Outsourcing, Complementary Innovations and Growth*
Alireza Naghavh
Gianmarco I.P. Ottaviano^
May 12, 2008
Abstract
This paper studies the parallel creation of complementary upstream and downstream inno-
vations by independent labs to shed light on the impact of outsourcing on R&D when supply
contracts are incomplete. In particular, we argue that outsourced upstream production con-
tributes to the emergence of innovation networks by creating a demand for upstream R&D. We
then analyze under which conditions this leads to faster innovation than in the case of verti-
cally integrated production relying on integrated R&D. In the presence of incomplete supply
contracts, the ex-post bargaining power of upstream and downstream parties feeds back to inno-
vation. This determines whether outsourcing decisions leading to static gains from specialized
production generate or not also dynamic gains in terms of faster innovation.
Keywords: outsourcing, complementary innovations, incomplete contracts, organization of
firms.
J.E.L. Classification: L14, L23, O32, D91.
*We are grateful to Elhanan Helpman, Dalia Marin, Thierry Verdier and seminar participants to the 2nd Workshop
on Globalization and Contracts at PSE for useful comments. The second author gratefully acknowledges financial
support from MIUR.
tUniversità di Modena. naghaυi<Qunimore.it
^CORRESPONDING AUTHOR: Università di Bologna, FEEM and CEPR. gianmarco.ottaυiano<Qunibo.it