Determinants of international fragmentation of production in European Union

TLDR: In this article, the authors reveal empirical evidence on parts and components trade as an indicator for international fragmentation of production in the European Union and determine its main explanatory factors, including industry specific factors as well as communication and transportation infrastructure are likewise important for shifting production to or sourcing components from foreign countries.

Abstract: The growth in world trade during the last decades was largely caused by increasing bilateral exchanges of parts and components as a consequence of international fragmentation of production. Apparently, the international integration of the Newly Industrializing and Eastern European economies prompted firms in ‘high-wage’ countries to exploit factor price differences in order to increase their international competitiveness. However, theory predicts that, beside factor price differences, international fragmentation of production should be driven by a multitude of additional determinants. Against this background, the present paper reveals empirical evidence on parts and components trade as an indicator for international fragmentation of production in the European Union and determines its main explanatory factors. The results of a panel data analysis show that especially industry specific factors as well as communication and transportation infrastructure are likewise important for shifting production to or sourcing components from foreign countries.

Figures

Table 1: OLS Estimation Results

Table 2: One-way Fixed Effects Estimation Results

Figure 1: Share of Parts and Components Trade in Total Trade by Country Groups in 2005.

Table 3: Random Effects Estimation Results

Figure 2: Parts and Components Trade Balance in Relation to Total Parts and Components Trade by Country Groups in 2005.

Full text

Institut für Halle Institute for Economic Research
Wirtschaftsforschung Halle
IWH-Diskussionspapiere
IWH-Discussion Papers
Determinants of
International Fragmentation of Production
in the European Union
Götz Zeddies
Dezember 2007 No. 15

Determinants of
International Fragmentation of Production
in the European Union
Götz Zeddies
Dezember 2007 No. 15

IWH
__________________________________________________________________
IWH-Diskussionspapiere 15/2007 2
Autor: Dr. Götz Zeddies
Abteilung Makroökonomik
Götz.Zeddies@iwh-halle.de
Tel.: (0345) 77 53-854
The responsibility for discussion papers lies solely with the individual authors. The views ex-
pressed herein do not necessarily represent those of the IWH. The papers represent preliminary
work and are circulated to encourage discussion with the author. Citation of the discussion pa-
pers should account for their provisional character; a revised version may be available directly
from the author.
Comments and suggestions on the methods and results presented are wellcome.
IWH-Discussion Papers are indexed in RePEc-Econpapers and in ECONIS.
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__________________________________________________________________
IWH
IWH-Diskussionspapiere 15/2007 3
Determinants of
International Fragmentation of Production
in the European Union
Abstract
The last decades were characterized by large increases in world trade, not only in absolute
terms, but also in relation to world GDP. This was in large parts caused by increasing ex-
changes of parts and components between countries as a consequence of international
fragmentation of production. Apparently, greater competition especially from the Newly
Industrializing and Post-Communist Economies prompted firms in ‘high-wage’ countries
to exploit international factor price differences in order to increase their international com-
petitiveness. However, theory predicts that, beside factor price differences, vertical disin-
tegration of production should be driven by a multitude of additional factors. Against this
background, the present paper reveals empirical evidence on parts and components trade
as an indicator for international fragmentation of production in the European Union. On
the basis of a panel data approach, the main explanatory factors for international fragmen-
tation of production are determined. The results show that, although their influence can not
be neglected, factor price differences are only one out of many causes for shifting produc-
tion to or sourcing components from foreign countries.
Keywords: Economic Integration, International Fragmentation of Production
JEL classification: F14, F23, L23

IWH
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IWH-Diskussionspapiere 15/2007 4
Determinants of
International Fragmentation of Production
in the European Union
Zusammenfassung
Die zurückliegenden Jahrzehnte waren weltweit durch eine erhebliche Ausweitung der
internationalen Handelsströme, nicht nur absolut, sondern auch in Relation zum Welt-
BIP, gekennzeichnet. Dies ist zu einem Großteil auf den zunehmenden bilateralen Han-
del mit Vor- und Zwischenprodukten als Folge der internationalen Fragmentierung der
Produktion zurückzuführen. Offensichtlich hat der im Laufe der Zeit zunehmende inter-
nationale Wettbewerbsdruck, insbesondere seitens der südostasiatischen und der mittel-
und osteuropäischen Länder, die Unternehmen in Hochlohnländern veranlasst, internati-
onale Unterschiede in den Faktorpreisen, vor allem in den Arbeitskosten, zur Steigerung
ihrer preislichen Wettbewerbsfähigkeit auszunutzen. Allerdings wird die Verlagerung
von Teilelementen der Wertschöpfungsketten ins Ausland aus theoretischer Sicht, neben
Faktorpreisunterschieden, von einer Vielzahl weiterer Faktoren bestimmt. Vor diesem
Hintergrund veranschaulicht der vorliegende Artikel auf der Basis bilateraler Daten zum
Außenhandel mit Vor- und Zwischenprodukten das Ausmaß der internationalen Frag-
mentierung der Produktion in der Europäischen Union. Zudem werden im Rahmen einer
Paneldaten-Analyse die wesentlichen erklärenden Größen der vertikalen Aufspaltung
von Wertschöpfungsketten bestimmt. Die Ergebnisse zeigen, dass internationale Unter-
schiede in den Arbeitskosten zwar ein wesentlicher, aber dennoch nur ein erklärender
Faktor unter vielen sind.
Schlüsselwörter: Internationaler Handel, Europäische Integration, Fragmentierung der
Produktion
JEL-Codes: F14, F23, L23

Frequently asked questions

Q1. What are the contributions mentioned in the paper "Determinants of international fragmentation of production in the european union" ?

Against this background, the present paper reveals empirical evidence on parts and components trade as an indicator for international fragmentation of production in the European Union. 

Q2. What is the precondition for a firm to relocate parts of the production process?

A necessary precondition for a firm to relocate parts of the production process is the ability of potential partners abroad to manufacture components or services according to its specific needs. 

Q3. What is the first step of the pooled OLS regression technique?

In the first step, a pooled OLS regression technique will be used which, if indicated by test statistics, has to be extended by fixed and/or random effects estimations. 

Q4. What is the effect of firm size on the cost of transport?

Whereas firm sizes affect service link costs per unit of output, the absolute level of service link costs between different production sites depend inter alia on transportation costs. 

Q5. What is the phenomenon of the tremendous increases in trade with parts and components?

The phenomenon of the tremendous increases in trade with parts and components entered into the literature under the labels ‘slicing up the value chain’ (Krugman 1995), outsourcing (Feenstra and Hanson 1996), disintegration of production (Feenstra 1998), intra-product specialization (Arndt 1997), vertical specialization (Balassa 1967) or, as already mentioned, fragmentation of production (Deardorff 1998, Jones and Kierzkowski 1997). 

Q6. What is the significance of the correlation between imports and exports of these countries?

an increasing correlation between imports and exports of these countries could be observed, suggesting that fragmentation of production plays effectively an important role (Kaminski and Ng 2001). 

Q7. What countries have surpluses in intermediate goods trade with the former communist countries?

But on the other hand, Ireland and the Netherlands as well as the Southern European countries have considerable surpluses in intermediate goods trade with the former communist countries.