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Federal Reserve Bank of Boston
Supervisory Research and Analysis Working Papers
Offshore Production and Business Cycle Dynamics with Heterogeneous Firms
Andrei Zlate

To examine the effect of offshoring through vertical FDI on the international transmission of business cycles, I propose a two-country model in which firms endogenously choose the location of their production plants over the business cycle. Firms face a sunk cost to enter the domestic market and an additional fixed cost to produce offshore. As such, the offshoring decision depends on the firm-specific productivity and on fluctuations in the relative cost of effective labor. The model generates a procyclical pattern of offshoring and dynamics along its extensive margin that are consistent with data from Mexico's maquiladora sector. The extensive margin enhances the procyclical response of the value added offshore to expansions in the home economy, as the number of offshoring firms mirrors the dynamics of firm entry at home. As a result, offshoring increases the comovement of output across economies, in line with the empirical evidence.

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Andrei Zlate, Offshore Production and Business Cycle Dynamics with Heterogeneous Firms, Federal Reserve Bank of Boston, Supervisory Research and Analysis Working Papers RPA 16-1, 17 Feb 2016.
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Keywords: Offshore production; extensive margin; heterogeneous firms; firm entry; business cycle dynamics; terms of labor.
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