Abstract

International supply chains require coordination of numerous activities across multiple countries and firms. We develop a theoretical model in which the optimal organization of a supply chain involves a series of linked decisions that equate, at the margin, transaction costs and the costs of coordinating more tasks within the firm. The parameters that govern the two types of costs explain variation in supply chain length as well as cross-country variation in gross output-to-value added ratios. Comparative advantage within chains depends solely on the coordination cost parameter. Conditional on participation in a chain, countries with lower coordination costs locate downstream. Within a chain, domestic transaction costs only affect countries' absolute advantage, but a country with large transaction costs tends to specialize in those chains for which its coordination costs are especially low. We provide an analytical treatment of trade and welfare responses to trade cost change in a simple two-country model. To explore the model's implications in a richer setting we calibrate the model to match key observables in East Asia, and evaluate implications of changes in model parameters for trade, welfare, the length of supply chains and countries' relative position within them.