In this paper we present a differential game model of two firms with different

technologies producing the same good and selling in the same world market.

The firm equipped with advanced technology is deciding whether to outsource parts

of its production to the home country of its competitor, where wages and the level of

technology are lower. Outsourcing reduces production costs but is associated with

spillovers to the foreign competitor. The degree to which the foreign competitor can

absorb these spillovers depends on its absorptive effort. Using numerical methods

the properties of a Markov Perfect Equilibrium of this game are characterized and

the implications of the variation of different key parameters are examined.