Macroeconomic consequences of outsourcing: An analysis of growth, welfare,and product variety

Outsourcing of non-core activities is nowadays a common business strategy. Declining transaction and transportation costs caused by the advent of Info rmation and Communication Technology are a potentially important driving fo rce behind this development. This paper provides a theoretical framework fo r analysing a firm's incentive to follow such a strategy of outsourcing and its consequences for macroeconomic variables like growth and product varie ty. We divide production activities into core and non-core activities. Non- core activities can be performed within the firm or can be mediated by the market. We derive conditions under which outsourcing occurs, and under whic h outsourcing is socially desirable. These conditions do not necessarily co incide. Outsourcing may hence be a profitable strategy for firms, while it is socially suboptimal. Crucial parameters in the model are the relative sc ale of core versus non-core activities, management costs, transaction costs and love for variety of consumers.