Input Quality, Relational Contracts and International Outsourcing

This paper presents a Ricardian trade model in which the quality of intermediate inputs affects the productivity of labour at the final production stage. The role of contracting frictions is shown by comparing the chain of comparative advantage obtained with full information with that resulting when the quality of inputs is affected by actions that are not verifiable in court. Conditions are derived under which parties can use the potential for repeat business (relational contracts) to sustain efficient production choices. These results yield predictions for how country and industry characteristics will affect the level of contracting frictions. Copyright 2008 The Author. Journal compilation 2008 Blackwell Publishing Asia Pty Ltd