Essays on specialization pattern, international fragmentation of production and trade in value added

Specialization and production fragmentation: conceptual frameTrade specialization,supply and production networks with VA trade

The Euro trade effect with VA trade

Essays on specialization pattern,international fragmentation of production

and trade in value added

Laura Dell’AgostinoPhD student in Economics

Roma Tre University

Supervisor: Prof. Silvia Nenci



Research framework

I Recently, international trade theory has seen a resurgence in studieson comparative advantage and specialization pattern and onthe determinants trade flows

I These studies are aimed to properly decline these topics in a worldwith an increasing relevance of international fragmentation ofproduction and a growing trade in intermediate and unfinishedgoods

I Furthermore, the field of international trade has exhibited anexpansion of the range of the analytical tools brought to bear onthese topics

I In this framework, my dissertation consists of three essays ⇒



Research structure1. The first essay provides a conceptual framework of the links

between trade specialization and fragmentation of productionon global scale. Starting from an historical excursion of the issueof comparative advantages in the international trade theory, theessay analyses how trade specialization is increasingly influenced bythe international fragmentation of production

2. The second essay presents a descriptive analysis of the comparativeadvantages shaping the pattern of specialization and theinternational supply and production networks of Italy and itsmain competitors and suppliers, using value added trade data andthe most recent mathematical frameworks for trade decomposition

3. The third essay presents a quantitative analysis of the relationshipbetween bilateral trade flows and the sharing of a commoncurrency (more specifically the Euro), using bilateral value addedtrade data and the gravity-like framework



Linking trade specialization and internationalfragmentation of production:A conceptual framework



Specialization and fragmentation of production



Specialization and international trade theoryI Starting in 19th century with Ricardo’s priciple of comparative

advantage, the pattern of specialization is at the core ofinternational trade theory, which -during the 20th century-presented different explanations of how countries specialize

I In last two decades, there has been increasing interest, boththeoretically and empirically, in the splitting of productionprocesses across international locations. A new strand of researchemerged in which the role of intermediate inputs in internationaltrade seems to be viewed as increasingly relevant

I In recent years, the intersection between the literature onspecialization and this new research strand brought back to thecenter of debate the role of comparative advantage in explaining thepatter of trade

I This first essay reconstructed this theoretical journey until the mostrecent contributions



Specialization in traditional trade theoryI Ricardo (1817) ⇒ Principle of comparative advantage:

A country has a comparative advantage in producing a good if,relative to some other goods and compared to some other countries,its opportunity cost is lowerSpecialization is shaped by technology differences across countries

I Heckscher (1919) e Ohlin (1933)Stolper and Samuleson (1941) , Rybczynski (1955):Specialization is shaped by differences in relative factor abundanceEach country tends to export goods whose production used moreintensively those factors that in the country are relatively moreabundant

I Dornbusch, Fischer and Samuelson (1977):Specialization is the results of a chain of comparative advantagesdetermined by technology differences across countries

I Common features:I Assumptions: constant returns to scale, perfect competitionI International trade = interindustry trade in final goods



Specialization in ’new trade theory’I Grubel and Lloyd (1975): a significant and increasing share of

international trade consists of goods within the same industriesand occurs between countries with similar levels of technology andsimilar relative factor endowments

⇒ International trade = inter + intraindusty trade in final goodsI Krugman (1980), Krugman and Helpman (1985) shifted the

attention to the relationship between international trade andindustrial structure

I Specialization is explained in a framework of increasingreturns to scale, imperfect competition and productdifferentiation

I The assessment of the industrial structure needs to take intoaccount also firms characteristics⇒ Assumption: homogeneous behavior of firms within anindustry/sector



Specialization in the ’new new trade theory’

I In the 1990s, new-available firm-level data from various countriesstressed the existence of a significant heterogeneity of firms withinsectors

I Melitz(2003), Meliz and Ottaviano(2008)⇒ Countries do not trade, firms do and very few of them do it

I The selection mechanism of productions in which a countryspecializes is activated by a comparative advantage ofproductivity, due to different access to technologiesThe comparison is no longer about whole sectors but the individualfirms within them



International fragmentation of production

I Since Jones and Kierzkowski (1990), also a new strand of literatureemerged, focusing on fragmentation of production processes intosubsequent phases, which are carried out separately and indifferent countries

I Feenstra (1998), Jones (2000), Baldwin (2006, 2011) havehighlighted how, since the ’80:

I decreasing transmission costs due to the ICT revolutionallowed to transform the organization of production and toincrease the international division of labour

I manufacturing production is associated with the increasingimport/export of parts and components

⇒ International trade = trade in final goods+ trade in intermediate goods



Production, trade and specialization in the 21st century

I The current production paradigm changed the ’nature of trade’:I Grossman and Rossi-Hansberg (2008):

trade in goods ⇒ trade in taskI Baldwin (2011):

selling things ⇒ making thingsI Baldwin (2011) ⇒ Antras (2015): ’Made in the world’I Baldone, Sdogati e Tajoli (2007) argue that international

fragmentation of production shifts the concept of integration fromsimple trade integration to production integration

I ’From the perspective of the 21 st century trade and industry,exporting a good tell us much less about the exporting nation’scapacities. [The kind of exported good are] a sign that the nation islocated along a particular segment of an international valuechain’ (Baldwin, 2011)



Comparative advantages in the 21st centuryI Eaton and Kortum (2002): with trade in intermediate goods

geography has a complementary role to technology in determiningspecialisation

I Chor (2010) looks at different sources of comparative advantage:I interactions between country and industry characteristics

(Romalis, 2004)I financial development (Antras, 2008; Manova, 2008), contract

enforcement (Costinot, 2009) and labour market flexibility(Cunat and Melitz, 2009)

I Deardorff (2005): comparative advantages are less informative withintermediate inputs, they works on average as a predictor ofpatterns of trade

I Baldone, Sdogati and Tajoli (2007): with trade in intermediategoods, traditional empirical measures of comparative advantagemay be misleading, because traded goods embody ’advantages’specific to different countries⇒ Ricardo’s theory of comparative advantage is back



Trade specialization,international supply and production networksusing value added trade dataThe case of Italy



GoalAnalysing the dynamic of Italy’s trade specialization pattern in themanufacturing industry and identifying Italy’s trade and productivelinks with its competitors and suppliers, taking advantage of the recentcontributes of the literature on international fragmentation ofproduction and trade in value added.

MotivationBecause of increasing fragmentation of production, traditional tradedata in gross terms become less and less appropriate to offer a goodpicture of the global division of labour and to detect international supplychains

Original contributionIt’s the first work to provide this kind of descriptive analysis for Italyusing value added trade data and trade accounting techniques derivedfrom the perspective of international fragmentation of production,offering a fresh contribute to the long-standing debate on the’anomaly’ of the Italian specialization pattern



Research questions

1. Do the long-term trends in the Italian comparativeadvantages diverge significantly when trade is measured invalue added instead of gross value exports?

2. How does the picture of Italy’s main competitors changewith value added data?

3. Who are Italy’s main suppliers with value added data?4. What kind of trade and productive links do Italy have with

its suppliers?



Trade in VAI Because of a large share of international trade flows consists of

intermediate and unfinished goods, official trade statistics in grossterms double count the value of intermediate goods andoverestimate the amount of domestic value added of a country inits exports

I World value added exports are equal to about 70-75% of grossexports (Johnson,2014)



Trade in VA: new data and methodologies

In recent years:I new indicatorsI new datasets using global input-output tablesI and new mathematical frameworks to decompose gross exports

flows in value added components

have made possible to estimate value added trade



Trade in VA: indicators

⇒ focus on a specific aspect of the international fragmentation ofproduction

I Hummels et al. (2001): vertical specialization (VS), the share ofimported inputs in exported goods

I Daudin et al. (2011): VS1*, the share of the intermediate exportedgoods used by partner countries as input in their own exports to thehome country (domestic value added embedded in re-importedgoods)

I Johnson et al. (2012): VAX, ratio of value added to gross exports



Trade in VA: datasets

⇒ they typically merge input-output tables with national accountdata and international trade statistics

I the Global Trade Analysis Project (GTAP)I the Asian International Input-Output Tables constructed by Institute

of Developing Economies,Japan External Trade Organization(IDE-JETRO)

I the TiVA database by OECD-WTOI the World Input-Output Database (WIOD)

⇒ It provides global input-output tables for 40 countries (EU-27,Turkey, Canada, USA, Mexico, Japan, Korea, Taiwan, Australia,Brazil, Russia, India, Indonesia and China) and 35 sectors(including 14 manufacturing) in the period 1995-2011



Trade in VA: datasets

⇒ they typically merge input-output tables with national accountdata and international trade statistics

I the Global Trade Analysis Project (GTAP)I the Asian International Input-Output Tables constructed by Institute

of Developing Economies,Japan External Trade Organization(IDE-JETRO)

I the TiVA database by OECD-WTOI the World Input-Output Database (WIOD)⇒ It provides global input-output tables for 40 countries (EU-27,Turkey, Canada, USA, Mexico, Japan, Korea, Taiwan, Australia,Brazil, Russia, India, Indonesia and China) and 35 sectors(including 14 manufacturing) in the period 1995-2011



Trade in VA: gross trade decomposition frameworks

⇒ they decompose gross trade in VA components at national, bilateraland sectoral level

I the most influential methodologies:I Koopman, Wang and Wei (2014)I Wang, Wei and Zhu (2013)

I the alternative methodologies:I Stehrer (2013)I Borin and Mancini (2015)I Los, Timmer and De Vries (2016)



Bilateral gross export decomposition by Wang et al. (2013)The algebra



Bilateral gross export decomposition by Wang et al. (2013)

4 main components

I The domestic value added (DVA) represents the exporter’s domestic value added that is absorbed abroadI The foreign value added (FVA) consists of the value added embedded in intermediate inputs imported from

abroad to produce exportsI The domestic value added returns home (RDV) is the share of the exports in parts and components that is

initially exported but ultimately returned home by being embedded in the imports and consumed at homeI The pure double counted items (PDC) arises from intermediate goods that cross border multiple times



Bilateral gross export decomposition by Wang et al. (2013)

Further decomposition

I The domestic value added (DVA) is further decomposed into:I DVA in final goods ⇒ DVA FINI DVA in intermediate goods absorbed by the direct importer⇒ DVA INT

I DVA in intermediate goods re-exported by the direct importerto other foreign countries (or indirect value added)⇒ DVA INTrex

I The foreign value added (FVA) is further decomposed into:I FVA that comes from the direct importer ⇒ MVAI FVA that comes from third countries ⇒ OVA



Trade specialization indicatorsI Empirical research uses a wide range of descriptive indictors to

detect a country’s comparative advantage or disadvantage indifferent production, using gross trade data

I The well-known index of Revealed Comparative Advantages(RCA) by Balassa (1965) remains the most largely used index inthe analysis of trade specialization

I We used the RCA symmetrical version, that is the RevealedSymmetric Comparative Advantage (RSCA) index proposed byDalum, Lauresen and Villumsen (1998)

I These indexes are defined as:

xi,j and xw,j are the exports of the sector j from country i and the world exports w of product jXi e Xw are the total exports of countryi and the world total exports



RSCA with VA data

I We computed the RSCA at the country-sector level both in grossvalue and in value added

I In order to obtain the index in value added, we used the domesticvalue added in exports (or GDP in exports) as presented byKoopman, Wang and Wei (2014)

I It is the sum of five components:1. DVA in direct final goods exports2. DVA in intermediates exports absorbed by direct importers3. DVA in intermediates exports re-exported to third countries4. DVA in intermediates that returns within the country of origin

via final imports5. DVA in intermediates that returns within the country of origin

via intermediate imports



Italy’s trade specialization1. Comparative advantages in value added are basically in line with

the ones in gross value and confirm the main sectors ofspecialization and despecializationTable 1 RSCA indexes in value added and gross value for the Italian manufacturing sectors

Source: authors’ elaboration on WIOD dataNote: (1) Sectors listed by the decreasing value of the RSCA value added in 2011;(2) Leather clothes isexcluded from this sector;(3) It includes furniture;(4) It includes computers and office equipment, radios,televisions and telecommunication equipment



Italy’s trade specialization

2. RSCA in value added confirms a weakening specializationin some traditional industriesTable 1 RSCA index in value added and gross value for the Italian manufacturing sectors

Source: authors’ elaboration on WIOD data




3. In general, focusing on domestic value added in exports brings to alower magnitude of the RSCA index, signaling the incidence offoreign value added on gross exportsTable 1 RSCA index in value added and gross value for the Italian manufacturing sectors





4. ... with two exceptions: in these sectors the domestic contributionresults more significant than usually registered with gross exportsTable 1 RSCA index in value added and gross value for the Italian manufacturing sectors




Italy’s international competitors

I We computed the RSCA index (both in gross and value addedexports) for all 40 countries in WIOD and select the 5 countrieswith the highest positive value of RSCA for each sector whereItaly registers a comparative advantage

I In each sector, the top five countries can be considered the maincompetitors of Italian exports

I We present the results for 2011




1. Italy has the strongest comparative advantage at global level inits two main specialization sectors, both in gross and value added

Table 2 Trade specialization indexes - Year 2011

Source: authors’ elaboration on WIOD data. Italy’s rank reported within brackets




2. Several Eastern European countries (Czech Republic, Hungary,Poland, Slovak Republic and Slovenia) appear among the top fivecompetitors with value added data

Table 2 Trade specialization indexes - Year 2011

Source: authors’ elaboration on WIOD data. Italy’s rank reported within brackets



The supply chains with VA data

I We computed the composition of the foreign value added in theItalian exports in terms of source countries of FVA, following themethodology by Wang et al. (2013)

I We selectd the top five suppliers of FVA both in 1995 and in 2011,observing how their places in the rankings change in the period

I We present the results for the Machinery sector



The supply chains with VA dataItalyI Except for China, Italy strengthens its comparative advantage in this sector with no radical changes in its

main suppliersI Germany is the leading supplier. China has a growing role in the Italian international supply chain,

whereas the EU contribution declinesI Italy presents a decreasing concentration of FVA from the top suppliers, with a slight consolidation in the

supply chains in 2011

Table 3 Main source countries of FVA in Italian Machinery exportsUnit: % of gross export, (n) position in the rankings of foreign suppliers

Source: authors’ elaboration on WIOD dataNote: Countries listed by FVA share in 2011



The supply chains with VA dataItaly vs GermanyI In both countries, China performs a surprising progression in the rankings of main foreign suppliersI EU countries’ share declines in Italy, while it increases in Germany, confirming the strengthening of

German productive links especially with the Eastern European countriesI The share of the top five suppliers in the total FVA in German exports is lower than in Italian exports:

German supply chain seems to be more fragmented

Table 3 Main source countries for FVA in Machinery exportsUnit: % of gross export, (n) position in the rankings of foreign suppliers

Italy Germany




The supply chains with VA dataEurope vs North America vs AsiaI Moving from the European exporter’s supply chains to the USA and

China’s ones, it allows to point out the strong regional focus ofinternational production networks

Table 3 Main source countries for FVA in Machinery exportsUnit: % of gross export, (n) position in the rankings of foreign suppliers

USA China




Supply and production links of Italywith its main source coutries

I The Wang et al (2013) decomposition allows us to obtain a broaderknowledge of the bilateral links between countries shaping thegeography of the production networks

I We focus on Italy’s imports from its main source countries offoreign value added in Machinery exports (Germany, China, France,USA and Russia), in order to detect any difference in the supply andproduction links with different countries

I We present the results for 2011



Supply and production links of Italy:machinery sector

I Exports of China, France and Germany to Italy contain more FVA than that from other countries,especially FVA from third countries (OVA)Exports of Russia and USA rely considerably on own value added

I China, France and Germany exports to Italy are dominated by DVA in the final goods⇒ Italy is mostly a ”consumer”

I Russian and US exports to Italy are dominated by intermediate goods:⇒ Italy is a relevant processing country in their international supply chains

I France and Germany show the highest MVA share in exports to Italy, signalling a major productiveintegration between Italy and its main European partners

Table 5 Decomposition of exports to Italy - Year 2011




Conclusions

I Looking at trade specialization ’through the lenses of value added’basically confirms the picture observed with gross export data, butsome differences emerge in some sectors

I These differences makes evident that the current tradespecialization of Italy and its main competitors is influenced bythe reorganization of supply chains at international level and thedegree of participation of each country in these global networks,confirming from a macro perspective some sectoral trends alreadyobserved in previous firms level studies

I Combining different methodologies, this work showed how it ispossible to better understand the role of traditional trade partnersand some emerging countries both as competitors in the creationof value added exports and as suppliers of value added



The Euro trade effectusing value added trade data:A gravity-like approach



GoalInvestigating the Euro’s impact on bilateral trade from avalue-added perspective, by applying the workhorse of theempirical analysis of international trade, namely the gravityapproach

MotivationBaldwin and Taglioni (2011) argued that a gravity analysis basedon gross exports alone may perform poorly in a world of globalvalue chains, in which parts and components trade is relevant

Original contributionThis work is the first to studying the trade implications of the Euroadoption using different value added components of theexport flows, rather than gross exports



Research questions

1. Using trade in value added flows do we get results consistentwith the findings of the literature on Euro’s trade effectsbased on gross exports?

2. Do some specific evidences emerge considering each valueadded component separately?

3. If yes, how we can interpret the results from an internationalfragmentation of production’s perspective?



The gravity approach: the first stepsI Tinbergen (1962) proposed an econometric model formulated along

the lines of Newton’s law of universal gravitation, where trade flowsare directly related to the economic size of the countries involved,and inversely related to the distance between them

Tradei,j = λ(GDPi )α(GDPj)β

distγi,j

or in log terms:

ln Tradei,j = lnλ+ α ln GDPi + β ln GDPj − γ ln disti,j

I From this first conceptualization the gravity equation has beenused time and again to empirically analyze bilateral trade

I It’s ability to correctly approximate bilateral trade flows makes itone of the most stable empirical relationships in economics(Leamer and Levinsohn 1995)



The gravity approach: recent developmentsI Inspiring by Anderson (1979), three decades of theoretical work

has shown that the gravity equation can be derived from differenttrade frameworks, providing the ’theory’ underlies the ’empiricalrelationship’

I At present, the basic idea behind the gravity analysis is that twocountries will trade more or less with each other depending on anumber of factors related to geographical, cultural andinstitutional proximity

I At turn of the 21st century, a rich methodological literaturebrought to the fore the importance of defining carefully the form ofthe gravity equation

I A relevant contribution is Anderson and van Wincoop (2003), thatshowed how the flow of bilateral trade is influenced by both thetrade obstacles that exist at the bilateral level and by the relativeweight of these obstacles with respect to all other countries (whatthey called the Multilateral Resistance)



Why a gravity-like approach?

I The gravity approach is currently the main tool for quantifying theimpacts of trade policy on bilateral gross trade flows

I Baldwin and Taglioni (2011) argued that a gravity analysis based ongross exports alone may perform poorly in a world of global valuechains, in which parts and components trade is relevant

I Therefore, we present gravity analysis separately on the fourbilateral value added components making up gross exports: DVA,RDV, FVA and PDC, following Altomonte et al (2015) who havebeen the first to engage in such analysis

I The theoretical reflection on the appropriate use of value addedtrade data rather than gross data in a gravity approach is really inits infancy (Noguera, 2012; Johnson and Noguera, 2014), so weprefer to talk about a ’gravity-like’ approach



The common currency effect on trade: the first stepsI According to the theory of optimal currency area by Mundell

(1961), an increasing in trade would be the main gain enjoyedwhen two nations joins in a currency unionUntil relatively recently, no robust empirical evidence was producedon this topic

I The pioneering work: Rose (2000) finds that a common currencyenhances trade by more than 235%, that is countries in acurrency union trade 3 times more ⇒ Too Big to Believe!

I Pakko and Wall(2001) demonstrate that the Rose(2000)’s resultwas due entirely to econometric mistakes

I A rich empirical literature has followed, taking advance of theconsiderably methodological work on the gravity model

I Rose and van Wincoop (2001): a Rose effect of 91%I Glick and Rose (2002): countries in a currency union trade

from 3.7 to 1.9 times more



The common currency effect on trade: the Euro’s impactWhen data about the Eurozone became available, some scholars focustheir attention on the Euro:

I Micco, Stein and Ordonez (2003): Euro induced 4-6% more tradeamong Eurozone members

I Flam and Nordstrom (2003): the Euro effect from 9 to 15%I Berger and Nitsch (2005): no effects on trade of the EuroI Bun and Klaassen (2007): the Euro effect equal to 18%I De Nardis, De Santis and Vicarelli (2007): a Euro effect of around

4-5%I Gil-Pareja, Llorca-Vivero and Martinez Serrano (2008): the Euro

effect range from 38% to 71%I Baldwin and Taglioni (2008): a Euro effect of about 2%I Santos Silva and Tenreyro (2010) : no effects on trade for the EuroI Frankel (2010) finds a more optimistic 15% increase of trade



The common currency effect on trade:recent developmentsI A series of studies have provided a wide range of results, using

different datasets, different specification of the model anddifferent econometric techniques

I The meta-analysis by Head and Mayer (2014) on the trade effectsof the common currency reports a mean effect of 0.79 over 104estimates, corresponding to a doubling of trade

I The most recent and relevant paper on this topic is Glick and Rose(2016):

I the symmetry between the effects of entering and leaving acurrency union seems reasonable in the data, also for Euro

I the Euro has a substantively different effect on trade thanother monetary unions

I the Euro has a strong positive effect in stimulating bothbilateral trade (around 50%) and bilateral exports (around50%)

I At present, no studies using value added export components toassess the Euro’s impact on trade have been carried out



The gravity-like specificationWe follow the specification proposed by Glick and Rose(2016) and, because our focus on the Eurozone, we insert a

specific set of dummy variables for the euro

ln TVAijt = αEUROijt + βTAijt + γZijt + {λit}+ {ωjt}+ {γij}+ εijt

I TVAi,j,t is the nominal sectoral bilateral exports from i to j at time t, in one of the value addedcomponents (DVA, RDV, FVA and PDC)

I EUROi,j,t is a complete set of dummy variables for the common currencyI EUROZi,j,t = 1 if both countries are using the Euro as their currency at time t and 0 otherwiseI EUROEXi,t = 1 if country i is a Eurozone member and country j is not a member at time t and 0

otherwiseI EUROIMj,t = 1 if country j is a Eurozone member and country i is not a member at time t and 0

otherwiseI TAi,j,t = 1 if both countries are in a trade agreement at time t and 0 otherwise

I Z is a vector of control variables that may affect bilateral tradeI λi,t is a complete set of time-varying exporter dummy variables

I ωj,t is a complete set of time-varying importer dummy variables

I γi,j is a complete set of country-pair dummy variables

I εi,j,t represents the myriad other influences



Data and sources

The sample dataset consists of 40 countries (17 Eurozone, 27 EU)covering the period 1995-2011

1. Bilateral sector value added export components: derived from Wanget al. (2013), using WIOD Database

2. Control variables from CEPII database:I DISTWi,j,t : log of weighted distance between the two countries i and jI CONTGi,j,t : dummy variable, 1 if countries i and j share common border in year t, 0 otherwiseI COMLANGOi,j,t : 1 for the common official primary language between country i and country j in

year t, 0 otherwiseI COMLANGEi,j,t : 1 if a language is spoken by at least 9% of the population in both the countries

in year t, 0 otherwiseI COLONYi,j,t : 1 for pairs even in colonial relationship, 0 otherwise



Gravity-like estimates

I Econometric technique: Least Squares with time-varing countryDummy Variables and dyadic fixed effects

I Expected results:I We expect to find results consistent with the standard findings

of the literature on the Euro’s impact on gross export flows,suggesting that a gravity-like approach might remain valuablewhen studying value added trade flows rather than gross flows

I For RDV, we expect to find even stronger (negative) roleplayed by distance between countries, consistent with the factthat this component refers to domestic value added firstexported and then re-imported



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Essays on specialization pattern, international fragmentation of production and trade in value added

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