Outsourcing with Home Bias and Trade Policy∗

This paper examines a simple model of outsourcing involving matching frictions and home bias in firms’ acquisition of intermediate goods. Two groups of seller firms—local sellers and foreign sellers—may face different degrees of search frictions even though they are identical in terms of productivity. Two groups of buyer firms are considered: one group accepts local and foreign sellers equally, whereas the other group accepts only local sellers and never acquires intermediate goods from foreign sellers (communication with foreign sellers may be too costly for this group). The existence of buyers whose demand is biased toward locally produced intermediate goods allows unbiased buyers to exploit foreign sellers. Though only few buyers have biased demand, the entry of foreign sellers would be greatly deterred. In such an environment, the home government may adopt rent-shifting trade policies rather than mitigate production inefficiency caused by the home bias. JEL Classification Numbers: F13, F15, F61