Vertical specialization across the world: A relative measure

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Abstract

This article investigates the dynamics and the international distribution of vertical specialization (VS) - the use of imported inputs to produce goods that are afterwards exported. We propose a relative measure of VS-based trade that combines information from Input-Output matrices and international trade data, producing results for a large sample of countries with a detailed product breakdown. We illustrate this measure by showing the evolution of VS activities at the world level over the 1967-2005 period. The results are consistent with partial evidence existing in the literature, pointing to a substantial increase of VS in high-technology products and in East Asia.

Introduction

Over the last decades, international trade has grown strongly and its pattern has evolved significantly. The international fragmentation of production, i.e., the division of the production chain with different countries specializing in particular stages of the production sequence, has been an important feature of the deepening structural interdependence of the world economy in recent decades (see Arndt and Kierzkowski, 2001). This fact resulted in a growth of trade in parts and components that exceeds that of trade in final goods. There are no comprehensive statistics to measure the role of international production and trade networks across many countries, products and time. Although some partial evidence can be drawn from the analysis of different data sources (such as customs statistics, international trade flows, Input-Output tables and firm-level data), it is important to develop systematic and internationally comparable empirical evidence on international production linkages.

This article investigates one aspect of international production linkages that, following Hummels, Ishii, and Yi (2001), is commonly designated as vertical specialization (VS) - the use of imported inputs to produce goods that are afterwards exported. We propose a relative measure of VS-based trade that combines information from Input-Output matrices and international trade data, producing comparable results for a large sample of individual countries and geographical areas with a detailed product breakdown over the 1967-2005 period.

The measure associates countries’ trade flows with VS activities through the use of thresholds. One initial threshold establishes technological links by determining whether a particular input i is important in producing an output j. A second threshold establishes whether, for an identified technological link and in a particular country, the export share of product j and the import share of product i simultaneously and significantly exceed the respective world average shares. Next, for each country/product pair previously identified, a proxy of the level of VS-based trade is obtained by considering the value of intermediate imports that surpasses the one defined by the second threshold. In other words, we argue that, for a country p, a simultaneous high export share of a specific product and a high import share of an intermediate good used in its production, relative to the world average, provide indirect evidence of VS. By quantifying this “excess” of intermediate imports, we obtain a proxy of trade related to VS activities. The proposed measure has a relative nature because it bases the yearly identification and quantification of VS activities on trade flows whose relative dimension is above an international threshold. The measure is perceived as conservative because, in dynamic terms, it only captures the cases where the increase of actual VS activities is strong enough to translate into a level of intermediate imports that surpasses what is implied by the international threshold, which is also changing over time. Nonetheless, the measure has adequate additive properties in the sense that, in each period, the results of each pair country/product can be summed to provide any upper-level product or geographical breakdown of VS-related trade.

The article is organized as follows. Section 2 reviews the main empirical approaches used to measure the international fragmentation of production. In Section 3, the relative measure of VS is presented and its general intuition is discussed. In addition, Section 3 formalizes the methodology and describes the data sources. Section 4 illustrates the evolution of VS activities in the world over the last four decades using a product breakdown by technological intensity and a geographical breakdown by main areas. A special focus is put on the evolution of VS-based trade in East-Asia and in high-tech goods, since these are the cases where the most substantial increases occurred over the last two decades. Section 5 presents some concluding remarks.

Section snippets

Measuring the international fragmentation of production

One of the factors underlying the high growth rate of international trade over the past two decades is the division of the production chain, with different stages of production located in different countries (see Jones, Kierzkowski, & Lurong, 2005; Yi, 2003). This phenomenon has been labeled in the literature as “vertical specialization”, “slicing up the value chain”, “outsourcing”, “offshoring”, “international production sharing”, “disintegration of production”, “multi-stage production”,

Methodology and data

One of the most serious limitations of the I-O based methods is the access to up to date matrices and the difficulty to perform accurate cross-country comparisons. In fact, I-O matrices are computed sparsely in time and across countries, and sometimes with different product breakdowns. Thus, it is difficult to produce an assessment of how dynamic are VS activities across countries. This section proposes a relative measure of VS-based trade in the spirit of Hummels et al. (2001), i.e., the use

Measuring vertical specialization across the world

This section provides an illustration of the main results at the world level over the last four decades. The detailed analysis of the results both at the country and at the product levels is beyond the scope of this article and will be developed in future work. In order to facilitate the analysis, VS-based trade is presented as a percentage of total world imports. The section also includes a sensitivity analysis. This is important because the method requires choices on crucial aspects as the

Conclusions

Vertical specialization (VS) activities, as defined by Hummels et al. (2001), stand as a new paradigm in the organization of world production and represent an important element of international trade. Therefore, it is important to date its evolution and map its distribution across countries and products in a comparable and flexible way. This article introduces a new relative measure that uses simultaneously information from Input-Output (I-O) matrices and from international trade statistics to

Acknowledgements

The authors thank seminar participants at the ETSG 2008 Annual Conference in Warsaw and two anonymous referees for valuable comments.

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