Due to the rapid technological progress, countries have become increasingly intertwined in their economic activity through integration into the world economy. According to Arkolakis et al. (2018), the integration process generally depends on a country’s decision about its specialization. It can either decide to specialize in production or focus on innovation processes and outsource its production to another country. Since one of the impacts of globalization is a decline in multinational production costs, many countries tend to choose the second option. In this case, the profit from the outsourced production will flow back to the place of innovation to compensate for associated expenses. In short, they decide to export ideas and import goods afterward, which proves to be an increasing-returns-to-scale activity (Arkolakis et al., 2018). On the contrary, focusing on production provides only comparative advantages.
When companies choose to produce for particular markets, they find themselves facing a dilemma. Locating production in the proximity of the selected market might not reduce the production costs, but it successfully reduces the associated trade costs. Thus, the production specialization allows for efficiency gains if the economy produces for the local markets. However, production specialization could cause the country’s terms of trade to deteriorate (Arkolakis et al., 2018). In addition, low innovation might ultimately limit the economy’s growth prospects.
Therefore, in the short-term production costs management, a good practice would be to focus on logistics and efficiency gains assessment. Another option would be to import innovation, which allows controlling production costs and competitive profit from production specialization. However, in the long run, if the multinational production costs continue to decrease, the most optimal decision would be to consider shifting to innovation activity in search of cheaper production elsewhere.
References
Arkolakis, C., Ramondo, N., Rodríguez-Clare, A., & Yeaple, S. (2018). Innovation and production in the global economy. American Economic Review, 108(8), 2128-2173.