國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
1. INTRODUCTION
In this more and more integrated global economy, producers have frequently moved part of production process to foreign counties with lower factor cost. Previous literatures focusing on which organizational structures, namely vertical integration or outsourcing, the final-good producers choose when they distributed production processes to different location (Antras, 2003). We abstract from firm structures and narrow our topic to the R&D activities of a final-good producer’s foreign supplier. In partucular, we discuss the problem within the context that final-good producers choose outsourcing as the organi-zational structure. We provide the theoretical model and empirical evidence to confirm previously empirical study revealing that R&D activities are positively correlated with capital intensity (Bound, Cummins, Griliches, Hall, and Jaffe, 1982). We further theo-retically analyze how the suppliers’ decision of R&D alters when the level of competition is intensified. We show that within an industry or across industries, suppliers have more incentive to engage in R&D when the production process of final goods is more capital in-tensive. When competition other countries with lower factor price emerge, current foreign suppliers of more capital intensive final-good producers tend to upgrade their technology.
On the contrary, foreign suppliers of less capital intensive final-good producers tend to exit. Factors are therefore reallocated toward suppliers of capital intensive producers within an industry or toward suppliers of capital intensive industries.
Figure 1.1 provides a scatter plot of the capital intensity, measured as the ratio of total capital stock to total employment, and foreign supplier’s R&D spending of
Tai-‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
1. Introduction 2
Fig. 1.1: Scatter plot of capital intensity and R&D
wanese firms, and each point represents a firm. The Y-axis measures the logarithm of R&D spending of ODM (Original Design Manufacturing) and OEM (Original Equipment Manufacturing) firms. The X-axis corresponds to the logarithm of capital intensity in each industry. From the simple regression model, we can see that capital intensity is significantly connected to R&D activities.
Why foreign suppliers of capital-intensive industries engage in more R&D activities?
To answer this question, we build on the theory of incomplete contracts initially proposed by Williamson (1971) and Grossman and Hart (1986) and later developed by Antras (2003). Similar to Antras (2003), to produce the final good we assume that capital is provided by final-good producers and labor is provided by foreign suppliers. Because of contract incompleteness, revenue is distributed according to two parties’ ex-post bargain-ing power instead of the contribution of input they provide. Therefore, part of the capital contribution might be captured by foreign suppliers. This foreign suppliers’ excess profit can be used to cover the fixed R&D costs. Because excess profit increases with amount of capital or the contribution of capital, both positively correlated with capital intensity, we
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observe R&D expenditure increases with capital intensity. When new suppliers located in a country with lower factor cost emerges, only capital intensive suppliers within an industry or suppliers in a capital intensive industry are willing to invest in R&D activities and upgrade their productivity to compete with the new suppliers. Others choose to exit the market. In suppliers’ countries, factors are reallocated toward suppliers of capital intensive producers to form the fixed R&D cost and to satisfy their higher demand of factors after productivity is augmented. We therefore observe that in suppliers’ countries, labor intensive industries contract and capital intensive industries grow after competition is intensified. Furthermore, since suppliers of labor intensive producers exit, they are re-placed by suppliers in newly emerged countries. In the empirical section, we use firm-level data of Taiwanese enterprises to testify our propositions, and we also find a significantly consistent result.
Previous literatures trying to link R&D activities and capital intensity show two vari-ables are positively correlated (Bound, Cummins, Griliches, Hall, and Jaffe, 1982) 1, although they are silent in providing a theoretical explanation. We provide a theoretical explanation based on the division of production process between different firms and the nature of contract incompleteness. Our model also complements with previous theories explaining the organizational structures of multinational firms under global division of production process and incomplete contracts (Antras, 2003; Antras and Helpman, 2004).
They find that vertical integration rather than outsourcing will be adopted in high capital intensive industries, and they also assume that foreign suppliers are passive and static in R&D activities. To fill this gap in the literature, this paper focuses on outsourcing rela-tionship between two parties and investigates how foreign supplier behaves in the theory of incomplete contracts and finds the answer of figure 1.1. Moreover, in this model we can explain the endogenous R&D activities as well as endogenous industry evolution.
The rest of the paper is organized as follows. The next section develops a theoretical
1The only exception is Liu and Chen (2003) which show two variables are negatively correlated.
‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
1. Introduction 4
framework to analyze the foreign supplier’s behavior in R&D activities. In section 3, we present econometric evidence supporting the view in our theoretical work. Section 4 concludes.
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Consider a world with two countries, country A and country B. There inhabits a group of representative consumers with identical preference. These representative consumers’
utility function follows this form,
U = x0+ 1 µ
XJ
j=1
Xjµ, 0 < µ < 1, (2.1)
where x0 is the consumption of a homogeneous good. We assume that x0 is produced in both countries, but the production efficiency differs in these countries. We also assume that x0 is tradable and labor is the only input. Xj denotes the composite consumption in sector j, and µ is a parameter. Such composite consumption in each sector j is a constant elasticity of substitution function of different varieties xj(i),
Xj =
Z
xj(i)αdi
α1
, 0 < α < 1 (2.2)
where the number of variety in sector j is exogenously determined. It could also be easily showed that the elasticity of substitution between two varieties in sector j is 1/ (1 − α).
We assume µ < α, and this setting implies that varieties within a sector are more sub-stitutable for each other than they are for varieties from a different sector. We could compute its inverse demand function for each variety i in sector j:
pj(i) = Xjµ−αxj(i)α−1 (2.3)
Let’s assume that production involves two input factors: capital and labor. In country A, each final-good producer in variety i in sector j owns Ki amount of capital without any cost. We assume that the Ki amount of capital follows a distribution G(K) with