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 lowskilled 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.