North American Journal of Economics and Finance
17 (2006) 257–281
Fragmentation and vertical intra-industry
trade in East Asia
Mitsuyo Ando ∗
Faculty of Economics, Hitotsubashi University, 2-1 Naka, Kunitachi, Tokyo 186-8601, Japan
Received 21 April 2005; received in revised form 14 June 2006; accepted 21 June 2006
Available online 21 August 2006
Abstract
East Asia experienced an unprecedented change in its international trade patterns in the last 10–15 years.
To investigate this development, the paper decomposes machinery trade into one-way trade, vertical intraindustry trade (vertical IIT), and horizontal intra-industry trade (horizontal IIT), using finely disaggregated
international trade data. Our empirical analysis confirms that the significance of vertical IIT drastically
increased, while the relative importance of one-way trade dropped. In addition, our empirical results show
no evidence that most vertical IIT conforms to the vertical product differentiation model. Rather, the explosive
increase in vertical IIT is largely due to the expansion of back-and-forth transactions in vertically fragmented
cross-border production processes. The findings show that vertical international production sharing did
become an essential part of each economy in East Asia in the 1990s, particularly with the explosive increase
in vertical transactions of machinery parts and components.
© 2006 Elsevier Inc. All rights reserved.
JEL classification: F14; F19
Keywords: Vertical intra-industry trade; Fragmentation; Vertical international production sharing
1. Introduction
East Asia experienced an unprecedented change in its international trade patterns in the past
decade or so. Until the 1980s, East Asian trade was clearly dominated by typical North-South
inter-industry trade patterns. East Asian developing countries exported resource-based and laborintensive products, while Japan exported a wide range of final manufactured goods. The traditional
theory of comparative advantage works well to explain such trade patterns; differences in resource
∗
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doi:10.1016/j.najef.2006.06.005
258
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
endowments, capital-labor endowment ratios, and technological capabilities among countries
largely determine the pattern of production location and international trade.
The current trade patterns of East Asia, however, can no longer be fully explained by the
traditional comparative advantage theory. The last 10–15 years witnessed the rapid development
of cross-border production networking among East Asian countries that have been aggressively
receiving foreign direct investment (FDI).1 In particular, trade in machinery parts and components
drastically increased in both exports and imports, pushing up the share of machinery products, and
commodity compositions of exports and imports became similar in many East Asian countries.
Such a convergence of commodity compositions of exports and imports as well as the enormous
increase in machinery parts and components trade implies that intra-industry trade has become
much more important than before in East Asia.
What sort of intra-industry trade do we currently observe in East Asia? The typical model
of intra-industry trade that appears in textbooks is the horizontal intra-industry trade (horizontal
IIT) model, which is usually accompanied by horizontal product differentiation and well explains
intra-industry trade among developed countries such as the members of the European Union (EU).
Another popular theoretical model of intra-industry trade is the vertical product differentiation
model in which high-income countries export high-price, high-quality products while low-income
countries in exchange export low-price, low-quality products. Intra-industry trade in East Asia
does not seem to be fully explained by these models, however. Rather, intra-industry trade resulting
from international fragmentation, the importance of which is addressed by Jones, Kierzkowski,
and Leonard (2002), seems to be the key to understanding current trade patterns in East Asia.
Using a method applied in empirical studies of intra-industry trade, we examine developments
in East Asia’s trade structure in the 1990s, particularly by distinguishing among types of intraindustry trade. The paper focuses on machinery trade and decomposes each country’s machinery
trade at the finely disaggregated level into one-way trade, vertical intra-industry trade (vertical
IIT), and horizontal intra-industry trade (horizontal IIT). In our empirical framework, trade of
commodities with a certain range of overlapping values of exports and imports is regarded as
intra-industry trade, while the rest is classified as one-way trade, and intra-industry trade of commodities with a certain range of unit-price differentials between exports and imports is classified
as horizontal IIT, while the rest is categorized as vertical IIT. Unlike previous empirical studies,
however, our study incorporates trade patterns reflecting international fragmentation.
Our major findings can be summarized as follows. First, the significance of vertical IIT
increased sharply in East Asia in the 1990s, while the relative importance of one-way trade
declined. Second, the share of vertical IIT in machinery parts and components rose more rapidly
than that of vertical IIT in machinery goods as a whole. Vertical IIT in machinery parts and
components expanded significantly. Third, horizontal IIT is rare in machinery trade. Fourth, the
drastic increase in vertical IIT was largely due to the expansion of back-and-forth transactions in
vertically fragmented production processes, rather than trade of quality-differentiated commodities. Fifth, even in the transportation equipment sector, in which one-way trade is still the main
pattern, vertical transactions of parts and components across borders rose significantly between
2000 and the beginning of the 1990s. All of these findings confirm that vertical international
production sharing in the machinery sector has become an essential part of each economy in East
Asia in the 1990s.
1 See Kimura and Ando (2003a, 2005) and Ando and Kimura (2005) for the analysis of the formation of international
production/distribution networks in East Asia and their mechanics, using micro data of Japanese corporate firms.
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
259
The remaining sections are organized as follows: Section 2 provides an overview of the trade
structure of East Asia and emphasizes the major changes in the 1990s. Section 3 briefly presents
a literature survey of empirical studies of one-way trade and vertical and horizontal IIT and
discusses the theoretical foundations upon which our empirical work is based. Section 4 provides
our empirical methodology and data description. The results for each East Asian economy are
provided in Section 5, and the summary and concluding remarks are in Section 6.
2. Emergence of intra-industry trade in East Asia
Table 1 presents intra-regional trade in East Asia in terms of exports in 1981, 1991, and 2001.2
Between 1981 and 2001, intra-regional trade in East Asia expanded by 6.7 times, while world
trade increased 3.1 times during the same period. Intra-regional trade reached almost half of total
East Asian trade in 2001. Countries throughout the region and at various stages of development
were drawn into the trading system, rather than concentrating on trade relationships with specific
countries in the region, as Table 1 (the share in East Asia) indicates.
The commodity composition of trade also changed during that period. Fig. 1 provides the
commodity composition of exports and imports of each country in the period 1989–2002 at the
two-digit level of the Harmonized System (HS) classification.3,4 Importantly, the commodity
composition of exports and imports converged in many East Asian countries. If trade patterns
can be fully explained by traditional comparative advantage applied to inter-industry trade, then
the commodity composition of exports and imports should be very different. The fact that the
composition is converging is an indicator of the importance of intra-industry trade.
Drastic changes have occurred, in machinery industries, including general machinery (HS84),
electric machinery (HS85), transport equipment (HS86-89), and precision machinery (HS90-92).
The share of machinery trade rose significantly in the 1990s (Fig. 2).5 In addition, both exports
and imports of machinery parts and components increased more rapidly, suggesting a pattern
that would be typical of back-and-forth transactions in vertical production networks within the
region.6,7 Convergence of the commodity composition of exports and imports, as well as increases
2 “East Asia” includes China, Association of Southeast Asian Nations 4 (ASEAN4: Indonesia, the Philippines, Thailand,
and Malaysia), and Newly Industrializing Economies 4 (NIEs4: Taiwan, Korea, Hong Kong, and Singapore), and Japan,
except in some cases that are mentioned.
3 Due to the lack of data at the HS six-digit level, data are shown from 1992 for China, from 1993 for Hong Kong, and
from 1996 for the Philippines. Although the Philippines is omitted in Fig. 1 due to limited space and coverage, it also
clearly presents converging commodity compositions of exports and imports as other East Asian countries do. See Ando
(2004) for the case of the Philippines.
4 Ideally, for Singapore and Hong Kong, one should look at data on domestic exports (total exports minus re-exports),
but data may not be available.
5 The Philippines and Taiwan are omitted in Fig. 2 due to limited space. Both economies, particularly the Philippines,
have outstandingly high shares of machinery trade and rapidly increasing parts and components trade as Fig. 4 indicates.
Note that numbers for Taiwan are based on the SITC classification (SITC 7) available from World Trade Analyzer. See,
again, Ando (2004) for the Philippines and Taiwan.
6 See Ando and Kimura (2005, Table A.1) for the definition of machinery parts and components used in this paper,
based on HS classification. This is more finely defined than the one used in Francis and Yeats (2003), based on the SITC
classification.
7 Close to 60% of machinery parts and components exports in East Asia was intra-regional in 2003, while the corresponding portion was 40% in 1990, and the intra-regional export value of machinery parts and components was 5.5 times
of that in 1990 on a current price basis. See Ando and Kimura (2006) for details on intra-regional and inter-regional trade
patterns in East Asia.
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M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
Table 1
Intra-regional exports in East Asia
(100 million US$, %)
1981
Country/region
Value
Destination
East Asia
East Asia (region)
World
1991
Share
Total
(world)
Value
East
Asia
2001
Share
Total
(world)
Value
East
Asia
Share
Total
(world)
East
Asia
1045
3019
34.6
100.0
–
–
3331
7928
42.0
100.0
–
–
7028
14972
46.9
100.0
–
–
China
Japan
NIEs4
- Hong Kong from China
- NIEs3 from China
ASEAN4
East Asia (total)
World
47
60
53
7
7
114
165
28.5
36.3
32.1
4.2
4.2
69.0
100.0
41.2
52.6
46.5
6.1
6.1
100.0
–
103
369
321
48
21
493
718
14.3
51.4
44.7
6.7
2.9
68.6
100.0
20.9
74.8
65.1
9.7
4.3
100.0
–
450
698
465
233
100
1248
2661
16.9
26.2
17.5
8.8
3.8
46.9
100.0
36.1
55.9
37.3
18.7
8.0
100.0
–
ASEAN4
Japan
China
NIEs4
ASEAN4 (region)
East Asia (total)
World
162
4
89
17
272
468
34.6
0.9
19.0
3.6
58.2
100.0
59.6
1.5
32.7
6.3
100.0
–
231
23
234
41
529
1008
22.9
2.3
23.2
4.1
52.5
100.0
43.7
4.3
44.2
7.8
100.0
–
403
110
588
180
1281
2416
16.7
4.6
24.3
7.5
53.0
100.0
31.5
8.6
45.9
14.1
100.0
–
NIEs4
Japan
China
- China from Hong Kong
- China from NIEs3
NIEs4 (region)
ASEAN4
East Asia (total)
World
91
22
20
2
83
92
288
866
10.5
2.5
2.3
0.2
9.6
10.6
33.3
100.0
31.6
7.6
6.9
0.7
28.8
31.9
100.0
–
320
286
267
19
417
277
1300
3057
10.5
9.4
8.7
0.6
13.6
9.1
42.5
100.0
24.6
22.0
20.5
1.5
32.1
21.3
100.0
–
499
984
701
283
871
586
2940
5861
8.5
16.8
12.0
4.8
14.9
10.0
50.2
100.0
17.0
33.5
23.8
9.6
29.6
19.9
100.0
–
51
213
107
371
1520
3.4
14.0
7.0
24.4
100.0
13.7
57.4
28.8
100.0
–
86
669
254
1009
3145
2.7
21.3
8.1
32.1
100.0
8.5
66.3
25.2
100.0
–
309
875
375
1559
4034
7.7
21.7
9.3
38.6
100.0
19.8
56.1
24.1
100.0
–
Japan
China
NIEs4
ASEAN4
East Asia (total)
World
Source: Author’s calculation, based on METI (2004), UN Comtrade online, and Council for International Economic
Cooperation and Development (2004).
in machinery parts and components trade, underscore the growing importance of intra-industry
trade in East Asia.
To highlight key features of East Asia’s trade, let us examine the shares of machinery goods and
machinery parts and components in total exports and imports at the beginning of the 1990s and
in 2003, in comparison with countries in other regions (Figs. 3 and 4). The figures array countries
in terms of the export share of machinery parts and components. The last decade witnessed a
rapid expansion of machinery trade, particularly machinery parts and components trade in many
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
261
Fig. 1. Changes in the commodity composition of trade in East Asia in the 1990s: (a) China, (b) Indonesia, (c) Thailand,
(d) Malaysia, (e) Korea, (f) Hong Kong, (g) Singapore, (h) Japan. Source: Author’s calculation, based on UN Comtrade.
Notes: “X” expresses exports and “M” imports. Sectoral composition based on the HS classification is as follows—HS124: food; HS25-27: mineral products; HS28- 38: chemical products; HS39-40: plastics and rubber; HS41-43: hides and
skins; HS44-46: wood and wood products; HS47-49: wood pulp products; HS50-63: textiles and textile articles; HS64-67:
footwear; HS68-70: articles of stone, plaster, and cement; HS71: pearls and precious stones; HS72-83: base metals; HS84:
general machinery; HS85: electric machinery; HS86-87: vehicles and railway; HS88-89: aircraft and ships; HS90-92:
precision machinery, others: others, and not classified elsewhere.
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M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
Fig. 1. (Continued ).
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
263
countries in the world, suggesting that trade at the intra-product level, rather than at the final
good or industry level, became more active. Importantly, the share of machinery goods in East
Asian countries increased not only in absolute terms but also in relative terms. At the beginning of
the 1990s, most countries with higher shares of machinery parts and components were developed
countries such as Japan, the United States, the United Kingdom, and Germany. By 2003, however,
Fig. 2. Trade in machinery goods and machinery parts and components as a share of total exports and imports in East Asia
in the 1990s: (a) China, (b) Indonesia, (c) Thailand, (d) Malaysia, (e) Korea, (f) Hong Kong, (g) Singapore, (h) Japan.
Source: Author’s calculation, based on UN Comtrade. Note: Machinery goods are HS84-92.
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M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
Fig. 2. (Continued ).
Fig. 3. Machinery goods and machinery parts and components: shares in total exports and imports in 1990–1994. Source:
Author’s calculation, based on UN Comtrade. Note: Japan90 and U.S.A.91, for instance, imply 1990 for Japan and 1991
for U.S.A.
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
265
Fig. 4. Machinery goods and machinery parts and components: shares in total exports and imports in 2003. Source: Ando
and Kimura (2006).
the East Asian developing countries had moved to the left, with high export and import shares of
machinery parts and components, implying growing export-oriented operations. Although China
and Indonesia are still relatively on the right side, they are rapidly moving towards the left.
While Japan has maintained a share of about 80% of its total exports in machinery goods, the
composition of its machinery exports changed from final goods at the beginning of the 1990s to
parts and components in 2003. Moreover, its share of imports in machinery parts and components
increased. Trade patterns between the North and South, or developed and developing countries,
seem to have changed considerably, particularly in East Asia.
In other regions, some developing countries also rapidly moved to the left and higher shares
of machinery trade and of machinery parts and components trade, including Mexico in Latin
America and Hungary, the Czech Republic, Slovakia, and Poland in Central and Eastern Europe
(CEE). Combined with relatively high shares of parts and components trade by neighboring
developed countries such as the U.S. and Germany/U.K., it suggests the existence of production
networks in machinery industries between the U.S. and Mexico and between Germany/U.K. and
CEE countries. These networks, however, are less widespread in those regions than in East Asia.8
Moreover, other developing countries, particularly those in Latin America except Mexico, are
8 In the case of these four CEE countries, for instance, exports to and imports from other CEE countries remain small,
which is different from East Asia’s active transactions among intra-regional countries: shares of intra-CEE trade in total
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M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
found on the right-hand side, with only a few percent of machinery exports, almost zero percent
of parts and components exports, and relatively high shares of parts and components imports.
This implies import-substituting structures in these countries.
3. Conceptual framework and empirical estimation
Before discussing our empirical approach, this section reviews key empirical methodologies
used in studies of intra-industry trade and summarizes relevant conceptual frameworks.
3.1. Empirical methodologies used in studies on vertical and horizontal IIT
The empirical literature on intra-industry trade has made extensive use of the Grubel–Lloyd
(G–L) intra-industry trade index, adjusted in various ways to mitigate its shortcomings.9 Decomposition of intra-industry trade into its various types was not undertaken until recently, due to the
difficulties in distinguishing vertical IIT from horizontal IIT in the data.
Abd-el-Rahman (1991) uses unit-price differentials between exported and imported goods as
a criterion for distinguishing vertical IIT from horizontal IIT. We call this criterion the “threshold
method”. Unit-price differentials within a certain range are taken to reflect horizontal product
differentiation, while price differentials outside the range reflect differences in quality in the
context of vertical product differentiation.10 The threshold method has received more attention
in empirical studies after the work of Greenaway, Hine, and Milner (1994, 1995), who adapt it
to the G–L index in measuring the intensity of vertical IIT and horizontal IIT in the U.K. We call
this “the G–L type threshold method”. Most recent work based on the threshold method follows
this G–L type of threshold method.11
An alternative approach, which is proposed by Fontagné and Freudenberg (1997) and Fontagné,
Freudenberg, and Péridy (1997), following Abd-el-Rahman (1991), breaks down total trade into
three categories, namely, one-way trade, vertical IIT, and horizontal IIT, in order to measure the
relative importance of each type of trade in total trade. In this approach, one-way trade is distinguished from intra-industry trade by using a certain range of overlapping values of exports and
imports for a given commodity category, while vertical and horizontal IIT are identified by using
some range of unit-price differentials between exported and imported goods for a given commodity category.12 We call this “the decomposition-type threshold method.” Compared to the G–L
type threshold method, the decomposition-type threshold method has received less attention.13
exports and imports of both machinery intermediate goods and final goods are only 6–7% in 2003, while shares of trade
with Western Europe (WE) are 64% for exports and 50% for imports of machinery parts and components. It indicates that
production sharing in Europe is based on the relatively simple WE-CEE nexus, rather than involving active transactions
among CEE countries. See Ando and Kimura (in press) for discussion of production networking in Europe.
9 See Grubel and Lloyd (1975) for G–L intra-industry index.
10 His study uses the terms “intra-range trade” for vertical IIT of quality-differentiated commodities and “two-way trade
in similar products” for horizontal IIT.
11 Examples of empirical studies using the G–L type threshold method include Aturupane, Djankov, and Hoekman
(1999) for trade between the EU and Central and Eastern European economies, Hu and Ma (1999) for Chinese trade with
its 45 major trading partners, Durkin and Krygier (2000) for U.S. trade with OECD countries, and Martin-Montaner and
Rios (2002) for Spanish trade with several OECD countries.
12 See the next section for details.
13 Relevant studies include Fontagné and Freudenberg (1997) and Fontagné et al. (1997) for trade in Europe, Fukao,
Ishido, and Ito (2003) for trade in Europe (intra-EU trade) and in East Asia (intra-East Asian trade), and Kimura and Ando
(2003a, 2003b, 2005) for trade among Japan, Korea, and China.
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
267
3.2. Theoretical foundations for each pattern of trade
As will be discussed in the next section, our study adapts the decomposition-type threshold
method by reinterpreting the conceptual framework. Table 2 provides a summary of the theoretical
foundations for each type of trade in our empirical analysis.
3.2.1. Traditional comparative advantage and one-way trade
Traditional trade theories explain inter-industry trade patterns based on comparative advantage in relative factor endowments or technology. In a standard setting of the Heckscher–Ohlin
model or the Ricardian model with constant-returns-to-scale technology and perfect competition, a country exports capital (physical/human)-intensive or high-tech products when it is
capital (physical/human)-abundant or technology-superior, and labor-intensive or low-tech products when it is labor-abundant or technology-inferior. Such inter-industry trade is classified as
part of one-way trade in our empirical framework.
3.2.2. Horizontal production differentiation and horizontal IIT
The most convenient and popular theoretical basis of product differentiation is horizontal
product differentiation. Horizontal product differentiation models have been analyzed under
monopolistic competition derived from the existence of economies of scale in the differentiated product industry.14 In these models, products are different because of certain attributes, but
they are fundamentally the same in terms of quality, cost, and technology employed in their production. Horizontal IIT in our empirical analysis is basically interpreted as intra-industry trade
with horizontal product differentiation.
3.2.3. Vertical production differentiation and vertical IIT
In Falvey (1981) and Falvey and Kierzkowski (1987), intra-industry trade with vertical product
differentiation takes place under perfect competition.15 Falvey and Kierzkowski (1987) assume
that the differentiated product sector is of the Heckscher–Ohlin type with constant-returns-toscale technology identical across countries, but Ricardian in terms of technology, with fixed and
different factor intensities at the variety level; higher (lower) quality variety is produced with
a higher (lower) capital-labor-ratio technology and has a higher (lower) price. Each individual
demands only one type of differentiated product according to the individual’s income, resulting in
an aggregate demand for a variety of quality-differentiated goods. Vertical IIT occurs when two
countries with differences in income distribution have different factor endowments, or different
technologies in the homogeneous product sector.
Flam and Helpman (1987) propose a model of North-South trade with vertical product differentiation, in which the North uses high technology to export high-quality products and the
South uses low technology to export low-quality products. There exist differences between the
two countries in technology to produce differentiated goods or in labor input per unit of output of
14 See, for instance, Lancaster (1980) and Helpman (1981) for the “ideal variety” approach that assumes a diversity
of “ideal package” of characteristics among consumers, resulting in demand for variety at the aggregate level. See, for
example, Dixit and Stiglitz (1977) and Krugman (1979, 1980, 1981) for the “love of variety” approach that assumes
a representative consumer demanding many varieties of the differentiated good or an individual’s demand for variety.
Horizontal IIT extends the variety of goods available beyond those supplied by domestic producers. Helpman and Krugman
(1985) observe that these two approaches lead to similar results, regardless of specifications on the demand side.
15 Other articles of vertical production differentiation include Shaked and Sutton (1984).
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M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
Table 2
Trade patterns: theory and empirical perspectives
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
269
the differentiated goods, and the North (South) has comparative advantage in high-quality (lowquality) products. On the demand side, similar to Falvey and Kierzkowski (1987), each individual
demands a quality level of differentiated product consistent with the individual’s income. As a
result, differences in technology and income distribution (with an overlap in income distribution)
explain vertical IIT.
The results of these models can be interpreted as a sort of “quality ladder” story; high-income
countries export high-price, high-quality products, while low-income countries export low-price,
low-quality products. Vertical IIT in our empirical analysis includes intra-industry trade of vertically differentiated products with differences in quality.
3.2.4. International fragmentation and one-way trade and vertical IIT
Jones et al. (2002) argue that international fragmentation in vertical production chains, i.e.,
the splitting of an initial vertically integrated production process into two or more production
blocks and locating them beyond national borders, also results in intra-industry trade (and interindustry trade). A general framework for analyzing fragmentation was first introduced by Jones
and Kierzkowski (1990).16 The physical dispersion of production processes requires costly service
links to connect production blocks, including transportation, telecommunication, and various
coordination tasks, which are often subject to economies of scale. In the case of international
fragmentation, in particular, trade and regulatory barriers impose additional service link costs.
Recent developments in the world trading system, as well as technological advances, have lowered
service link costs and created new opportunities for extending production fragmentation across
national frontiers.
Unlike previous studies, our empirical framework based on the threshold method incorporates the possibility of trade patterns reflecting international fragmentation. In this context,
unit price differentials outside a certain range can be interpreted as the reflection not only of
differences in quality, but also of back-and-forth transactions with value-added embodied in vertically fragmented production processes. Thus, the trade pattern categorized as vertical IIT in our
decomposition-type threshold method could reflect international fragmentation within the same
commodity category.17 Note that exchanges of products in vertically fragmented production processes are not necessarily conducted in the same commodity category. The simplest example
is an exchange of intermediate goods and final goods belonging to different commodity categories in the same industry. Another relevant example is back-and-forth transactions in vertically
fragmented production processes, with changes in commodity categories of imports and exports
through some production processes. These sorts of intra-industry trade would be classified as
one-way trade in our empirical analysis.
4. Methodology and data description
This section presents the empirical methodology used to examine the relative importance of
each type of trade, namely, one-way trade, vertical IIT, and horizontal IIT. Our study employs
16 See also Jones and Kierzkowski (2001), Arndt and Kierzkowski (2001), Deardorff (2001a, 2001b), and Cheng and
Kierzkowski (2001) for the fragmentation theory.
17 Horizontal IIT through international fragmentation would also occur, for instance, if imported parts and components
are exported with small unit-price differentials embodied in the local market. Such patterns, however, do not seem to be
very important currently in East Asia.
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M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
the decomposition-type threshold method, rather than the G–L type, with reinterpretation of the
conceptual framework.
4.1. Methodology
Three steps are required to obtain the share of each type of trade for the sector concerned. The
first step is to identify whether trade of commodity j is one-way trade or intra-industry in nature
by using a certain range of overlapping values of exports and imports. Trade of commodity j is
regarded as one-way trade when the following Eq. (1) holds and as intra-industry trade otherwise:
Min(Xkj , Mkj )
≤ 0.1
Max(Xkj , Mkj )
(1)
where Xkj represents country k’s exports of commodity j to the world, and Mkj country k’s imports
of commodity j from the world. While a large portion of one-way trade would be inter-industry
trade that can be explained by traditional comparative advantage considerations, one-way trade
would also include trade with changes in commodity categories in the process of transactions in
vertically fragmented production chains.
The second step is to identify whether intra-industry trade of commodity j is horizontal IIT
or vertical IIT by using a certain range of relative unit prices of exported and imported goods.
Intra-industry trade of commodity j is regarded as horizontal IIT when the following Eq. (2) holds
and as vertical IIT otherwise:
X
Pkj
1
≤ M ≤ 1.25,
1.25
Pkj
(2)
X expresses the unit value of commodity j exported to the world by country k, and P M
where Pkj
kj
the unit value of commodity j imported from the world by country k.18 The threshold percentage
to distinguish between horizontal IIT and vertical IIT is usually 15% or 25%. Although the 15%
threshold is more often used, this paper employs a definition of narrower range of vertical IIT,
namely, the 25% threshold, to more precisely analyze the development of vertical IIT.
Intra-industry trade of commodities with a small range of price differentials is regarded as
trade of similar goods or horizontal IIT in the context of horizontal product differentiation. On
the other hand, trade of commodities with unit-price gaps outside that range is regarded as vertical IIT. Previous empirical studies typically argue that differences in quality are reflected in
such price gaps, as the vertical product differentiation model predicts. We, however, incorporate
the possibility of trade patterns reflecting international fragmentation as briefly explained in the
previous section, so that unit-price differentials outside a certain range may reflect not only differences in quality, but also back-and-forth transactions with value-added embodied in vertically
18 Most empirical studies using price differentials to distinguish vertical IIT from horizontal IIT define the criteria as
X /P M ≤ 1 + α, where α = 0.15 or 0.25. As Fontagné and Freudenberg (1997) point out, however,
follows: 1 − α ≤ Pkj
kj
the left-hand side of this condition is incompatible with the right-hand side. For instance, the threshold of 25% means
that export unit values can be 1.25 times higher than import unit values. The lower boundary, 0.75 in this case, means
that export unit values can be 75% of the import unit values. That is, export unit values can be 1.33 (1/0.75) times of
import unit values, which is incompatible with the right side of the condition. To avoid this problem, we use the criteria
X /P M ≤ 1 + α, where α = 0.25.
1/1 + α ≤ Pkj
kj
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
271
fragmented production processes. Therefore, the trade pattern categorized as vertical IIT could
partially reflect international fragmentation in the same commodity category.
If most vertical IIT in lower-income countries is systematically of commodities with export
prices lower than import prices and most vertical IIT in higher-income countries is of commodities
with export prices higher than import prices, then the hypothesis of “quality ladder” may hold.
If that is not the case, on the other hand, then vertical IIT may include not only trade of qualitydifferentiated commodities, but also back-and-forth transactions with value-added embodied in
vertically fragmented production processes in the same commodity category.
n ), for the
Finally, the share of the n-type trade pattern, i.e., the threshold-based index (S(i)
aggregated commodity category i is calculated as follows:
n
n
j (Xkj + Mkj )
n
S(i) = [n = (a), (b), and (c)],
(3)
j (Xkj + Mkj )
where the n-type of trade patterns are (a) one-way trade, (b) horizontal IIT, and (c) vertical IIT.
Note that some commodities unfortunately have discordant units between exports and imports,
and some have no information on quantities. Since relative unit prices are used in distinguishing
among types of intra-industry trade, it is not possible to determine whether intra-industry trade
of such commodities is vertical IIT or horizontal IIT. Unlike previous studies, however, such
commodities are retained in our data set as “not classified IIT” and are included in calculating the
index. Without this treatment, the relative significance of one-way trade would be overvalued for
countries with relatively large amounts of “not classified IIT”.
The threshold-based index of each East Asian economy is calculated for trade of each
machinery sector, i.e., general machinery, electric machinery, transport equipment, and precision machinery, as well as for machinery trade as a whole. To shed light on the development
of back-and-forth transactions in vertically fragmented production chains, we also calculate the
index for trade in machinery parts and components.
4.2. Data description
Values and quantities of exports and imports at the HS six-digit level are obtained from the
United Nations (UN) Comtrade and the UN Personal Computer Trade Analysis System (PC-TAS),
published by the UN Statistical Division.19 Unit values of exports and imports at the HS six-digit
level are calculated by dividing values by the corresponding quantities.
Most previous studies use differences in f.o.b. and c.i.f. values as a part of price differentials
between exports and imports. To consider price differentials purely as ones due to differences
in quality or ones caused in the process of back-and-forth transactions in vertically fragmented
production chains across borders, however, we conduct the f.o.b.–c.i.f. adjustment in calculating
unit-price differentials as well as in using trade values in the first and third steps described above;
export values on an f.o.b. basis are multiplied by 1.05, a proxy, to adjust import values on a c.i.f.
basis.
Countries in the sample include China, ASEAN4 (Indonesia; the Philippines, Thailand,
and Malaysia), NIEs3 (Korea, Hong Kong, and Singapore), and Japan. Data for 3 years,
19 Data for 1996 and 2000 are obtained from the UN PC-TAS. Note that commodities covered by the PC-TAS are those
with trade values of no less than US$ 50,000.
272
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
Fig. 5. Vertical IIT in machinery goods and machinery parts and components in East Asia. Source: Author’s calculation,
based on Table 3. Note: The Philippines is not included for 1990. Data for 1990 for China and Hong Kong are for 1992
and 1993, respectively.
1990, 1996, and 2000, are used to examine the development of East Asian trade in the
1990s.20
5. The development of East Asia’s trade structure
We first present the development of machinery trade patterns in East Asia as a whole, including
China, ASEAN4, NIEs3, and Japan. As Fig. 5 clearly shows, vertical IIT, particularly vertical IIT
in machinery parts and components, grew in the 1990s. There is also a stable amount of one-way
machinery trade.
Table 3 presents threshold-based indices of each East Asian economy for machinery trade in
the 1990s: (a) indices for overall trade in machinery (including parts and components); (b) indices
for trade in machinery parts and components; and (c) shares of machinery parts and components
in total machinery trade by type of trade. In Table 3, countries are listed from those with the lowest
per capita GDP at the top to those with the highest per capita GDP at the bottom.
Our main findings may be summarized as follows. First, the importance of vertical IIT rose
sharply, while that of one-way trade declined for overall machinery trade. The share of oneway trade at the beginning of the 1990s was around 40–50%, except for Indonesia with a very
high share and Hong Kong and Singapore with considerably lower shares. They decreased by
20 Due to the lack of data available from UN Comtrade/PC-TAS, we calculate indices for China in 1992, 1996, and 2000,
those of Hong Kong in 1993, 1996, and those of the Philippines in 1996 and 2000. Moreover, Taiwan is not included in
East Asia due to the lack of data available from these UN databases.
Table 3
Development of machinery trade in East Asia in the 1990s
(100 million US$, %)
(a) Machinery goods
(total)
Indonesia
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices > import prices
Not classified IIT
1990
1996
2000
1990
1996
2000
1990
1996
2000
50381
101442
194948
20303
42483
103421
40
42
53
52
14
48
3
20
5
25
43
16
57
11
44
8
2
27
16
73
8
64
6
1
26
2
74
4
18
9
53
12
3
88
20
65
9
3
9
3
91
8
81
10
2
20
7
62
47
36
70
84
12
9
65
78
62
47
53
17
9
66
55
68
86
69
10224
23379
21436
3988
11588
11239
39
50
52
93
2
7
2
5
3
0
73
12
27
5
22
11
0
66
38
34
4
30
18
0
89
0
11
4
7
2
0
66
6
34
7
26
13
0
58
32
42
6
36
20
0
37
7
61
89
53
32
–
45
26
63
73
61
56
–
46
44
64
67
64
57
–
30373
48651
21991
38827
72
80
59
20
41
21
20
14
0
51
43
49
11
37
18
0
55
24
45
28
16
9
1
44
39
56
14
42
20
0
68
86
79
97
60
48
91
69
73
91
99
89
88
93
273
Philippines
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices > import prices
Not classified IIT
(c) Share of parts and
components
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
China
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices > import prices
Not classified IIT
(b) Machinery parts
and components
(100 million US$, %)
(a) Machinery goods
(total)
1990
Malaysia
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices>import prices
Not classified IIT
Korea
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices > import prices
Not classified IIT
2000
(c) Share of parts and
components
1990
1996
2000
1990
1996
2000
20177
59195
61535
11940
34557
41576
59
58
68
57
6
43
5
36
11
2
40
12
60
8
51
15
1
21
12
79
4
73
26
1
45
3
55
6
47
9
2
27
5
73
9
64
18
1
8
3
92
5
86
30
1
47
29
75
70
76
48
61
39
23
72
63
74
70
53
26
19
79
92
79
78
29
27110
95839
120228
16358
60730
85864
60
63
71
32
11
68
6
42
22
20
32
13
68
3
63
26
1
18
13
82
3
69
21
11
18
5
82
2
48
29
31
17
0
83
3
78
30
2
2
0
98
2
80
26
15
35
31
72
21
69
79
94
33
1
78
55
79
74
90
10
2
85
60
84
86
99
57728
135539
174540
24029
63949
94998
42
47
54
42
19
58
4
51
10
3
32
18
68
21
47
2
0
27
21
73
38
34
3
0
18
3
82
4
77
19
0
16
6
84
38
46
3
0
5
2
95
61
34
2
0
18
6
59
41
63
83
6
23
15
59
86
47
66
35
10
5
71
87
54
40
26
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
Thailand
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices > import prices
Not classified IIT
1996
(b) Machinery parts
and components
274
Table 3 (Continued)
Table 3 (Continued)
(100 million US$, %)
(a) Machinery goods
(total)
Singapore
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices > import prices
Not classified IIT
Japan
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices > import prices
Not classified IIT
1990
1996
2000
1990
109459
157685
195018
47029
2
0
98
27
34
19
37
2
0
98
24
36
24
38
2
0
98
14
42
22
42
58940
173601
4
1
96
15
38
23
44
1996
(c) Share of parts and
components
2000
1990
1996
2000
77775
116357
43
49
60
1
0
99
11
30
11
59
0
0
100
18
23
19
59
1
0
99
7
32
19
60
21
94
43
17
37
25
68
3
0
50
38
31
38
76
56
1
60
28
45
50
86
191859
29117
98757
127972
49
57
67
2
1
98
11
40
22
47
1
0
99
8
35
24
55
3
1
97
5
8
4
84
0
0
100
3
18
2
79
0
0
100
3
16
11
81
42
34
50
18
10
9
95
9
4
58
17
25
4
96
10
11
68
24
31
31
97
271640
399121
462924
97483
192434
240058
36
48
52
46
43
54
10
41
7
3
33
32
67
12
53
19
2
26
26
74
8
64
25
2
39
38
61
21
38
9
2
30
30
70
14
55
22
1
21
21
79
10
68
30
1
31
32
40
73
33
49
25
45
46
50
55
50
56
14
42
42
55
60
56
60
19
275
Source: Author’s calculation, based on UN Comtrade and UN PC-TAS. Note: Data of 1990 for China and Hong Kong are of 1992 and 1993, respectively.
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
Hong Kong
(i) Total value (millions US$)
(ii) Trade pattern (%)
One-way
- One-way: exports > imports
Intra-industry trade
Horizontal IIT
Vertical IIT
- Vertical IIT: export prices > import prices
Not classified IIT
(b) Machinery parts
and components
276
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
half in 2000 in most East Asian countries. This increase in intra-industry trade was due mainly
to the sharp increase in vertical IIT, except for Korea and Singapore; shares of vertical IIT in
1990 and 2000 were 20% and 64%, respectively, for China, 5% and 30% for Indonesia, 36%
and 73% for Thailand, 42% and 69% for Malaysia, 51% and 34% for Korea, 35% and 43%
for Hong Kong, 38% and 35% for Singapore, and 41% and 64% for Japan. Combined with an
explosive increase in the value of vertical IIT, these figures clearly indicate how rapidly vertical IIT
became an essential element of machinery trade among East Asia countries, and in East Asia as a
whole.
Second, the share of vertical IIT in machinery parts and components increased more rapidly
than that of vertical IIT in machinery products as a whole in many East Asian countries; the share
of vertical IIT in machinery parts and components went up from 18% in 1990 to 81% in 2000
for China; from 7% to 37% for Indonesia; from 16% to 42% for the Philippines; from 47% to
86% for Thailand; from 48% to 80% for Malaysia; and from 38% to 69% for Japan. In addition,
machinery parts and components trade increased more rapidly than machinery trade as a whole:
machinery trade and machinery parts and components trade grew by 3.9 times and 5.1 times
from 1990 to 2000 for China, 2.1 times and 2.8 times for Indonesia, 3.1 times and 3.5 times for
Thailand, 4.4 times and 5.2 times for Malaysia, 1.8 times and 2.5 times for Hong Kong, 3.3 times
and 4.4 times for Singapore, and 1.7 times and 2.5 times for Japan, respectively.21 Given the
fact that a large portion of trade in machinery intermediate goods is intra-regional, these numbers
suggest how active vertical back-and-forth transactions of machinery parts and components across
borders became and how rapidly cross-border production networking in East Asia was formed in
the 1990s.
Third, horizontal IIT in machinery parts and components is not very important in East Asia.
Although the Philippines and Korea present relatively high shares of horizontal IIT, compared
with other East Asian countries, machinery parts and components trade accounts for 99% of the
total horizontal IIT in the machinery sector for the Philippines and 87% for Korea. This confirms
that the important pattern of intra-industry trade in East Asia is vertical IIT, not horizontal IIT as
typically observed among incumbent EU members.22
Fourth, the sharp increase in vertical IIT was largely due to the expansion of back-and-forth
transactions in vertically fragmented production processes, in addition to intra-industry trade of
quality-differentiated commodities. Our results provide no evidence that vertical IIT in lowerincome countries is systematically of commodities with export prices lower than import prices
and vertical IIT in higher-income countries is of commodities with export prices higher than
import prices: 9% of vertical IIT is trade of commodities with export prices higher than import
prices in China, 61% in Indonesia, 49% in the Philippines, 36% in Thailand, 31% in Malaysia, 8%
in Korea, 53% in Hong Kong, 70% in Singapore, and 40% in Japan (Table 4).23 In other words,
vertical IIT cannot be fully explained by the hypothesis of the “quality ladder;” rather vertical IIT
reflects not only intra-industry trade of quality-differentiated commodities, but also back-and-forth
transactions in vertically fragmented production chains in the same commodity category.
21
Trade values here are the sum of imports and adjusted exports, and growth rates are on a current-price basis.
For instance, Fontagné and Freudenberg (1997) and Fontagné et al. (1997), who use a definition of narrower range of
horizontal IIT (15% threshold), show that close to 20% of intra-EU trade is horizontal IIT from the middle of the 1980s
to the middle of the 1990s. Fukao et al. (2003), who use a broader definition of horizontal IIT, find that around 26–29%
of intra-EU trade is horizontal IIT during the latter half of the 1990s.
23 Since Hong Kong and Singapore have large shares of unclassified IIT, they are omitted in Table 4.
22
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
277
Table 4
Vertical IIT in East Asian machinery trade in the 1990s
Index: vertical IIT
Share of vertical IIT with export
prices higher than import prices in
total vertical IIT
Total (including parts
and components)
Parts and
components
1990
1990
2000
18
7
2000
The machinery sector as a whole
China
20
64
Indonesia
5
30
Philippines
37
Thailand
36
73
Malaysia
42
69
Korea
51
34
Japan
41
64
The electric machinery sector
China
23
Indonesia
12
Philippines
Thailand
54
Malaysia
54
Korea
58
Japan
20
65
35
49
80
68
32
74
47
48
77
38
25
14
53
59
81
26
Total (including parts
and components) (%)
Parts and
components (%)
2000
2000
81
36
42
86
80
34
68
9
61
49
36
31
8
40
12
55
48
35
32
6
43
80
39
47
87
75
31
73
13
78
44
54
45
8
47
14
78
45
52
46
6
37
Sources: Author’s calculation, based on UN Comtrade and UN PC-TAS.
In the case of Korea and Japan, two countries with relatively high incomes, the share of
vertical IIT with export prices higher than import prices is low at 8% (indices for vertical IIT
with higher export prices and whole vertical IIT are 3% and 34%, respectively) for Korea and
somewhat higher at 40% (25% and 64%) for Japan. At the same time, most of their one-way trade
is export-based one-way trade: 77% (indices for export-based one-way trade and whole one-way
trade are 21% and 27%) for Korea and 98% (26% and 26%) for Japan. These numbers suggest
the presence of exports of capital goods or of specific and complicated parts and components
in certain commodity categories, and of imports of products with some production conducted in
other East Asian countries, using upstream parts exported from them.
The opposite is true for Indonesia with relatively low income: the portion of vertical IIT
with export prices higher than import prices is 61% (indices for vertical IIT with higher export
prices and whole vertical IIT are 18% and 30%), and 27% of Indonesia’s total machinery trade is
import-based one-way trade. This implies that Indonesia imports capital goods or some specific
and complicated parts and components in certain commodity categories, and at the same time
exports products with some production conducted at the local level, using imported up-stream
parts in the same commodity categories at the HS six-digit level.
Fifth, in the transport equipment sector, in which one-way trade is still the main pattern of
trade, vertical IIT became important for parts and components trade.24 The electric machinery
sector accounts for around half of the machinery trade of each country and has a large portion of
24 Although the indices for machinery trade of each sector (general machinery, electric machinery, transport equipment,
and precision machinery) are calculated by country, the detailed results are omitted in this paper. See Ando (2004) for the
detailed results.
278
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
Table 5
Trade patterns in the transport equipment sector
Index: one-way trade
Index: vertical IIT
Total (including parts
and components)
China
Indonesia
Philippines
Thailand
Malaysia
Korea
Japan
1990
2000
55
90
60
65
63
45
48
84
44
93
27
56
50
Parts and
components
1990
3
9
3
2
70
15
2000
77
32
68
72
79
81
24
Source: Author’s calculation, based on UN Comtrade and UN PC-TAS.
vertical IIT (Table 4). In the transport equipment sector, on the other hand, one-way trade is still
more important than vertical IIT. We, however, observe that for parts and components trade in the
transport equipment sector, there was a drastic shift from one-way trade to vertical IIT. The shares
of vertical IIT in parts and components are 3% in 1990 and 76% in 2000 for China, 9% and 32%
for Indonesia, 3% and 72% for Thailand, 2% and 79% for Malaysia, 70% and 81% for Korea,
and 15%, and 24% for Japan. These indicate that vigorous transactions in parts and components
across borders are observed in 2000 in contrast to cases at the beginning of the 1990s even in the
transport equipment sector, though one-way trade is still the main pattern of trade in the whole
sector, reflecting import-substituting policies in many developing countries (Table 5).
6. Conclusion
This paper has explored developments in trade structure and vertical international production
sharing in East Asia in the 1990s. During the last 10–15 years, trade in machinery parts and
components increased sharply in both exports and imports, pushing up the share of machinery
products, including general machinery, electric machinery, transport equipment, and precision
machinery. As a result, the commodity composition of exports and imports converged in many
East Asian countries. As suggested by convergence of commodity composition of exports and
imports as well as the strong increase in machinery parts and components trade, intra-industry
trade has become much more important in East Asia.
Given the significance of machinery trade, the paper decomposed each country’s machinery
trade at the HS six-digit level for 1990, 1996, and 2000 into one-way trade, vertical IIT, and
horizontal IIT, employing the decomposition-type threshold method, in which we incorporated
trade patterns reflecting international fragmentation in the conceptual framework. Our empirical
analysis at the finely disaggregated level confirms that vertical international production sharing
did become an essential part of each East Asian economy in the 1990s, particularly with the
explosive increase in vertical IIT in machinery parts and components. The significance of vertical
IIT increased, while the relative importance of one-way trade dropped in East Asia over the last
decade. Although theoretical models of intra-industry trade often analyze horizontal IIT, and a
certain amount of such horizontal IIT is indeed observed, for instance, in intra-EU trade, horizontal
IIT is rarely found in East Asia in machinery trade. We emphasize the significance of vertical
IIT, particularly vertical IIT in machinery intermediate goods in East Asia. Even in the transport
M. Ando / North American Journal of Economics and Finance 17 (2006) 257–281
279
equipment sector, in which one-way trade is still the main pattern of trade as a whole, vertical
transactions of parts and components across borders are observed in 2000, while they were seldom
found at the beginning of the 1990s.
The increase in vertical IIT was largely due to the expansion of back-and-forth transactions with value-added embodied in vertically fragmented production processes, rather than
intra-industry trade of quality-differentiated commodities. If most vertical IIT in lower-income
countries is systematically of commodities with export prices lower than import prices and
most vertical IIT in higher-income countries is of commodities with export prices higher than
import prices, the hypothesis of “quality ladder” may hold. Our empirical observation, however, confirms that for vertical IIT, some higher-income countries import more expensive products than they export and some lower-income countries export more expensive products than
they import. We conclude that vertical international production sharing developed in East Asia
and with it the expansion of back-and-forth transactions in vertically fragmented production
processes.
These changes in the patterns of production location and international trade occurred with
the help of the region’s aggressive promotion of FDI. In the process of the evolution of vertical
international production networking, various location advantages have determined the pattern of
fragmentation of production and international trade. In East Asia, there exist large differences
in the components of location advantages, such as static and dynamic service link costs and
agglomeration effects in addition to wages and technology transferability. Such elements have
shaped the evolving pattern of fragmentation of production and trade and the vertical division of
labor in East Asia.
Acknowledgements
The paper was presented at the Claremont Regional Integration Workshop with Particular Reference to Asia and at the Japan Economic Association. The author would like to thank anonymous
referees, Fukunari Kimura, Masaru Umemoto, Chisa Fujioka, and participants of the conferences
for useful comments and suggestions.
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