Athukorala, Prema-chandra (2006) Product Fragmentation an

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Production Fragmentation and Trade Patterns in
Asia
Prema-chandra Athukorala Division of Economics
Research School of Pacific and Asian
Studies Australian National University Prema-chand
ra.athukorala_at_anu.edu.au
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• This presentation draws upon
• Athukorala, Prema-chandra (2006) Product
  Fragmentation and Trade Patterns in East Asia,
  Asian Economic Papers, 4(3), 1-27.
• Athukorala, Prema-chandra (2007a) Singapore and
  ASEAN in the New Regional Division of Labour,
  Singapore Economic Review (forthcoming).
• Athukorala, Prema-chandra (2007b),
  Multinational Production Networks and the New
  Geo-economic Division of Labour in the Pacific
  Rim Countries in Juan Palacious (ed.), New
  Geo-economic Division of Labour in the Pacific
  Rim, London Routledge (forthcoming).
• Avaiable at http//rspas.anu.edu.au/athu/

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• Structure
• Introduction Purpose and scope
• International product fragmentation An
  Introduction
• Quantifying product fragmentation
• Trends and patterns of fragmentation trade
• Production fragmentation and trade patterns
• Conclusion/inferences

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1. Introduction Purpose and Scope

• What is International product fragmentation?
• The geographic separation of activities
  involved in producing a good (or service) across
  two or more countries
• Alternative terms
• Vertical specialization
• intra-product specialization
• Slicing the value chain
• International production sharing
• Outsourcing
• intra-mediate trade
• Example Barbie Doll

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Barbie Doll

• A product of
• Mettels Inc, a US-based MNEs
• But, produced in factories in Hong Kong and China
• with,
• hairs from Japan,
• paints and decorations from US,
• cotton cloth from China, and
• labour in final assembly from Hong Kong and
  China
• Sold world-wide at the rate of two dolls every
  second under the trade name of Mettels Inc.

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• Why Production Fragmentation deserves especial
  attention in trade policy debate?

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Why Production Fragmentation deserves especial
attention in trade policy debate?

• Opens up new opportunities for export-led
  industrialisation in developing countries (a
  challenge to the fallacy of composition argument
  against export-led industrialization)
• Reinforces the linkage between trade and FDI
  policies.
• Makes a strong case for the removal/harmonisation
  of non-border policy barriers with a view to
  enhancing gains from global integration
• Has implications for the debate on regional
  versus multilateral (global) economic integration
  approaches to international trade policy making
  (This is the prime focus of this presentation)

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• What do I intend to do in this presentation?
• Examine the extent, trends and patterns of
  fragmentation-based trade (with emphasis on Asia)
• Discuss implications of this new form of
  international specialisation for analysing
  international trade patterns
• Hypothesis
• In a context where fragmentation-based
  international specialisation is growing rapidly,
  the conventional trade flow analysis, which is
  based on the (implicit) assumption that countries
  always trade in goods, can lead to misleading
  inferences about economic integration through
  trade.
• - Multiple border crossing of parts and
  components
• - Differences between inter- and intra-regional
  patterns of fragmentation trade and final trade

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2. The Process of International Production
Fragmentation

• The geographic separation of activities involved
  in producing a good (or service) across two or
  more countries
• Not an entirely new phenomenon, but began to
  expand rapidly only from about the late 1960s
• The process started in the electronics and
  subsequently and spread into many other
  industries such as sport footwear, automobile,
  televisions and radio receivers, sewing machines,
  office equipment, electrical machinery, power and
  machine tools, cameras and watches, and printing
  and publishing.

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• Initially the process involved locating small
  fragments of the production process in a low cost
  country and reimporting the assembled components
  to be incorporated in the final production in the
  home country.
• Over time,
• - production networks have begun to encompass
  many countries involving in the assembly process
  at different stages, resulting in multiple-border
  crossing of product fragments before getting
  incorporated in the final product.
• - some fragments of the production process in
  certain industries have become standard
  fragments which can be effectively used in a
  number of products (eg cellular batteries,
  electronic chips)

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• Multinational enterprises (MNEs) are the key
  players.
• - a close relationship between foreign direct
  investment (FDI) and trade in parts and
  components (henceforth referred to as
  fragmentation-based trade).
• However, in recent years, fragmentation practices
  have begun to spread beyond the domain of MNEs
• - As production operations in host countries
  become firmly established, MNE subsidiaries have
  begun to subcontract some activities to local
  (host-country) firms to which they provide
  detailed specifications and even fragments of
  their own technology.

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• - Many firms which are not part of MNE networks
  have begun to procure components globally through
  arms-length trade.
• - Many MNEs in electronics and related
  industries now rely increasingly on independent
  contract manufacturers for the operation of
  their global-scale production networks (a
  process that has been facilitated by the
  standardisation of some components)

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• Three mutually reinforcing factors have
  contributed to the rapid expansion production
  fragmentation
• Advancement in production technology, enabling
  the industry to slice up the value chain into
  finer components.
• Technological innovations in communication and
  transportation that have contributed to
  significant reduction in the cost of service
  links involved in coordinating international
  operations (See Jones et al 2005 for a
  theoretical exposition)
• Liberalisation policy reforms in both home and
  host countries

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3. Quantifying Product Fragmentation in World
Trade

• Three methods
• Using input-output framework (to estimate the
  degree of dependence of manufacturing industries
  on imported input)
• (eg Hummels et al 2001)
• Using data from records maintained by developed
  countries under tariff provisions for overseas
  assembly (eg. Egger and Egger 2005)
• Separating parts and components from final
  products using trade data for individual
  countries from the UN trade data reporting system
  (Comtrade database)
• (This is the approach used here)

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• Data are extracted at the 5-digit level of the
  Standards International Standard Trade
  Classification (SITC), Rev 3
• Focus on manufacturing trade - SITC 5 though 8
  net of SITC 68
• Parts and components are separately reported at
  the 5-digit level) from for
• Sector 7 Machinery and transport,
• and
• some items of SITC Sector 8 (miscellaneous
  manufacturing)

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• Data tabulation is based on importer records
• Time period 1992-2004
• Cavitate
• Coverage of pats and components in SITC Rev 3 is
  incomplete
• Therefore, estimates presented in the paper
  understate the magnitude of fragmentation trade

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Trends and Patterns of Fragmentation Trade

• Trade in parts and components (fragmentation
  trade) has grown faster than total world
  manufacturing trade
• This pattern in much more prominent in trade in
  machinery and transport equipment (SITC 7) (which
  accounts for more than half of total
  manufacturing trade)
• See Figures 1 and 2

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Figure 1 World Manufacturing Trade Total
Trade, Trade in Parts and Components (PCs) and
PC share in total trade
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Figure 2 World Trade in Machinery and Transport
Equipment (MT) Total Trade, Trade in Parts and
Components (PCs) and PC share in total trade
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• Profile of fragmentation trade
• Table 1 Production Fragmentation in World
  manufacturing Trade, 1992/3 and 2004/5 ()
• Table 2 Percentage Composition of Parts and
  Components Exports and Imports by two-digit SITC
  Categories1, 2004/5
• Table 3 China and India in Parts and Components
  Trade 1992/3, 1999/0 and 2004/5

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• Key Points
• Growth of fragmentation trade in East Asia has
  been much faster compared to total world trade
  and trade of NAFTA and EU.
• The degree of dependence of East Asian countries
  as a group on fragmentation trade is much higher
  by world standards.
• The dependence of AFTA countries on fragmentation
  trade is much greater compared to other East
  Asian countries
•  

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• The formation of NAFTA and EU enlargement has not
  diminished developing East Asias pre-eminence in
  fragmentation-based specialization.
• China is becoming an important player in regional
  fragmentation trade network
• India (and South Asia) is still a minor player in
  fragmentation-based international exchange

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• China in fragmentation trade
• A dramatic shift in export composition away from
  the standard light manufactured goods (clothing,
  footwear and sport etc) and towards other
  seemingly more sophisticated product lines, in
  particular various products classified under the
  category of machinery and transport equipments
  (henceforth machinery)
• Pivotal role played by assembly operations within
  global production networks in the expansion of
  machinery and transport equipment exports
  (henceforth referred to as machinery exports
  for brevity).

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• - Share of parts and components in imports
• 1992/3 32.5 2004/5 63.4
• Share of final goods (1 parts components) in
  exports
• remained around 75 throughout
• - Trade balance driven by surplus in final
  (assembled) goods.
• Chinas export success has so far been
  underpinned by cost competitiveness in final
  assembly arising from labour abundance policy
  reforms that facilitates linking to economy to
  global production chains.
• No evidence of increased sophistication of the
  export mix (a la Rodrik 2006).

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• A notable diversification of China sources of
  component procurement within the region
• Japan is still the major source, but the share
  has declined (from 27 in 1992/3 to 23 in
  2004/5.
• Growing importance of ATA countries
• AFTA share is now much larger than the combined
  share of the North-east Asian NICs
• Indias trade in parts and components with China
  is minuscule

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5. Production Fragmentation and regional
vs. Global Trade Integration

• Table 4 Direction of manufacturing trade total
  manufacturing, 1992/3 and 2004/5 ()
• Table 5 Direction of manufacturing trade parts
  and components, 19922004 (per cent)
• Table 6 Intra-regional trade shares total
  manufacturing, parts and components, and final
  trade, 1992 and 2004 (per cent)

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• Parts and components account for a much larger
  share of intra regional trade in East Asia
  compared to total (global) trade
• Share of parts and components is much larger and
  growing rapidly time in imports compared to
  exports points to the increasing importance of
  the region as an assembly centre in the global
  economy

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• A vast literature (based on standard trade data
  analysis) which unequivocally infer a persistent
  increase in intra-regional trade in East Asia
  (both including and excluding Japan) (an ongoing
  process of natural regional economic
  integration)
• But, In a context where intra-regional trade in
  parts and components is growing rapidly, this
  inference may be misleading, because growth
  dynamism of assembly activities depends on demand
  for final goods (which in turn depends on
  extra-regional growth dynamism)
• Thus, it is important to separate parts and
  components from reported trade in order to
  meaningfully measure intra- versus inter-regional
  (global) trade integration

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• Patterns in terms of conventional data
  analysis
• Total intra-regional trade
• 1992/3 2004/5
• East Asia 41.7 56.3
• Developing East Asia 38.7 50.1
• Intra-regional trade in East Asia is much Larger
  compared to NAFTA (1992 39, 2003 43).
• Increase in the share of intra-regional trade is
  faster for developing East Asia and AFTA compared
  to the overall regional figure.  

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• Patterns in terms of final trade (reported
  trade parts components)
• The picture changes significantly when trade
  shares are estimates net of fragmentation trade.
•  
• The measured degree of intra-regional trade
  integration is smaller, and remains virtually
  unchanged or declined over time
• (In other words, the bulk of final exports from
  East Asia find markets in countries outside the
  East Asian region)
• 1992/3 2004/5
• East Asia 46.2 44.2
• Developing East Asia 31.0 36.0
•    

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• For East Asian developing countries Japan is a
  much smaller market for final exports (accounting
  for less than 10 in 2003), compared to the NAFTA
  28 and the EU 21.
• Unlike in East Asia, the estimated intra-regional
  trade shares for NAFTA and the EU are not
  sensitive to the inclusion or exclusion of
  fragmentation trade
• 1992/3 2004/5
• NAFTA 43.5 49.7
• EU15 62.6 54.4

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6. Conclusion and Inferences

• Fragmentation trade is expanding much faster
  compared to conventional product-based trade.
• The degree and intensity of participation of East
  Asian economies in fragmentation trade is much
  greater compared to countries in other parts of
  the world
• East Asias dependence on NAFTA and extra-Pacific
  Rim countries for final goods has increased over
  the years
• So far India has remained a small player in
  fragmentation-based international exchange
  (Why? Does this really matter?)

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• Increase in intra-regional trade in East Asia in
  recent years has largely emanated from
  fragmentation-based specialisation
• (Hypothesis Indias relatively export
  performance can largely be ascribed to its
  failure to get into regional production networks)
• The regions dependence on extra-regional trade
  in final goods has increased over the years.
• The ongoing process of international product
  fragmentation strengthens the case for a global,
  rather than a regional, approach to trade and
  investment policymaking in East Asia (and also
  Asia at large).

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• Thus, the ongoing process of international
  product fragmentation strengthens the case for a
  global, rather than a regional, approach to trade
  and investment policymaking in East Asia
• - Maintaining barriers against non-members
  (while allowing free trade among members) can
  hinder natural expansion of fragmentation-based
  specialization across countries
• - Rules of origin in FTA can be more binding
  for fragmentation trade compared to conventional
  final good trade
• value added at each stage of production is
  general very small
• (even though total value added is large given
  the volume factor)
• So, presumably more sensitive to trade cost and
  delays arising from rules of origin compliance