Domestic Offshoring in a Knowledge Economy∗

During past decades, substantial skill and occupation relocation took place across U.S. cities: big cities attract more skilled workers and specialize more in cognitiveintensive occupations. Motivated by the empirical literature on improvement in Information and Communications Technology (ICT) and the increasing domestic production fragmentation—or domestic offshoring—we develop a spatial equilibrium model with domestic offshoring to analyze the impact of reduction in cross-city production team formation cost—e.g., communications cost—on the spatial distribution of skills and economic activities. The model generates predictions consistent with observed empirical patterns, including more spatial segregation of skilled and unskilled workers, and occupation specialization across US cities over time. In contrast to findings in the international offshoring literature, in which there are winners and losers, we find Pareto welfare gains for all agents with heterogeneous talents, together with a substantial measured labor productivity increase at the aggregate level. ∗We are indebted to Donald Davis, Jonathan Eaton, Pablo Fajgelbaum, Juan Carlos Hallak, Rocco Macchiavello, Antonio Miscio, Stephen Redding, Stephanie Schmitt-Grohé, Martín Uribe, Eric Verhoogen, Jonathan Vogel, Shang-Jin Wei and David Weinstein for helpful discussions and comments. †Department of Economics, 420 W. 118th St., New York, NY 10027. Email: [email protected]. ‡Department of Economics, 420 W. 118th St., New York, NY 10027. Email: [email protected].