Make and buy in a polluting industry

The literature paid significant attention to analyze the rationale for the make‐or‐buy strategy of firms. However, a related empirically relevant strategy of make and buy did not get much attention. We show that the presence of tax/subsidy policies, which are particularly important in the presence of environmental pollution, may create a rationale for the make‐and‐buy strategy of firms. Thus, we provide a new rationale for the make‐and‐buy strategy of firms which is different from the existing reasons, such as uncertainty, market power of the input suppliers, moral hazard, and capacity utilization. We also show that international harmonization, where countries set taxes cooperatively, can promote outsourcing compared with the situation where the countries set taxes non‐cooperatively. Further, global welfare maximizing outsourcing is less than the harmonization case. While global welfare is higher under global welfare maximization compared with harmonization, the total environmental damage can be lower under the latter case than the former case. Hence, higher welfare not necessarily implies lower environmental damage.