Multinational Firms’ Sourcing Decisions and Wage Inequality: A Dynamic Analysis

Abstract

This paper uses a two-country dynamic general equilibrium model to consider how, following a trade cost shock, multinational firms’ offshoring decision and the countries’ different factor endowments affect wage inequality between high- and low-skilled workers in the home country. Highlighting task-offshoring, heterogenous firms, and factor proportions, the study sheds light on how offshoring shapes wage inequality along different time horizons. While the paper’s focus is the relationship between the U.S. (home country) and China (foreign country), its findings are more broadly relevant. The three main findings are these: First, both intensive and extensive margins contribute to the widening wage gap, with the latter playing a more important role in the short- to medium- term than it does in the initial stage after the trade cost shock. Second, endogenous firm entry raises wage for both low-skilled and high-skilled workers while also widening the wage gap between the two groups over time. Third, whether firms offshore to a foreign country like Mexico, where the supply of low-skilled laborers is moderately larger than in the home country, or to a country like China, where the supply of low-skilled laborers is vastly larger, makes scant difference to wage inequality in the long term.