Outsourcing and skill-specific employment in a small economy: Austria after the fall of the Iron Curtain

We set up a model, in which firms in a small industrialized country outsource part of their production to a foreign economy, which is rich in low-skilled labour. We analyse, how a decline in trade costs affects outsourcing activities and the production structure in the small economy. A stimulation of cross-border outsourcing raises wage dispersion and, if labour markets are unionized, also the employment of high-skilled relative to low-skilled labour. Using a panel of Austrian industries, we find, first, that decreasing trade barriers-as observed after the fall of the Iron Curtain—indeed stimulate outsourcing to Central and Eastern Europe and the former Soviet Union, and, second, that outsourcing to these countries significantly shifts relative employment in favour of high-skilled labour.