O¤shoring and Unemployment1

In this paper, in order to study the impact of o¤shoring on sectoral and economywide rates of unemployment, we construct a two sector general equilibrium model in which labor is mobile across the two sectors, and unemployment is caused by search frictions. We …nd that, contrary to general perception, wage increases and sectoral unemployment decreases due to o¤shoring. This result can be understood to arise from the productivity enhancing (cost reducing) e¤ect of o¤shoring. If the search cost is identical in the two sectors, or is higher in the sector which experiences o¤shoring, the economywide rate of unemployment decreases. We also …nd multiple equilibrium outcomes in the extent of o¤shoring and in the unemployment rate. Furthermore, an o¤shoring …rm’s domestic employment can be higher than a …rm that chooses to remain fully domestic. When we modify the model to disallow intersectoral labor mobility, the negative relative price e¤ect on the o¤shoring sector may o¤set the positive productivity e¤ect, and result in a rise in unemployment in that sector. In the other sector, o¤shoring has a much stronger unemployment reducing e¤ect in this case. Finally, allowing for an endogenous number of varieties provides an additional indirect channel, through which sectoral unemployment can go down due to the entry of new …rms brought about by o¤shoring.