Working Paper: Dynamics and Determinants of Fragmentation Trade: Asian Countries in Comparative and Long-term Perspective

No: WP-2019-040

Author: C Veeramani and Garima Dhir

Title: Dynamics and Determinants of Fragmentation Trade: Asian Countries in Comparative and Long-term Perspective

Abstract: This paper analyses the dynamics and determinants of fragmentation trade in major Asian countries in comparative and long term (1962-2018) perspective. Based on the available literature, we identify certain product categories, referred to as “network products” (NP), where trade flows based on international fragmentation of production processes are most prevalent. Our analysis shows that Asian countries entered the market for NP exports in a sequential manner. The pattern of entry, rise, survival, and relative decline of countries in this market is consistent with the “wild-geese flying pattern”. The first Asian country to enter the export market for NP was Japan – the lead goose – followed by a number of East and Southeast Asian countries. The export market participation of these countries, over the years, depicts a clear “inverted V” pattern. At this point in time, Japan, Hong Kong, Malaysia and Korea are on the declining part of the inverted V-curve while China seems to have reached the inflection point. Thailand and Vietnam are on the rising part of the curve while Philippines seem to be experiencing a premature descent. India and Indonesia are the only two major Asian countries that have not yet taken off, though some indication of a beginning of the growth process can be seen, particularly in India. A major concern among policy makers is whether participation in fragmentation based trade implies that low wage countries would perpetually stuck at the lower end of the production processes. Our analysis suggests that this concern is unwarranted. Econometric results suggest that stringent rules of origin requirements limit the positive impact of free trade agreements (FTAs) on NP exports. Importers of NP, in particular, may find it difficult to satisfy the rules of origin clause as production process in these industries are spread across nations. Finally, our results show that a low level of service link costs and a liberal FDI regime are critical for countries to boost fragmentation based exports.

Keywords: Fragmentation, Exports, Free trade agreements, Asia

JEL Code: F13, F14, F15