'Globalization' and Relocation in a Vertically Differentiated Industry

In this paper, we adopt the vertical differentiation duopoly framework to give a full description of firms’ relocation decisions, when the removal either of trade barriers or of restrictions on capital outflows/inflows (‘globalization’) allows them to serve the domestic market through foreign plants. We identify the advantages associated with production abroad with the possibility of exploiting a given wage differential. We show that when the liberalization of trade or investment flows yields the relocation of the whole industry, autarchy is strictly better, in welfare terms, than ‘globalization’. It is only when relocation is a dominant strategy for one (and only one) of the firms, that ‘globalization’ may be unambiguously welfare improving. Furthermore, we show that the effects of the relocation of the high or of the low quality firm are different. In particular, if the economy is ‘high quality biased’ (‘low quality biased’) the relocation of the firm producing the high quality variant (the low quality variant) is preferred, in welfare terms, to the relocation of the other firm, if the wage differential is high enough.