Contracting Institutions and the Insertion of LAC in International Production Networks

May 2012
This paper examines the role of contracting institutions on the insertion of developing countries in international production networks and particularly on the prospects of LAC to source goods beyond the region's traditional patterns of specialization. We show that LAC's insertion in global production networks is biased towards arm's-length transactions in industries that tend to be labor-intensive and that do not typically require relation-specific investments. We also show that the countries that have been able to diversify their export successfully in international production networks have not focused exclusively on arm's-length transactions but engage in both types of sourcing via arm's-length and intra-firm trade. Results from an econometric model indicate that taking advantage of offshoring opportunities arising from capital- and contract-intensive industries requires fostering the quality of contractual institutions. Increasing the quality of contracting institutions is likely to improve first the chances of supplying contract-intensive activities through FDI, but further increases may potentially induce additional offshoring through local contractors.