Production Fragmentation and Trade Patterns in Asia

Prema-chandra Athukorala

Division of Economics Research School of Pacific and Asian Studies Australian National University [email protected]

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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 Introduction product fragmentation:



Quantifying product fragmentation



Trends and patterns of fragmentation trade



Production fragmentation and trade patterns



Conclusion/inferences

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An

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 4

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) 7

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 inferences about economic integration through trade.

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 Multiple border crossing of parts and components Differences between inter- and intra-regional patterns of fragmentation trade and final trade 8

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) 10

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 arm’s-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) 12

Three mutually reinforcing factors have contributed to the rapid expansion production fragmentation 1.

Advancement in production technology, enabling the industry to slice up the value chain into finer components.

2.

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) 3.

Liberalisation policy reforms in both home and host countries 13

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

) 14

Data are extracted at the 5-digit level of the Standards International (SITC), Rev 3 Standard Trade Classification 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 manufacturing) SITC Sector 8 (miscellaneous 15

 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 16

4.

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 17

Figure 1: World Manufacturing Trade: Total Trade, Trade in Parts and Components (P&Cs) and P&C share in total trade 8000 7000 6000 5000 4000 3000 2000 1000 0 Total mfg P&C P&C % 18 16 14 12 10 28 26 24 22 20 18

Figure 2: World Trade in Machinery and Transport Equipment (M&T) : Total Trade, Trade in Parts and Components (P&Cs) and P&C share in total trade 4000 3500 3000 2500 2000 1500 1000 500 0 M&T P&C P&C % 40 38 36 34 48 46 44 42 19

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 20

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 21

The formation of NAFTA and EU enlargement has not diminished developing East Asia’s 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 22

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. [China’s 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)]. 24

 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 India’s trade in parts and components with China is minuscule 25

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, 1992–2004 (per cent) Table 6: Intra-regional trade shares: total manufacturing, parts and components, and final trade, 1992 and 2004 (per cent) 26

 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 27

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 28

Patterns in terms of ‘conventional’ data analysis: Total intra-regional trade: East Asia 1992/3 41.7

2004/5 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 EU15 43.5

62.6

49.7

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 Asia’s 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?) 32

 Increase in intra-regional trade in East Asia in recent years has largely emanated from fragmentation-based specialisation (Hypothesis: India’s relatively export performance can largely be ascribed to its failure to get into regional production networks)  The region’s 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 34