Why do they JUST DO IT? A Theory of Outsourcing and Working Conditions

Abstract

Nike and other brand companies have long been criticized for outsourcing their production to contract factories with dismal working conditions. Despite the overwhelming amount of interest, there exists no theory for studying this topic. The current paper fills this gap. The framework embeds a compensating-wage-differentials model into the global sourcing model of Antras and Helpman (2004). In the model, the most productive firms in the North make high profits and outsource their manufacturing production to contract factories in the South. Manufacturing production is inherently dangerous. The level of working conditions depends on their provision cost and on the country’s labor productivity. To attract workers, factories pay wages that can compensate for poor working conditions. Despite being higher, factory wages might not meet workers’ basic needs, but the reason is that the country’s labor productivity is too low. In the benchmark model, the only source of comparative advantage between the two countries is the difference in their labor productivities. Thus, a low-productivity country can attract more outsourcing contracts since its factories can produce at lower costs. The paper also studies an extension in which factory workers misperceive the true level of working conditions and in which factories might not comply with local legal standards. Under this extension, factory workers are not appropriately compensated for inferior working conditions. Moreover, differences in the degree of workers’ misperception and of factory noncompliance can be additional sources of comparative advantage between the countries.