I present a two-country neoclassical growth model of international outsourcing consistent with the empirical observation that capital and unskilled labor are substitutes. The model studies the static effects of outsourcing, and also its dynamic effects on investment, the real interest rate, and the current account balance. The model predicts a decline in the capital stock and output of U.S. manufacturing, a rising U.S. skill premium, a lower real interest rate, and a boom in the export sectors of unskilled-labor-abundant countries such as China. There will be a decrease in the world (physical) capital stock due to more efficient use of the world's unskilled labor resources. U.S. unskilled workers and domestic investors lose, whereas Chinese unskilled workers gain from outsourcing. Nearly all the benefits associated with outsourcing are enjoyed by China.; With standard consumer preferences the U.S. runs a current account deficit at all times. However, with an endogenous rate of time preference outsourcing causes only a temporary deterioration of the U.S. current account. The deficit arises as U.S. households borrow from countries such as China, in part to be able to increase foreign direct investment (FDI) into China.; The predictions of the model are broadly consistent with recent evidence of lower global savings and investment rates, a widening of the U.S. current account deficit, and lower real interest rates.; Finally, I study the effects of a U.S. import tariff on intermediate goods.
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