Modularity and the Organization of International Production

In recent decades, complex manufacturing sectors such as electronics have transformed from an industry dominated by vertically integrated firms that source locally to an industry dominated by horizontally specialized firms that source globally. To account for this, we build an two-country industry-equilibrium model in which firms concurrently choose (i) a product architecture, (ii) an ownership structure and (iii) a location for production. In industries with partial input specificity and economies of scale in input production, we find that the industry transformation can be explained by a reduction in synergistic specificity, a reduction in the cost of internationalizing and an increase in industry demand.
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