeneity into a modelof global sourcing, a step deemed necessary both from a theoretical and an empirical perspectivein the literature of …rm organization (Antràs, 2014). Indeed, the business and economic literature
has to a great extent treated …rst-tier suppliers as being similar in nature. A closer look within
industries, however, reveals a di¤erent reality, and more so after the 21st century trends towards
the globalization of outsourcing strategies. Suppliers’ heterogeneity issues have been discussed in
Kamath and Liker (1994), who observe that suppliers have di¤erent e¤ects on the manufacturers andthat their roles with regards to innovation vary extensively. Their study on the Japanese and theAmerican automotive industry reveals for example that few suppliers can make the full investment
in personnel, computer-aided-design (CAD) systems, prototyping facilities, and R&D capabilities
that a true partnership with their …nal producer requires. Suppliers tend to be reluctant to stationengineers full-time in their partners’ o¢ ces or to devote substantial resources to the developmentof goods and technologies customized to a …nal producer that will be of no use to them after a few
years.2 Also Sutton (2004) shows the vast heterogeneity across the capability of auto part suppliersin India and China to achieve the quality required on the components supplied to multinational
car makers. The investigation examines the range of quality by measuring the number of defects
found in incoming components.3 Finally, UNCTAD (2001) provides evidence that multinationals
reduce their operations to only deal with selected range of the best suppliers, which are able tocomply with international standards. Superior knowledge and technology make some suppliers more
attractive and of higher competitive signi…cance to manufacturers in the global market. Linkages
1 See Helpman (2006) for a thorough overview.
2 See Kamath and Liker (1994) for a more detailed explanation of the survey on auto-part suppliers to Toyota,

Nissan, Mazda, General Motors, Ford, and Chrysler.
3 In particular, half of suppliers achieved a …gure under 100 parts per million (ppm) defective, 17% from 100 to 300
ppm, around 10% under 700 ppm, 6% in China and 20% in India under 1500ppm, and one-eighth of suppliers had
defect rates exceeding 1500.

2

with multinational enterprises can also have consequences for the domestic economy as a whole bya¤ecting competition and the quality of the supply chain, which in turn depends on …rms’choice of
suppliers.
Yet, how do multinationals decide their global sourcing strategy and select suppliers for the
procurement of their relation-speci…c inputs? Do they always rely on the best few …rst-tier suppliers in each country or do they behave di¤erently in di¤erent environments when choosing theirsubcontractor? This research aims to provide a theory in order to explain the patterns of outsourcing relationships between multinational …rms and suppliers. Suppliers are heterogeneous in termsof their technological capability in host countries that are characterized by their legal institutions.
Introducing supplier heterogeneity in the upstream market in the spirit of Andrabi, Ghatak and
Khwaja (2006), we can investigate the decisions of …rms in the formation of outsourcing contracts
with assorted suppliers. We emphasize di¤erences (or improvements) in institutional quality to explore how intellectual property rights (IPR) enforcement may in‡uence the supplier mix and examine
the e¤ect of supplier choice on the domestic economy.
More speci…cally, …nal producers source to a continuum of suppliers that are heterogeneous withrespect to their ability in undertaking relation-speci…c investments. Suppliers must commit to makean investment that can be interpreted as a customization (or R&D) cost, the extent of which depends
on their ability to carry out the relation-speci…c task. Less technologically-endowed suppliers are
required to make a larger investment to satisfy the multinational’s needs. After …nding a partner,…nal producers are bound to make a payment to their supplier to cover a part of the necessary
investment, in order to minimize hold-up problems in the upstream-downstream relationship. The
more technologically capable the suppliers are, the lower that the required payment is. Consequently,
a higher joint surplus is generated within the relationship.
The framework adds a further important feature often overlooked in the literature when assessing
multinationals’links with the most capable suppliers: the outside option of suppliers in outsourcing
relationships.4 Multinationals on average tend to outsource to suppliers with better R&D capabilities
in countries with stronger IPR institutions. IPR enforcement ensures adequate relation-speci…cinvestment by lowering the supplier’s outside option and hence the probability of defection. By
contrast, when the IPR environment is weak, supplier technology plays a less important role andbuyer-supplier relations are also formed with less capable suppliers. This is because weak legal
institutions provide them with an outside option that increases their chances of survival in themarket.
Introducing heterogeneity among suppliers also allows us to make predictions regarding the consequences of IPR enforcement for the host economies. The results suggest that the impact of increasing
4 The few previous works that have touched upon the issue include Andrabi, Ghatak and Khwaja (2006), Lin and

Saggi (2007) and Assche and Schwartz (2010).

3

R&D e¢ ciency in the intermediate sector by creating a more stringent IPR environment in the home
economy is ambiguous. An enhancement in the average technology of rivals in the economy lowers
average pro…ts and makes it harder for less capable suppliers to survive in the market. On the one
hand, less competition increases the pro…tability of the most technologically capable suppliers in theintensive margin. On the other hand, a reduced number of active suppliers lowers the number of…rms and hence aggregate pro…ts on the extensive margin. The e¤ect of IPR enforcement is more
likely to be negative for technologically lagging host countries with a fat right tail distribution of
suppliers with inferior technologies. A shrinking upstream sector serving foreign producers causedby better quality IPR institutions can in this case be harmful to the economy. This is in line with
Che, Qiu, and Zhou (2014) who show that holding constant a multinational’s incentive to innovate,
better IPR enforcement encourages entry but reduces social welfare.
The rest of the paper is organized as follows. Section 2 discusses the related literature andevidence. Sections 3 introduces the basics of the model. Section 4 solves the equilibrium andpresents the results. Section 5 concludes.

2

Related Literature and Evidence

The organization of …rms was …rst incorporated into trade theory by McLaren (2000) and Grossman
and Helpman (2002). These papers also studied the degree to which suppliers decide to customize
intermediate products to the needs of their intended buyer. This is the emphasis of Grossman andHelpman (2003), who use the transaction cost approach to …nd that better contract enforcement
increases the fraction of …rms that engage in outsourcing.5 Grossman and Helpman (2005), however,show that in a general equilibrium setting an improvement in the contractual environment in theSouth can raise or lower the volume of outsourcing there. Antràs and Helpman (2008) turn thepage to the property-right theory to show that improvements in the contractibility of components
provided by suppliers in the South increases the relative prevalence of FDI over outsourcing.
As for the e¤ect of contract enforcement on the economy, another branch of the literature uses
a measure of contract dependence to show that countries with well-functioning contractual institutions will be net exporters of contract-intensive goods. Acemoglu, Antràs, and Helpman (2007)
show that greater contractual incompleteness leads to the adoption of less-advanced technologies
with a more pronounced e¤ect when there is greater complementarity among intermediate inputs.
Costinot (2009) derives the result that countries with better contracting institutions have a comparative advantage in more complex sectors. Levchenko (2007) and Nunn (2007) suggest measures ofcontract dependence related to the costs of contracting between upstream and downstream producers and provide empirical evidence that a country’s comparative advantage is partly determined by
5 See Defever and Toubal (2013) among others for evidence that supports this hypothesis.

4contracting institutions.
Despite the vast literature on outsourcing and incomplete contracts, the role of IPR enforcement in the outsourcing decision of multinationals remains to a large extent unexplored in economic literature. On this regard, Antràs and Rossi-Hansberg (2009) emphasize the e¤ects of the
non-appropriable nature of knowledge on the organizational decision of …rms, suggesting that past
literature has concentrated too much on hold-up ine¢ ciencies as the main drivers of outsourcing
decisions. As for evidence on multinational activities, Branstetter, Fisman, and Foley (2006) showthat technology transfer by US multinationals to their a¢ liates increase after IPR reforms. Ivus
(2010) …nds that increasing IPRs in developing countries raises the value of developed countries’
exports in patent-sensitive industries. Canals and Şener (2014) show that US …rms substantiallyexpand their intra-industry o¤shoring activities in high technology industries as a response to IPR
reforms in the host countries. Naghavi, Spies, and Toubal (2015) further show that technologysharing outsourcing of more sophisticated goods by French multinationals take place in countries
with better IPR enforcement. Despite clear evidence on technology transfer, however, controversies
on the appropriateness of IPR protection in the developing and emerging world persist. Lai and Qiu(2003) debate the suitability of North’s IPR standards for the South, whereas Chu, Cozzi, and Galli(2014) argue the relevance of the stage of development for the protection of IPRs.
In this paper, we focus on the impact of the quality of IPR institutions on industry pro…ts in the
supply chain in the destination country. In particular, we follow Grossman and Helpman (2005) to
explore the location decision of …rms that have already decided to engage in international outsourcing
and its impact on the supplier market and subsequently the host economy. While local manufacturers
may not need hefty investments from their local input suppliers, the number of suppliers that canmeet the customization standards required by multinational …rms are more limited.6 As a result, only
the most quali…ed suppliers enjoy technology transfer through the outsourcing partnership because
multinationals tend to focus their supplier development e¤orts on their key (most technologicallycapable) suppliers. Parallel to Melitz (2003), we therefore start from the underlying assumption that
globalization has weakened the position of less e¢ cient suppliers in host developing economies andmade it more di¢ cult for them to survive. Our paper adds to this argument by showing that thequality of IPR enforcing institutions in a host country decides the magnitude of this e¤ect.
6 Although we only study the case of international outsourcing, it is important to keep in mind that foreign …rms

tend to be in a di¤erent position than local …rms: they come from a world market where …rms enjoy establishedsuppliers aware of their technical/quality needs. As a result, it would only be worthwhile for multinationals to go to
the best available suppliers.

5

3

The Model with Heterogeneous Suppliers

The economy consists of two countries, North and South. We focus on an industry that produces anendogenous number of di¤erentiated consumer goods. The goods are designed and assembled in the
North, whereas the production of the required intermediate goods is outsourced to the South. The
goods speci…cally target consumers in the North. The South therefore plays the role of a production
site. We can think of a reduced form explanation, where …nal producers are multinationals andoutsource the production of their intermediates to a host country. We are interested in studying
the interaction between multinational …rms and input suppliers, and the impact of outsourcing toheterogeneous suppliers on the host economy given that the outsourcing decision has already takenplace for motives such as lower wages or the higher e¢ ciency of intermediate specialists.
The only factor needed for the production of the intermediate good is labor. Production of
the …nal good in turn uses these inputs, in such a way that one unit of the intermediate good isrequired to produce one unit of the …nal good. Moreover, because of the di¤erentiated nature of…nal goods, suppliers must customize their intermediate good perfectly so that it can only be usedby that particular producer. Customization costs in our model take into account the explicit form oflearning costs that an input supplier has to incur to acquire the necessary technology, management
and marketing techniques to compete in the world market. The …nal producer can provide support
for part of the training and technology transfer costs through a payment to partially reimburse theinvestment.
Suppliers are heterogeneous in terms of …xed customization/R&D costs, but all face the same
marginal costs once they start producing. The proposed formulation implies that some suppliers
adapt easier than others to …nal producers’ requirements and hence need less external support toachieve the targeted customization. The more technologically-endowed that the supplier is prior to
the partnership, the lower that the required payment to guarantee the desired quality of standards
is. More capable suppliers therefore yield a higher surplus, which makes them a more attractive
target.

3.1

Consumers

The consumption of the …nal good takes place in the North. Households share the same preferenceswith their utility de…ned over the consumption of a horizontally di¤erentiated good C, where

C=

Z n

1

cj dj

(1)

0

is a CES quantity index in which cj is the consumption of variety j, n is the number of varieties
produced, and 0 << 1 is an inverse measure of the degree of product di¤erentiation between

varieties. Households maximize consumption subject to the following constraint6E = wLN =Z n

pj cj dj

(2)0

where pj is the price of variety j, and the expenditure consumers incur on output from the industry,E, equals aggregate income, wLN , with LN representing total labor used in the industry under thecommon assumption of an in…nite supply of labor at an exogenously set market wage rate, w > 1.
The utility maximizing pro…t results in the demand for the j th variety of the form

cj = Apj(3)

where A is the aggregate demand associated with the quantity index C and is de…ned as
E
;
p1 dj
0 j

and

= 11

3.2

Firms

A = Rn(4)

is the elasticity of substitution.

Upon payment of an initial …xed search cost fe by a pair of potential partners to enter the market, thetechnology level of the intermediate supplieris revealed from a distribution g( ) with a continuous

cumulative distribution G( ) 2 [0; 1] where G(1) = 0, G(1) = 1. With
above which suppliers …nd it pro…table to enter, 1
in the market. The parameteras a threshold capability

G( ) represents the range of existing suppliers

can also be interpreted as the …rm’s marginal capacity of technology

absorption. It determines a cost in terms of the level of labor e¤ort they have to make in order toadapt to the technological needs of the representative …nal producer. Once (potential) suppliers
learn their customization capabilities, they go to the market where they negotiate contracts with…nal …rms. They must pay a …xed cost ks in terms of Southern labor to start producing, where
the market wage in the host country is normalized to one. Whenever a partnership is successful,production starts. Once in business, all suppliers need one unit of labor to produce one unit of theintermediate good, irrespective of .
Final …rms in turn engage in production upon payment of a …xed cost wkf in terms of Northernlabor. They then look for a supplier and upon success propose their desired prototype, and begin
the two-step negotiation. In general, they will have to incur costs that relate to a customization
payment or know-how transfer. We will see that this required payment will decrease in . Final…rms that have managed to form a successful partnership compete in a typical Dixit-Stiglitz manner:each pair of …rms is a monopolist in the production of a di¤erentiated good. They pay a …xed costeach period and use the intermediate good to produce and market their variety. Thus we assume
that …nal producers have no variable costs and can therefore consider them to be homogeneous in7

terms of productivity. It will be seen in Section 4.3 how things di¤er if heterogeneity is instead in
the variable cost of suppliers, i.e. their productivity.

3.3

Contracts

Any active …rm in this economy is part of a partnership composed of a supplier of customized
intermediate inputs and a …nal producer in charge of the assembly, marketing and distribution of(di¤erentiated) …nal goods. Prior to commencing production, …rms meet in pairs and negotiate
the terms of their future relations. Any supplier is a priori capable of customizing inputs to any
formulation required. Moreover, even though …nal producers manufacture di¤erentiated goods, thecost of building the right prototype is the same for all goods.
The negotiation takes place after the two parties meet under the assumption that pairs are always
formed (no search frictions). Following Grossman and Helpman (2005), such a negotiation can bethought of as being composed of two stages. Assume that the …nal producer owns all the know-how
about its particular product. In the …rst stage, it transmits the information about the exact type ofintermediate input it requires to the (prospective) supplier. We may call this stage the investment
contract, where we make explicit that the supplier needs to incur an investment cost in order toclose a deal. This contract commits the supplier to undertake the investment in customization sothat an acceptable prototype is created. The contract stipulates a payment to which the supplier isentitled if the prototype is satisfactorily developed.
Once the supplier has undertaken the necessary investment to manufacture the required prototype, the two parties move on to the second stage of negotiations. The two …rms write an ordercontract through which they stipulate the quantities that the …nal producer will demand and theassociated price. Incentives are fully aligned at this stage as both …rms have sunk investments, andthe only plausible source of income available to them is the joint surplus that arises from their relationship. Thus, the order contract will be the joint pro…t maximizing one, the quantity stipulated
will be the quantity of inputs needed to satisfy the demand for …nal goods in the market, and theprice of the intermediate good will be at its minimum level, i.e., the supplier’s marginal cost.7
3.3.1

The Order Contract

The order contract determines the surplus arising from a successful partnership. As discussed before,
the optimum strategy at this stage is to maximize joint variable pro…ts (revenue), since all …xed costs
are already sunk. Recall that …rms are monopolists in the production of their own j th variety, and sothey pick the optimum price facing a downward-sloping demand curve derived from the consumer’s
7 It will never be optimal for the supplier to charge a higher price, since that would result in a higher marginal costfor the …nal producer, and a higher-than-optimal price which entails lower joint pro…ts.

8maximization problem. We further denote the pro…t share that accrues to the …nal producer andthe supplier by [1!] and !, respectively.

The j th partnership maximizes

Rj =

f +

s = pj y j

xj

(5)

where yj = cj is the demand and xj is the quantity of the intermediate good. This is divided
according to the bargaining power of each side so that a share [1!] goes to the …nal producer and! to the intermediate supplier.
By the assumption that one unit of intermediate goods is required to produce one unit of …nal
goods and with iceberg costs on intermediate goods

R j = pjxj

xj = (

pj

1)xj = Apj (

pj =
1

pj

xj

. Thus, we may rewrite

1)

(6)

1 , and hence a price

The …rst-order condition yields pj =where 1 => 1, we have yj =

=

1

;

(7)

is the mark-up over marginal cost resulting from the monopoly position of a …rmin the production of its speci…c variety. As usual, this mark-up is inversely related to the elasticity)
of substitution: @(1=< 0, that is, it is positively related to the degree of product di¤erentiation.
@

The more that the pair of goods are substitutes, the less the market power that each …rm has andthus the lower the price that it charges.
The quantity e¤ectively demanded of each good j equals cj = Apj=A, which is equal

to the demand for the intermediate good. Total revenue is therefore
1

Rj = (1

)A

:

(8)

Using (7), we rede…ne aggregate demand as
E

A=

;

1

n

(9)

where the number of varieties n also represents the number of paired suppliers and …nal producers.
Replacing (9) in (8), we can rewrite the operating pro…t of each type of …rm in its …nal form
f = [1

!] (1

)

E
n

(10)

and
s = ! (1

)

E
:
n

(11)

Note that the trade costs disappear as a higher price is o¤set by a lower demand for the …nal good.

93.3.2The Investment Contract

Each supplier faces a constant customization investment
cost for a supplier with capability

for the relation-speci…c asset. The total

is equal to I = = so that those with a better technology draw

need to devote less e¤ort in terms of labor to create the required prototype. The supplier also has theoutside option of using the know-how provided by …nal producers for its own bene…t by serving the
local market. The idea is that after investing in the R&D cost, the supplier can sell the technology
to other …rms in the perfectly competitive local market at a price equal to the R&D investment,
subject to IPR enforcement. In other words, they can recover the R&D investment cost, I, by sellingto the local market with IPR protection creating a cost of defecting, thereby partially deterring thispossibility. Our speci…cation thus implicitly incorporates an outside option for suppliers equivalent
to O = (1)I, where

2 (0; 1] represents the cost of defecting.

The …nal …rm needs to give incentives to the supplier and does so by promising an up-front
payment T towards the completion of the investment. The pro…ts of the supplier can be written ass =s

I +O+T == + T:s(12)

IPR enforcement therefore obliges a supplier to invest more within the relationship, i.e. a proportionof the required relation-speci…c investment. The …nal …rm’s operating pro…ts are in turnf =The payment T

f

T:

(13)

T ( ; ) comes out of a Nash generalized bargaining process, through which bothparts maximize joint pro…ts by anticipating their share of those pro…ts:

T ( ; ) = [1!] = :(14)

Lemma 1 The transfer payment required by a subcontractor that satis…es the Nash bargaining outcome T ( ; ) is lower for more capable suppliers because they need less support as their investment
costs to customize are lower.
Proof. This follows directly from the Nash bargaining solution (14).
After replacing T ( ; ) in (12) and (13) from (14) we can rewrite the pro…ts functions of eachtype of …rm

s =

f =

(1

(1

) !E
n
) [1
n

!]E

= + [1[1!] = = !

!] = = [1

10

!]

E
(1
n
E
(1
n

)

=

)

(15)

=

(16)

for the supplier and the …nal …rm, respectively.

4

Equilibrium

4.1

Supplier Zero Cut-O¤ Conditions

Suppliers enter into outsourcing relations after paying the production …xed cost, ks , with the expected
gains of a supplier with technology

from a partnership being

ks .

s

Using (15), the zero cut-o¤ condition for the supplier implies thatks =The cut-o¤s == + T( ; ) = !

s

E
(1
n

)

=

(17)

needed, below which a supplier is required to make an investment it cannot a¤ord andhence cannot serve the multinational, is
= E

n (1

Note that the cut-o¤

ks
!

)

:

(18)

above which suppliers …nd it pro…table to enter into a relationship isdecreasing in !, which implies that a larger share ! tends to create a more favorable condition forless technologically capable suppliers to also enter relationship-speci…c contracts.
The …nal good producer who enters a partnership with the threshold supplier earns
E
(1
)
=
;
(19)
n
where pro…ts are equal to wkf to satisfy the zero pro…t condition. By substituting the capability of
wkf =

f

=

f

T ( ; ) = [1!]the threshold supplier from (18) into (19) we obtain
wkf
1 !
ks
=
=) ! =:
ks!
wkf + ks

(20)

Lemma 2 The pro…t share going to the threshold supplier ! can be interpreted as the industry’s(i) inverse measure of market thickness in the upstream intermediate inputs market, and (ii) level of
upstream representation or the importance of the role of suppliers in partnerships, being determinedby the suppliers’ relative …xed costs to produce within the relationship.
Proof. This follows directly from the condition (20).
The value ! can be thought of as an initial condition that determines the industry characteristics.
It is the minimum share required by suppliers in an industry. More precisely, it is the share paid
to the threshold supplier that makes both sides break even. The derivative @!
@ks > 0 shows thatlower …xed costs encourage more suppliers to enter outsourcing relationships, thereby increasing
the thickness in the input market.8 It can be also interpreted as an industry in which suppliers
8 In McLaren (2000), the thicker the market for inputs, the larger is the ex-post share of the surplus obtained bysuppliers, which in turn alleviates the hold-up ine¢ ciencies. In Grossman and Helpman (2002) instead, a thicker
market for inputs enhances the probability of …nding a match, which increases the attractiveness of outsourcing.

11

have a relatively higher representation or importance in outsourcing relationships (a higher relative
production …xed cost) and therefore require a larger share. It will be seen that the positive surplus in
outsourcing relations with suppliers above the threshold will be divided according to the bargaining
power of each side, which does not play an important role in our results.
We now rewrite

for the threshold supplier by substituting ! obtained in (20) back into (18) to

get a cut-o¤ technology level that just compensates for the …xed production costs of both partners:( )= E

n (1

4.2

)

wkf

ks

:

(21)

Final Good Market Entry

Equation (16) infers that there exists a threshold level of supplier capability under which they nolonger …nd it worthwhile to enter a partnership. For any given level of supplier capability, thethatmakes the …nal producer break even is
= E

n (1

wkf
(1 !
^f )

)

;

(22)

where !
^ f is the share of the surplus paid to the supplier that satis…es the …nal …rms’ zero pro…ts
condition:!
^f = 1

E
n (1

wkf
)

=

:

(23)

The supplier share that gives the …nal producer zero pro…ts is increasing with a supplier’s R&D
capability as this requires a lower transfer. This suggests that the better a supplier is (the lessinvestment cost it bears), the higher is the share of the surplus that a …nal producer can a¤ord to
give up and still break even.

4.3

Formation of Outsourcing Relations

As in Melitz (2003), we focus on steady state equilibria. A pair of …rms, the supplier in which
has the technology level , earn a joint surplus( ) in each period, until hit by a shock, at which

point they exit the market. A pair seeking to start operations expect a discounted value of pro…ts
equivalent to:(v( ) = max 0;

1
X

(1

t

)

t=0

)

( )

= max 0;1( ) ;where an anticipated negative operating pro…t makes the two sides exit the potential contract uponobserving . We now know there is a unique thresholdsuch that v( ) > 0 if>.

In the industry equilibrium, we have to solve for the number of paired partners (and varieties)n and the cut-o¤. To do this we must …rst determine the average joint surplus. This can beeasily calculated by using the share !
^ f from (23) to set the pro…ts of the …nal producers equal to12zero and solve for supplier average pro…ts

s =

s(

~)

ks . It is also possible to do the opposite,

giving the …nal producer full bargaining power. By doing so, we obtain the share !
^ s = E (1 wk)s=nthat sets supplier pro…ts equal to zero and solve for

f =

f(

~)

wkf . The derivations yield theexact same results as the two sides simply maximize joint pro…ts at the order contract stage.
We start by using the ratio technique in the spirit of Melitz (2003), which gives
= 1
=
= 2

2

=~ =

=)

1

= ;

~( )

where we de…ne ~( ) as the average technology of suppliers that are active in the market. This
allows us to calculate the average customization investment for suppliers using the cut-o¤ level in
(21):
=~ =

~( )

=

=

E
(1
n

~( )

)

wkf

ks

(24)

The average payment, on the other hand, can be found by substituting (24) in (14) and isT~ = [1!
^ f ] =~ = [1

!
^f ]

~( )

E
(1
n

)

wkf

ks

(25)

Relegating the calculations to the Appendix, we can derive the …rst equation of our system, whichsimpli…es to
=

=~

~

s+T

E
(1
n

ks =

)

wkf

ks

( );

(26)

where
( )=1

~( )

:

(27)

In line with Melitz (2003), we observe from (26) that since a higher

increases average capability,

it directly increases the average joint surplus. There is, however, also a negative e¤ect because
the capabilities of rival …rms are also increasing. The latter e¤ect tends to dominate if G( ) has asu¢ ciently fat right tail so that ( )0 < 0, making the ZCP schedule (26) downward sloping in.

The ex-ante probability of successful entry is

e(

)

1

G( ):

(28)

Recall that both sides of the relationship make investments wkf and ks to enter a partnership when
they have an expectation of future positive pro…ts. Let v represent the present value of the average‡ow of the joint surplus:
v=

1

:

The net value of entry can be de…ned as
ve =

ev

fe =

1

G( )

fe :

Thus, the free entry condition yields the second equation of our system
=

1

fe
=
G( )
13

fe
;
(
)
e

(29)

which is increasing in.

The novelty of the model is that it deals with R&D costs which are generally encompassed in the…xed part of the cost function of …rms. This gives heterogeneity in technological capability and IPRprotection a role in the upstream-downstream relationship between …rms, and in determining themarket structure. In our setting, moving heterogeneity from the …xed to the variable component of
the cost function would reduce the model to a standard Melitz (2003) heterogeneous …rm framework
where investment takes the shape of …xed costwith a constant . Heterogeneity would instead be

relevant for the order contract now (as opposed to the investment contract that involves technology)
with supplier productivity determining the outsourcing decision of …rms. Equation (7) turns to
pj (') ='jwith 'j representing supplier productivity, and investment

simply becomes another…xed cost added to the previous ones and can therefore be embedded in ks . More precisely, solvinghithe model yields average joint pro…ts = E) wkf ks
= wkf + ks +(' ) in placen (11of Equation (27), where (' ) ='~ (' )'

schedule in Melitz (2003), where= f (' ). Here it is true that the cut-o¤ supplier productivity is

1. This corresponds to the zero cuto¤ point (ZCP)

increasing in IPR protection level , but this is of little insight as a larger

simply implies a higher…xed cost, and a higher productivity level is required to cover it and start production.

4.4

Industry Equilibrium and IPR Enforcement

The two equations (26) and (29) together with two unknowns n andcan now be explicitly solved

to close the model. By equating the two equations obtained for , we solve for the number of relations(paired upstream and downstream …rms), n, which is also equivalent to the number of varieties:
E (1

n=
e(

fe
) (

)
;
) + wkf + ks

(30)

where we have used de…nitions (27) and (28). It is easy to see that @@n < 0. Replacing n from (30)in (21) gives the zero cut-o¤ technology level in its …nal form and thereby the equilibrium condition:( ) e( )=An increase in the RHS of (31) caused by a larger
by an increase in the LHS made possible by a higher

fe

:

(31)

or a lower entry cost must be accompanied(given that0( ) < 0 and0e() < 0) tosatisfy the equilibrium condition. We can therefore state the following proposition:
Proposition 1 The cut-o¤ technology level of suppliers is increasing with stronger IPR enforcement,
@

( )
@

> 0, making it more di¢ cult for less technologically capable …rms, which are deprived of theiroutside option, to lie within the range of technological capabilities governed by a contract. A more
stringent IPR environment therefore induces …nal producers to choose suppliers that are on average0

more technologically capable as outsourcing partners, i.e., ~ ( ) > 0.
14

Proof. This follows directly from the equilibrium condition in (31) derived from (30) and (21).
Using the de…nition of the weighted average supplier technological capability from the Appendix,
di¤erentiating average supplier capability with respect to~~0 ( ) = g( )( ( )1 G( )
which is always positive because ~( ) >yields:)> 0;.

Proposition 1 has important implications. The conventional wisdom suggests that …nal producers
tend to choose suppliers with better technologies to pair with. The results show that this is to agreater extent the case in countries with better IPR institutions: the average technology of suppliers
is higher in countries with stronger IPR enforcement. A better legal environment reduces the outside
option of less capable suppliers, making only suppliers with better technologies survive since …rms are
obliged to invest more within the contractual relationship. In contrast, under weak IPR institutions,less capable suppliers are provided with a larger outside option enabling them to also enter into
outsourcing relationships.
Our …nal aim is to study the impact of IPR enforcement and in turn the outsourcing decisions
by multinationals on the host economy. To do this recall that consumption of the …nal good takes
place in the North. Given that a positive share of the surplus ! > 0 goes to the suppliers and issuperior to the pay-o¤ outside the relationship after exiting the market, the total pro…ts earned from
economic activities that take place in the industry can be used to measure the industry gains in theSouthern economy that arise from outsourcing relationships.9 To do so, we multiply Equations (29)and (30) to obtainnfe E(1

=

)

=

E(1
1
( ) +

e(

)
)(wkf +ks )
fe

;

(32)

e(

fe
) (

) + wkf + ks

where we have used the de…nition fore() from (28).10 Equation (32) immediately reveals that

[1

G( )]

the impact of an upward shift inthat occurs due to strengthening IPR enforcement is ambiguous

and depends on the technology distribution. Since0( ) < 0 and0e() < 0, we observe two e¤ects.

The positive e¤ect is due to an increase in the pro…ts of the remaining more technologically capablesuppliers in the intensive margin brought about by reduced competition, a lowere(). This occurs

as a consequence of protection against the entry of more …rms into the market. The negative e¤ect
appears due to lower supplier pro…ts on the extensive margin that come from a reduced number ofactive …rms in the industry due to stronger rivals in the market, a lower ( ).
9 While condition LN= wkf can be used to determine consumption in the North, labor in the South used to

produce the intermediate goods in the industry under study is equal to LS = n(~x+=~ + ks ). This is however

irrelevant for our purpose of studying the gains from outsourcing relations in the South.
1 0 This is equivalent to replacing the number of …rms in (26) with its equilibrium value from (30) and then multiplying
the two equations.

15

Proposition 2 Given0( ) > 0,0( ) < 0 ande() < 0, the impact of strengthening IPR

enforcement on the host economy is twofold: reduced competition increases the average pro…ts of
the remaining more technologically capable …rms in the intensive margin, while a reduction in theabsolute number of …rms on the extensive margin lowers total industry pro…ts.
Proof. This follows directly from Lemma 2 and Proposition 1, Equations (31) and (32), and thede…nition of ( ) in (27). That is, the derivative of (32) with respect to
E(1
d(n )
=
d
The e¤ect of an increase in
We know that0( ) < 0 and

0
e(

0

)[ (( )2)
e(

1
( ) +

is:

)(wkf +ks )]fe:2)(wkf +ks )
fe

(33)

on aggregate industry pro…ts depends on the sign of
0
e(

0

(

(

)
)2

0
e(

)

7 0.

) < 0.

Next, we aim to show that IPR enforcement in technologically lagged economies represented bya fat right tail distribution of G( ) is more likely to have a negative e¤ect on the upstream suppliermarket given the attributes of their relationships with downstream multinational …rms. Gains fromreduced competition in the intensive margin are not su¢ cient to compensate for losses on theextensive margin brought about by the exit of less capable suppliers. In such economies, less strict
IPR enforcement generates a larger outside option for suppliers and creates gain by allowing more
suppliers to operate in the economy and bene…t from links to multinational …rms. An interestingcase is that of a Pareto distribution, in which the expression (33) turns to
E(1
d(n )
=
d

(wkf +ks )
+1
fe
2
wk +k
+ f fes)and is always positive but decreasing in the tail index. In this case, gains from IPR protection

are diminishing as countries are less developed as long as condition> 1= lnholds.11 Similar

to Melitz (2003), the downward sloping ZCP schedule turns ‡at under a Pareto distribution since( ) would no longer depend on. Consequently, the negative e¤ect of IPRs in (33) goes down

to zero, while it remains negative for other distributions where0( ) < 0, more so the lower is thelevel of development in the host country (larger ). We can therefore make the general conclusionthat
Proposition 3 Given the shape of the distribution function in ( ) ande(), an economy where

the distribution of technology leans towards less technologically endowed suppliers is more likely tolose from (or less likely to gain from) IPR enforcement. This is due to a smaller positive e¤ ect of achange inon aggregate pro…ts in the intensive margin and a larger negative e¤ ect on the extensive

margin.
1 1 See the Appendix for proof.

16

Proof. See the Appendix.
Finally, we turn to the welfare in the North, which consists of consumer utility and pro…ts of the…nal producers. In standard IPR literature, consumers are worse o¤ due to higher prices, but could
also gain from more varieites or better qualities arising from innovation. On the other side of themarket, Northern …rms are generally considered to be the winners of stronger IPR enforcement in theSouth. Given the above analysis, it is straightforward to see that consumers in the North lose from
IPR protection as a larger

reduces the number of …rms and hence the number of varieties madeavailable to Northern consumers through outsourcing. This is di¤erent from the standard channel ofprice changes and singles out the impact of IPRs on consumer welfare brought about by outsourcing.
At the same time, a more strict IPR regime in the South increases the average pro…ts of outsourcing
for Northern multinationals, which helps explain the vigorous lobbying e¤orts by Northern …rms
for the implementation of the agreement on Trade-Related Aspects of Intellectual Property Rights(TRIPS) by the World Trade Organization (WTO).
Proposition 4 Consumers in the North lose from stronger IPR enforcement in the South due to alower number of varieties, whereas average pro…ts of outsourcing increase for Northern …rms.
Proof. Given the utility function (1) and looking at (30), it is easy to see that n and therefore(1) is decreasing insince

are increasing in IPRs since

4.50( ) < 0 and

0
e(

0
e(

) < 0. At the same time average pro…tsin (29)) < 0.

Robustness to Alternative Explanations

The results obtained from this framework are robust to several parallel studies in the international
trade and IPR literature and can be put into di¤erent contexts. To name a few we put our …ndings
next to theory and evidence derived under the topic of imitation, technological complexity, andspillovers.
Starting with integration as an alternative to outsourcing in a foreign country, we mentioned
in the literature review that Antràs and Helpman (2008) show how contract enforcement in theSouth increases the relative prevalence of FDI over outsourcing. Corcos et al. (2013) accordingly…nd evidence that imports from countries with well-functioning judicial institutions are more likely
to be intra-…rm. In other words, the better a country’s judicial system, the less likely …rms are
to engage in outsourcing relationships. This can easily …t into our framework if the alternative tooutsourcing is integration through FDI. An outsourcing relationship with the threshold supplierwould give

OU T
(
f

)

wkfOU T =F DI
f

wkfF DI as opposed to zero pro…ts (

OU T
(
f

) = wkfOU T ).

FDI pro…ts do not rely on suppliers or depend on their capability as everything takes place within…rm boundaries. Hence, in the present framework it can be treated as a …xed expression
E
n (1

)

, where we have used

F DI
=
f

= 1 as the …rm does not exploit specialization gains from17

outsourcing and= 1 due to no imitation risk and therefore no problem with the IPR regime under

FDI. It is therefore always true that

OU T
(
f

F DI
, whereas the …xed costs of setting up anf)outsourcing relationship are higher than that for FDI (kfOU T > kfF DI ). Outsourcing would only takeplace with suppliers that possess a technology above the threshold…xed costs associated with outsourcing, i.e.,
protection increases the threshold

OU T
(
f

) wkfOU T

so that they can cover the extra
F DI
f

wkfF DI for. As IPR, outsourcing will be reduced and limited to the best suppliers,

thereby giving way to FDI. More directly, this is also consistent with the general observations in IPR
literature that a multinational will enter more aggressively when IPR enforcement is strengthened(Maskus and Penubarti, 1995; Smith, 2001; Branstetter et al., 2006; Ivus, 2010; Branstetter et al.
2011).
In the context of imitation, it was mentioned that in a weak IPR environment, suppliers are notobliged to respect the rules of the contract and can use their capability to defect and operate outside
the relationship. This is parallel to imitation under a weak IPR regime, where licensing contracts
are not respected and the licensees defect and use the acquired technology for their own purposes.
Arora and Merges (2004) is among a number of papers under this branch of the literature thatshow how IPR protection may encourage investments in specialized …rms with strong capabilities
in the area of innovative input supply. IPRs can therefore play a role in determining the locationof …rm boundaries. This is consistent with evidence by Anand and Khanna (2000) in a study of
1,612 licensing agreements using data from the Strategic Alliance database of the Securities Data
Company.
Moving to technological complexity, Acemoglu, Antràs and Helpman (2007) provide a theory
to show that contract enforcement stimulates the adoption of more complex technologies throughthe …rms’choice of suppliers. In a similar context, by using French …rm-level data Naghavi, Spies,
and Toubal (2015) provide evidence that …rms outsource more complex technologies to countries
that ensure stronger IPR protection. Our work can also be related to this context. Here, we showthat stronger IPR enforcement shifts multinationals to form outsourcing relationships with suppliers
endowed with better technologies by reducing the probability of defection.
Spillovers are another channel through which linkages between multinationals and local suppliersin a host country create bene…ts for both sides. Strong linkages with such …rms have been associatedwith fostering production e¢ ciency, productivity growth, and technological or managerial capabilities in supplier …rms. Local suppliers therefore self-select into production for multinational …rms.
In particular Carluccio and Fally (2013) provide a theory that sheds light on how vertical spillovers
from foreign …rms can generate technology transfer and improve the productivity of upstream …rms
in the domestic industry. This is in line with evidence collected in an empirical survey by Alfaro
and Rodriguez-Clare (2004) on manufacturing …rms in Chile, Mexico, Venezuela and Brazil thatare distinguished by sector and ownership. Our framework can be compared to this argument as18

strong IPR enforcement here also increases average technological capability in the supply chain. The
channel is however di¤erent here as this is made possible by excluding the less capable suppliers
from outsourcing relationships. In our framework, the previous …ndings are made possible throughstronger IPR institutions.

5

Conclusion

This paper introduces supplier heterogeneity in the literature on …rm organization in order to study
the selection mechanism through which multinationals outsource to suppliers. Doing so allows us
to study this decision under di¤erent IPR environments and highlights the impact of the latter on
the host economy. In particular, we study suppliers that are heterogeneous in terms of their ability
to make relationship-speci…c investments to customize the input according to standards required by
the multinationals. Suppliers of high value-added and sophisticated products and services are in abetter position to bene…t from such partnerships than those with simpler processes.
In this setting multinationals provide suppliers with assistance in raising suppliers’technologicalcapabilities and competitiveness to ensure that the inputs procured meet their stringent technicalrequirements. The extent of the technology transfer depends on the host economy and the levelof development of local …rms. Higher customization costs, less technologically endowed suppliers,
and a weak IPR regime in the host country all increase the required amount of investment by the
supplier. A multinational only o¤ers such support when the investment can be expected to yielda reasonable return. They are more likely to source to domestic suppliers when the technologicaland managerial gaps between them and their local suppliers are not too wide to minimize training
and technology transfer costs. In other words, when potential suppliers lack the minimum base ofskills and know-how needed to absorb technologies and management practices, it becomes too costly
for multinationals to transfer technology and train suppliers to match the required international
standards. In countries with less adequate enforcement of IPRs, a higher outside option granted toless capable suppliers enables them to also operate in the customization of inputs and supplying parts
to multinationals. Better IPR enforcement diverts attention along with the opportunity to obtainthe necessary technical assistance and know-how towards a limited number of …rst-tier supplierswith relatively better technologies. This is because a better IPR environment obliges …rms to invest
more within the contractual relationship, only allowing more technologically advanced suppliers tosurvive by taking away the outside option of the less capable ones.
The subsequent elimination of less capable suppliers and an enhancement of the average R&D
capability of the supply market also has numerous impacts on the host country. We …nd that
better IPR enforcement has an ambiguous e¤ect on the economy. Reduced competition increases
the average pro…ts in the industry in the intensive margin, whereas exit by less capable …rms reduces

19aggregate pro…ts on the extensive margin. Strict IPR enforcement can harm economies not endowedwith a favorable distribution of technological capabilities. When a substantial mass of suppliers in
the economy are on the low technology side, better IPR enforcement reduces intensive margin gains
from lower competition, while increasing the extensive margin losses from a lower number of …rms.
Our results shed light on why IPR enforcement is given more importance in technologically advanced
economies and continues to be neglected in countries such as China, which regardless enjoys an everincreasing share of outsourcing relationships worldwide.
A limitation of the model which we plan to tackle in the future is the fact that the partial
equilibrium nature of the framework does not allow us to establish a comprehensive welfare analysis
by measuring consumer surplus in the North. This is because although here consumers in the
North may lose from IPRs in the South due to reduced outsourcing and hence a lower number ofvarieties, less outsourcing may not necessarily mean a reduced number of varieties as the goods could
alternatively be provided locally or, as presented in Section 4.5, through other organizational forms
such as FDI. We also hope this study can motivate the challenging task of collecting …rm-level datathat contains information regarding suppliers, in order to make possible a more in-depth analysis of
outsourcing relationships between multinationals and subcontractors of di¤erent characteristics andattributes.

20

Appendix
Derivation of Equation (14)
By substituting (11) into (12), the surplus for the supplier (net of costs already sunk) is
E
(1
n

s =!

)

= +T

and the surplus for the producer is found by substituting (10) into (13) to obtainf = [1

!]

E
(1
n

)

T

To derive the payment, the Nash product is maximized with respect to T

M ax
T

By log-linearizing

= [1

!]

1 !

E
(1
n

)

T

!

!

E
(1
n

)

:

= +T

we can rewrite

M ax ln= [1T!] ln [1

!]

E
(1
n

1

!

)

T + ! ln !

E
(1
n

)

= +T

Solving for the FOC
@ ln
@T

=

[1

!] E
n (1

)

T

+

!
)

!E
n (1

= +T

=0

yieldsT ( ; ) = [1Note that the expression= incorporates both the investment cost and the outside option. One

can think of the outside option as O =in IPR protection,!] = :

1= , i.e. increasing in productivity, , and decreasing, and the investment cost as I = =, wheredetermines the relevance of

productivity within vis à vis outside the relationship. This yields I=O == so that the supplier

has a lower cost with higher productivity, (ii) a higher outside option with higher productivity, and(iii) a lower outside option with stronger IPR enforcement.
Derivation of Equation (26)Solving
T~

=~ =

!
^f

E
(1
n

~( )

21

)

wkf

ks ;

average net pro…ts can be written in terms of
s

=~

~

=

s+T

=

ks = !
^f

wkf
E
)
n (1

1
0

= @1

=~

!

:

E
(1
n

)

E
(1
n

)

~( )

E
n (1

)

wkf

ks

E
(1
n
1

E
(1
n

)

wkf

ks

ks

~( )

wkf
E
n (1

E
(1
n

=

E
(1
n

=

1

)
)

)

~( )

~(

)

~( )

E
(1
n

~( )
E
(1
n

)

E
(1
n

)

wkf

wkf

ks

)

wkf

ks

ks

)

wkf

ks

ks

A

wkf

ks

ks

where we have substituted for !
^ f from (23).
Derivation of the Average Technological Capability
Let us de…ne the weighted average supplier technological capability measure according to Melitz(2003):~=

Z 1( )d ;

1

where the conditional distribution of g( ) on [ ; 1] isZ 1( )=( )d =

1

g( )
G( )

from which we can rewrite average technological capability as
Z 11~( ) =
g( )d ;
1 G( )
where ~ is uniquely derived byand the exogenous distribution g( ) and G( ).

Proof of Proposition 3
It follows directly from Equation (32) and properties of the technology distribution function in(28) and (27). Looking back at the derivative of (32) with respect to0( ) < 0 and

0e(in (33), and recalling) < 0, the technology distribution in the economy determines the size of each

derivative. A poor distribution of technology, i.e. a fat right tail cumulative distribution of suppliers,
implies a larger0( ) and a smaller0e(), making it more likely for the expression to be negative.

To see this consider the case of a Pareto distribution. We can de…ne the probability density and thecumulative distributive function, g( ) and G( ), asg( ) =

221

and
G( ) = 1
where a larger

implies a less technologically advanced economy in terms of the distribution of

supplier capability,
Z1;> 1 andg( )d =

Z1

1 is the mean. This in turn gives

1

d =

1

1

1

=

h

1

i

1

11

=

1

1

:

Conditional average capability can be written as
1
G( )

1

Z1

1

g( )d =

=

1

:

1

and used to derive
( )=1

~( )

1

=1

=1

=

1

:

1

and
e(

The derivative of

e(

)=1

) with respect toG( ) =:

is in turn
0
e(

1

)=

:

If G( ) has a fat enough right tail, many …rms are on the less capable side so that with a changein, 1a smaller

G( ) does not change much and does not have much e¤ect on average pro…ts (due to
0
e(

0
e(

)). Formally, the expression

economies) as long as> 1= ln)=+1

is decreasing in(for less developed.

Applying Pareto distribution to our argument gives

n

E(1

=

1
( ) +

)

e(

)(wkf +ks )fe0)(wkf +ks )
fe

=

E(1

)

wk +k
+ f fes

;

where
d(n )
=
d

E(1

) e

1
( ) +

is always positive but decreasing ine(()(wkf +ks )fe

2 =(wkf +ks )
+1
fe
2
wk +k
+ f fes)so that gains from IPR protection are diminishing as countries

are less developed, as long as the condition above0

E(1> 1= lnholds. At the same time, while( ) = 0 under Pareto, it is negative for most distributions, and more so the less developed acountry is, i.e.

0( ) is decreasing at a faster rate the fatter is the right tail and hence the larger isthe negative e¤ect of the presence of more competitive rivals on average pro…ts.

23

References
Acemoglu, D., Antràs, P. and Helpman, E. (2007) Contracts and Technology Adoption, American
Economic Review 97, 916–943.
Ahmadijan, C. and Oxley, J. (2013) Vertical Relationships, Hostages, and Supplier Performance:
Evidence from the Japanese Automotive Industry, Journal of Law, Economics and Organization,
29, 485–511.
Ahmadijan, C. and Oxley, J. (2006) Using Hostages to Support Exchange: Dependence Balancing
and Partial Equity Stakes in Japanese Automotive Supply Relationships, Journal of Law, Economics
and Organization, 22, 213–233.
Alfaro, L. and Rodriguez-Clare, A. (2004) Multinationals and Linkages: An Empirical Investigation,
Economia 4(2).
Anand, B.N. and Khanna, T. (2000) The Structure of Licensing Contracts, Journal of Industrial
Economics 48, 103–135.
Andrabi, T., Ghatak, M. and Khwaja, A.I. (2006) Subcontractors for Tractors: Theory and Evidenceon Flexible Specialization, Supplier Selection and Contracting, Journal of Development Economics
79, 273–302.
Antràs, P. (2014) Grossman-Hart (1986) Goes Global: Incomplete Contracts, Property Rights, andthe International Organization of Production, Journal of Law, Economics and Organization, 30 S1,
i118–i174.
Antràs, P. and Helpman, E. (2008) Contractual Frictions and Global Sourcing, in Helpman, E., D.
Marin, and T. Verdier, eds., The Organization of Firms in a Global Economy, Cambridge, MA:
Harvard University Press.
Antràs, P. and Rossi-Hansberg E. (2009) Organizations and Trade, Annual Review of Economics
1(1), 43–64.
Arora, A. and Merges, R.P. (2004) Specialized Supply Firms, Property Rights and Firm Boundaries,
Industrial and Corporate Change 13, 451–475.
Assche, A.V. and Schwartz, G.A. (2010) Input Speci…city and Global Sourcing, Journal of theJapanese and International Economies 24, 69–85.
Branstetter, L., Fisman, R. and Foley, F. (2006). Does Stronger Intellectual Property Rights Increase International Technology Transfer? Empirical Evidence from U.S. Firm-level Data. Quarterly
Journal of Economics 121(1), 321–349.
Branstetter, L., R. Fisman, F. Foley, and Saggi, K. (2011). Does Intellectual Property Rights Reform
Spur Industrial Development? Journal of International Economics 83, 27–36.
Canals, C. and Şener, F. (2014) O¤shoring and Intellectual Property Rights Reform, Journal of
Development Economics 108, 17–31.
Carluccio, J. and Fally, T. (2013) Foreign Entry and Spillovers with Technological Incompatibilities24

in the Supply Chain, Journal of International Economics 90, 123–135.
Che, J., Qiu, L.D. and Zhou, W. (2014) Entry, Reputation and Intellectual Property Rights Enforcement, Canadian Journal of Economics 47 (4).
Chu, A.C, Cozzi, G. and Galli, S. (2014) Stage-dependent Intellectual Property Rights, Journal of
Development Economics 106, 239–249.
Corcos, G., Irac, D.M., Mion, G. and Verdier, T. (2013) The Determinants of Intra-Firm Trade, The
Review of Economics and Statistics, 95(3), 825–838.
Costinot, A. (2009) On the Origins of Comparative Advantage, Journal of International Economics
77, 255–264.
Defever, F. and Toubal, F. (2013) Productivity, Relation-Speci…c Inputs and the Sourcing Modes ofMultinationals, Journal of Economic Behavior and Organization 94, 245–357.
Grossman, G. M. and Helpman, E. (2002) Integration vs. Outsourcing in Industry Equilibrium,
Quarterly Journal of Economics 117, 85–120.
Grossman, G.M. and Helpman, E. (2003) Outsourcing versus FDI in Industry Equilibrium, Journalof the European Economic Association 1, 317–327.
Grossman, G.M. and Helpman, E. (2005) Outsourcing in a Global Economy, Review of Economic
Studies 72, 135–159.
Helpman, E. (2006) Trade, FDI, and the Organization of Firms, Journal of Economic Literature 44,
589–630.
Ivus, O. (2010) Do Stronger Patent Rights Raise High-tech Exports to the Developing World?
Journal of International Economics 81 (1), 38–47.
Kamath, R. and Liker J. (1994) A Second Look at Japanese Product Development. Harvard Business
Review 72, 154–170.
Lai, E.L.-C and Qiu, L.D. (2003) The North’s Intellectual Property Rights Standard for the South?
Journal of International Economics 59 (1), 183–209.
Levchenko, A. (2007) Institutional Quality and International Trade, Review of Economic Studies 74,
791–819.
Lin, P. and Saggi, K. (2007) Multinational Firms, Exclusivity, and Backward Linkages, Journal ofInternational Economics 71, 206–220.
Maskus, K.E. and Penubarti, M. (1995) How Trade Related are Intellectual Property Rights?
Journal of International Economics 39, 227–248.
McLaren, J. (2000) Globalization and Vertical Structure, American Economic Review 90, 1239–1254.
Melitz, M. J. (2003) The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry
Productivity, Econometrica 72, 1695–1725.
Naghavi, A., Spies, J., and Toubal, F. (2015) Intellectual Property Rights, Product Complexity, andthe Organization of Multinational Firms, Canadian Journal of Economics 48 (3), 881–902.

25

Nunn, N. (2007) Relationship-Speci…city, Incomplete Contracts, and the Pattern of Trade, Quarterly
Journal of Economics 122, 569–600.
Qiu, L.D. and Spencer, B. J. (2001) Keiretsu and Relationship-Speci…c Investment: A Barrier toTrade? International Economic Review 42, 871–901.
Qiu, L.D. and Spencer, B. J. (2002) Keiretsu and Relationship-Speci…c Investment: Implications forMarket-Opening Trade Policy, Journal of International Economics 58, 49–79.
Smith, P. (2001) How do Foreign Patent Rights A¤ect U.S. Exports, A¢ liate Sales, and Licenses?
Journal of International Economics 55 411–439.
Sutton, J. (2004) The Auto-component Supply Chain in China and India A Benchmarking Study”,
mimeo, London School of Economics.
UNCTAD (2001), World Investment Report 2001: Promoting Linkages. United Nations, New Yorkand Geneva.

26