Outsourcing or reshoring? A manufacturer's sourcing strategy in the presence of government subsidy

Abstract

Multinational firms can outsource to contract manufacturers in low-labor-cost regions. However, in recent years, several developed countries and regions have subsidized their local manufacturers (LM[s], she) to encourage reshoring for external benefit (e.g., creating more domestic jobs or improving industrial structure), especially after the COVID-19 pandemic started. This paper investigates the sourcing problem of an LM with brand premium in the presence of government subsidy and differences in labor costs. An LM faces three options: producing in-house, outsourcing to an original brand manufacturer (OBM, he), which sells competitive substitutes without brand premium, or outsourcing to a non-competing contract manufacturer (NCM). We find that, first, the LM chooses reshoring if the external benefit or brand premium is sufficiently high. Second, if the LM decides to outsource, she chooses the OBM (NCM) if her brand premium is high (low). Third, the government prefers to subsidize LM reshoring or outsourcing to an NCM. If the government intends to induce LM to reshore, the subsidy should be at a moderate level. Interestingly, when the LM has a low brand premium but chooses outsourcing, the government still subsidizes her to improve her competitiveness.