Uncertainty and coordination cost in vertically-linked industries: a model of New Economic Geography

(Grossman and Helpman 2004) have emphasized that the incompleteness of contracts in distant input-output linkages fosters agglomeration of downstream and upstream firms in the core region despite wage differential favoring to the periphery. Following this argument, this paper introduces uncertainty in input-output linkages in a NEG framework. We argue that uncertainty involves a coordination cost, which depends on: i) distance that prevents downstream firms to monitor fully their suppliers, ii) and the complexity of the production process. In a Venables (1996) framework, we show that coordination cost adds a new tradeoff for downstream firms that can halt the redispersion process. This result is in line with a new empirical phenomenon in Europe: the backsourcing, highlighted in (Dachs, Ebersberger, Kinkel, and Waser 2006).