Breaking Up Is Hard to Do: Why Firms Fragment Production Across Locations

Abstract

This paper documents the relative importance of labor cost differences, distance to suppliers, and communication technology in a firm's domestic and foreign sourcing decisions. Using an original dataset of U.S. manufacturers' decisions to contract for manufacturing services, I show that domestic fragmentation: i) is far more prevalent than offshoring; ii) changes firms' opportunity cost to offshore; and iii) is facilitated by communication technology. In contrast, communication technology does not necessarily lead firms to offshore. Firms fragment production to access cheaper labor, and countries that offer significant labor cost savings tend not to have the technology infrastructure to support high-tech production.