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countries.TheFTAeffectonverticalspecialisation-basedtradeincreaseswithpreagreement

verticallinkagelevel,thatis,thedeepertherealintegrationbetween

countriesthelargertheFTAimpact.Theresultsofthispaperalsosuggestthat

deepereconomicintegrations,suchascurrencyunions,willenhancetradebasedon

verticalproductionbyreducingtheriskofexchangeratevolatility.

Introduction

ThecountriesofEastAsiahavebecomeintensivelyinvolvedinglobaltradeandhave

steadilyincreasedtheirshare-goingfrom16%inthe1970sto23%ofworldtrade

flowsinthe1980s.Between1990and2006theincreaseinAsiantradeaccountedfor

approximately40%ofthetotalincreaseinworldtradeovertheperiod.EastAsia’s

risingshareofworldtradehaslargelyresultedfromitsincreasingintra-regionaltrade

flowswhichhavegrownfasterthanitstradeflowswiththerestoftheworld.1Intraregional

tradeflowsinEastAsiareflecttradeinintermediategoodsandvertical

specialisationthatexploitscomparativeadvantagebetweencountriesthroughregional

productionnetworks.Theintra-regionaltradeamongEastAsiancountries,whichis

muchhigherthaninotherpartsoftheworld,isshowninFig.1.

AsiaEurJ（2009）7:

145–160

DOI10.1007/s10308-008-0215-x

1FormoreinformationseeChapter4oftheAsiaandPacificRegionalEconomicOutlook,publishedby

theInternationalMonetaryFund,October,2007.

X.Li（*）

DepartmentofEconomics,UniversityofSussex,Falmer,SussexBN19SN,UK

e-mail:

x.li@sussex.ac.uk

RegionalintegrationinEastAsiahasbeendescribedas‘regionalisation’or

‘marketled’integrationsincethe1980sthathasbeendrivenbytheactivitiesof

multinationalcorporations（MNCs）insettingupcross-borderregionalproduction

networks.Asaresult,theboomingtradeinintermediategoodshasturnedthewhole

regioninto“FactoryAsia”.TheJapan–Asiaelectronicstradeprovidesagood

exampleofthis.ManyJapanesecompanies,inordertoreducecosts,beganto

outsourcedifferentstagesofproduction,especiallyfinalassemblytoSouthEast

Asiainthelate1980s.By1995,exportsofelectronicscomponentsfromJapanto

Asiaaccountedformorethanthreequartersofallitsexportstotheregion,morethan

halfofallexportsofcomponentsandmorethanonethirdoftotalelectronicsexports

（Hummelsetal1998）.Productionsharing,verticalintegrationandvertical

specialisationalldescribetheestablishmentofregionalproductionnetworksby

suchactivitiesofmultinationalfirmsinEastAsia.

Againstthisbackgroundofsuccessfulmarketledintegrationintheregion,stateled

regionalarrangementsdidnotprogressmuchuntiltheyear2000whenChina

triggereda‘dominoeffect’intheregionbyproposingthenegotiationofaChina-

ASEANfreetradeagreement（CAFTA）.Theconclusionofaframeworkagreement

forCAFTAin2002,has,sincethen,provokedanincreasingnumberofFTAsbyall

countriesintheregion.AndlargerscaleintegrationforthewholeofEastAsia

betweenChina,KoreaandJapanwithASEANintheASEAN+3process,oreven

APEC（AsiaPacificEconomicCo-operation）integrationhavenowbecometopicsof

importanceonthetradeagenda.

Thisraisesanimportantpolicyissueforconsideration—whetherornotfreetrade

agreementswillstrengthentheverticalproductionlinkagespromotingintra-regional

tradeand,therefore,furtherenhancetheeconomicintegrationbetweenEastAsian

countries?

Thevastbodyofexistingliteratureonregionalismhasfocusedmostlyon

Fig.1ShareofintermediategoodsintradeflowsinEastAsianeconomies.Source:

Author’scalculation

146X.Li

theeffectsof‘tradecreation’and‘tradediversion’oneconomicwelfareandregional

economicconvergence.FewpapersthathavestudiedtheeffectofFTAsonvertical

specialisation—basedtradebetweenmembercountriesinregionalproduction

networks.2ThispaperstudiestheFTAeffectsonverticalproductionlinkages

amongstEastAsianeconomieswherethisphenomenonismorepronouncedthanin

anyotherregionoftheworld.

Thepaperisorganisedasfollows.“Theconceptandmeasurementofvertical

specialisation”explainstheconceptofverticalspecialisationtradeandhowto

measureitsquantitativesignificanceforcountries.“Regionalintegrationandvertical

specialisation:

theoreticalaspects”summarisessometheoreticalinsightsofnew

regionalismandverticalspecialisation.“Regionalintegrationandverticaltrade:

empiricalanalysis”presentstheeconometricanalysisofFTAsandvertical

specialisation,“Concludingremarks”reportstheresultsofourestimations.

Concludingcommentsarepresentedinthefinalsection.

Theconceptandmeasurementofverticalspecialisation

Verticalspecialisationandproductionlocation

Astechnologyimprovesunderthecurrenttrendofglobalisation,productionisno

longerconstrainedwithinnationalboundaries.Instead,productionchainsare

dispersedacrossdifferentlocationsandcountries.Thisrelocationofproduction

fragmentstheproductionprocessintofinerandfinerstagesaccordingto

intermediateinputs.TaketheexampleofaLenovolaptop:

themotherboardmay

beproducedinJapan,theharddriveinSingapore,thememoryintheRepublicof

Korea,thedisplaypanelinChineseTaipei,themicroprocessorinMalaysia,etc.and

everythingfinallyisassembledintoarecognizablecomputerinChina.3This

examplereflectstheincreasingphenomenonofverticalspecialisationacross

countries.

Intheeconomicliterature,verticalspecialisationissometimesreferredtoas

productionsharingorasfragmentation—thesplittingofaproductionprocessinto

twoormorestepsthatcanbeundertakenindifferentlocationsofdifferentcountries

butthatleadtothesamefinalproduct.（Arndt1996）.Othertermsarealsousedsuch

asoutsourcing,offshoringandverticalFDI.Theseconceptsaresimilarbecausethey

areallaboutproductionlocations.However,verticalspecialisationisaconceptto

lookattheactivitiesofcountriesataggregatedlevelswhereastherestlookat

activitiesofmultinationalcorporations（MNCs）inthesenseofproduction

locations.4

AccordingtoHummelsetal.（2001）,verticalspecializationoccurswhenthe

followingoccur:

agoodisproducedintwoormoresequentialstages;

twoormore

2Hanson（1996）investigatestheverticaltradeontheproductionnetworkinatwo-countrymodeland

illustratewiththeapparelindustryinMexicoandtheUS.

3WorldTradeOrganisation2008,page112

4Hummelsetal.1998,page82

Freetradeagreementsandvertical-specialisationinEastAsia147

countriesprovidevalue-addedduringtheproductionofthegood;

atleastone

countrymustuseimportedinputsinitsstageofproductionprocess,andsomeofthe

resultingoutputmustbeexported.Oncetheabovethreeconditionsaresatisfied,one

wouldsayacountryisverticallyspecialisedandfullyinvolvedinaregionalor

globalproductionchain.Itimportsintermediateinputsfromwhichitproduces

output,someofwhichwouldbeexportedasfinalproductsorintermediatesfor

consumersorfirmsinforeigncountries.

Figure2illustratesthesituationofverticalspecializationandtradebasedonit.

Country2inthefigureisthecountryofourinterest.Forcountry2,itimports

intermediates,andpartsofitsproductswhichdirectlyorindirectlyembodyimported

inputswhichareexportedtoforeigncountrieseitherasnewintermediatesorfinal

goodsforforeigncountries.Thus,intheexportofCountry2,consistsoftwoparts:

1）thevalue-addedpartfromCountry2’sowninputsand2）theimported

intermediatesinputswhichareembeddedinCountry2’sexport.

Measurementofverticalspecialisation

Nowweturnourdiscussiontothemeasurementofverticalspecialisation.Hummels

etal.（2001）defineameasurementforverticalspecialisationtomeasurethe

importedinputcontentfromaforeigncountryofexportgoodsofsectoriinthe

homecountryh.Thatistosay,VSistheimportedinputcontentofexport,or

equivalently,foreignvalue-addedembodiedinexports.Iftherearesomesectors

whichdonotimportintermediateinputsordonotexportoutputseventhoughimport

Fig.2VerticalSpecialisation

148X.Li

intermediates.Thus,theVSforthosesectorsiszero.5Fromthediscussionabove,we

willseetherearetwoessentialelementsofinformationweneedinordertocalculate

theVSshareoftotalexportforthehomecountryhregardingitsverticallinkagesto

theforeigncountryf-1）thedistinctionbetweenfinalconsumptionandintermediate

inputs,and2）thebilateraltradeinformation.

Input-output（I–O）tablesareusedtoprovidetherequiredinformationto

distinguishbetweenforeignanddomesticinputs,value-added,grossoutputsand

exports.AkeyadvantageofusingI–Otablesistoavoidthearbitrarinessof

classificationschemesthatdividegoodsintointermediatesornot.Theoutputtable

dividesoutputsofeachsectorinacount