A Binary-State Continuous-Time Markov Chain Model for Offshoring and Reshoring

Abstract

We present a two-country model (North and South) that describes the phenomenon of offshoring and reshoring. The model is a continuous time-controlled Markov chain with binary states. The main trade-off involves production costs and transaction costs between one country and another. In the first part of this paper, we identify the key parameters of the model: the difference in unit production costs between the two countries considered, the marginal cost of transitioning between countries, and the incentive paid by the North country to all companies that have not relocated at the end of the planning interval. The final goal of our paper is to understand how national tax incentives can influence this process.

Keywords

• offshoring
• reshoring
• stochastic optimal control
• binary controlled Markov chain