O¤shoring and Directed Technical Change

To study the short-run and long-run implications on wage inequality, we introduce directed technical change into a Ricardian model of o¤shoring. A unique \u85nal good is produced by combining a skilled and an unskilled product, each produced from a continuum of intermediates (tasks). Some of these tasks can be transferred from a skill-abundant West to a skill-scarce East. Pro\u85t maximization determines both the extent of o¤shoring and technological progress. O¤shoring induces skill-biased technical change because it increases the relative price of skill-intensive products and induces technical change favoring unskilled workers because it expands the market size for technologies complementing unskilled labor. In the empirically more relevant case, starting from low levels, an increase in o¤shoring opportunities triggers a transition with falling real wages for unskilled workers in the West, skill-biased technical change and rising skill premia worldwide. However, when the extent of o¤shoring becomes su ¢ ciently large, further increases in o¤shoring induce technical change now biased in favor of unskilled labor because o¤shoring closes the gap between unskilled wages in the West and the East, thus limiting the power of the price e¤ect fueling skill-biased technical change. The unequalizing impact of o¤shoring is thus greatest at the beginning. Transitional dynamics reveal that o¤shoring and technical change are substitutes in the short run but complements in the long run. Finally, though o¤shoring improves the welfare of workers in the East, it may bene\u85t or harm unskilled workers in the West depending on elasticities and the equilibrium growth rate