- We investigate the effects of increased outsourcing of production to a low wage country. Such international outsourcing lowers the marginal cost of production and thus increases profits, creating greater incentives for innovation. A reduction in the resource requirement in adapting technology relative to improving products or an expansion in the portion of production that can be outsourced generates a greater extent of international outsourcing, a lower relative wage and a faster rate of innovation. An increase in production taxes in the North, production subsidies in the South, or a subsidy to adapting technologies has similar effects. 2001 Elsevier Science B.V. All rights reserved.