The Role of Labor and Transaction Costs in the Success of Manufacturing Offshore: Evidence from Mexico's Maquiladora Industry

The practice of shifting manufacturing activities to lower wage countries has thrived lately as firms attempt to reduce labor and other costs. However, success has been elusive for many of these firms. We investigate the determinants of offshoring success, with emphasis on the role of transaction costs in firms’ decisions to continue (or discontinue) manufacturing abroad. We hypothesize that labor constraints, supply chain frictions, and other transaction costs could impact production and potentially offset labor cost savings. We analyze labor costs and constraints and relevant transaction costs. We find that although successful plants pay a wage premium and more benefits to workers, their overall labor costs are relatively lower. These plants attract a more skilled and stable labor force, outsource non-manufacturing functions more often, and use fewer Mexican suppliers. Overall, our findings suggest that environmental frictions and transaction costs matter when shifting production offshore.