School of Economics and Management

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1 School of Economcs and Management TECHNICAL UNIVERSITY OF LISBON Department of Economcs Carlos Pestana Barros & Ncolas Peypoch Nuno Letão, Horáco Faustno and Yush Yoshda A Comparatve Analyss of Productvty Change n Italan and Determnants of Vertcal Portuguese Intra-Industry Arports Trade n the Automoble Manufacturng Sector: globalzaton and fragmentaton WP 006/2007/DE WP 06/2009/DE/SOCIUS WORKING PAPERS ISSN Nº

2 Determnants of Vertcal Intra-Industry Trade n the Automoble Manufacturng Sector: globalzaton and fragmentaton Nuno Carlos Letão ESGTS, Polytechnc Insttute of Santarém, Portugal Horáco C. Faustno ISEG, Techncal Unversty of Lsbon, and Yush Yoshda Faculty of Economcs, Kyushu Sangyo Unversty, Japan Abstract: Ths paper examnes the determnants of vertcal ntra-ndustry trade (VIIT) n the automoble components ndustry between Portugal and the European Unon 27 (EU-27) and the BRIC countres (Brazl, Russa, Inda and Chna) durng the perod Usng a statc and a dynamc panel data analyss, the results ndcate that VIIT s a postve functon of the dfference n per-capta GDP between Portugal and ts tradng partners. Moreover, there s statstcal evdence that geographcal dstance and proxmty shared border nfluence ths type of VIIT. Our results also confrm the hypothess that trade ncreases f the transportaton costs decrease and that there s a postve correlaton between dfferences n endowments and VIIT. Key Words: VIIT, ntermedate goods, automoble manufacturng ndustry, panel data, fragmentaton, globalzaton. JEL Code: F14 Addresses: Nuno Carlos Letão (correspondng author) Escola Superor de Gestão e Tecnologa de Santarém, Complexo Andaluz Santarém, Portugal.T: (+351) ;E-mal: nuno.letao@esg.psantarem.pt; nunocarlosletao@gmal.com Horáco C. Faustno IZEG- Insttuto Superor de Economa e Gestão, Rua Mguel Lúp, Lsboa, Portugal T: (+351) Emal: faustno@zeg.utl.pt.home Page: Yush Yoshda Kyushu Sangyo Unversty, Matsukada, Hgash-ku, Fukuoka, Japan. Emal: yush@p.kyusan-u.ac.jp 1

3 I. Introducton The role of the multnatonal corporatons (MNC) n the fragmentaton/outsourcng of the producton can be observed through the statstcs dealng wth nternatonal trade. Snce the 1970s, approxmately one-thrd of US exports and mports have taken the form of sales by one unt of an MNC to another unt. The trade n automoble components between dfferent unts of multnatonal corporatons s a good example of ths type of trade, manly vertcal ntra-ndustry trade (VIIT). The term outsourcng s often used to descrbe cases n whch an M relocates part of ts producton away from the home country to another country. In most cases, the foregn frm s a subsdary of the MNC. In other cases, the MNC subcontracts the operaton concerned to a foregn frm. Outsourcng s dscussed n the context that MNCs are purchasng nputs from abroad. Outsourcng has grown because frms seek to reduce labor-market costs. Vertcal IIT reflects the exchange of ntermedate goods whch belong to the same ndustry, but whch are located at dfferent stages n the producton process. Followng recent lterature, we apply country-specfc varables, such as per-capta ncome, dstance, relatve factor endowment, and shared borders, to explan VIIT. Ths study analyzes the determnants of VIIT between Portugal and 25 countres ( 21 countres of the European Unon 27 (EU-27), 3 of the BRIC countres (Brazl, Russa, Inda) and USA) n the automoble parts and components ndustry 1. The paper uses an unbalanced panel for the perod We have followed such other emprcal studes as Turkcan (2003, 2005), Clark (2006), Wakasug (2007), Kmura et al. (2007), Yoshda (2005), Res and Rua (2006) and Amador and Cabral (2008). In statc panel data, pooled OLS, fxed-effects (FE) and random-effects (RE) estmators are used n ths type of study. The RE estmator was excluded because our sample s not random. Furthermore, the Hausman test rejects the null hypothess RE versus FE. We decded aganst usng the fxed-effects estmator, as some relevant varables do not vary along tme. Therefore, the regresson coeffcents are estmated usng OLS wth tme dummes. We also decded to ntroduce a dynamc panel data. 1 Russa and the remanng sx EU countres were excluded due to the unavalablty of data. In addton, note that Belgum and Luxembourg are treated as one combned economy. 2

4 The estmator used (GMM-SYS) permts researchers to solve the problems of seral correlaton, heteroskedastcty and endogenety of some explanatory varables. These econometrc problems were resolved by Arellano and Bond (1991), Arellano and Bover (1995), and Bond (19988, 2000), who developed the frst-dfferenced GMM estmator (GMM-DIF) and GMM system estmator (GMM-SYS). The remander of the paper s organzed as follows. The second secton revews the theoretcal lterature. The thrd secton analyzes the relatonshp between fragmentaton and vertcal ntra-ndustry trade. The fourth secton reports the recent trend n Portuguese vertcal ntra-ndustry trade. The ffth secton presents the econometrc model. In the sxth secton, we analyze the results, and the fnal secton concludes. II. Lterature Revew Jones and Kerzkowsk ( 1990,2000, 2001) and Deardoff (1998, 2001)were the frst researchers to use the concept of fragmentaton n the nternatonal trade theory. However, the term fragmentaton s found to correspond to varous dfferng defntons n the lterature. Fragmentaton s synonymous wth outsourcng for Feenstra and Hanson (1995, 1996, 1997, and 2001), equal to dsntegraton of producton for Feenstra (1998), equal to vertcal specalzaton for Hummels, Rapoport, and Ke-Mu Y (1998), and wth ntra-product specalzaton for Arndt (1997, 1998, and 2001). Nowadays, t s generally accepted that the poneerng lterature on fragmentaton began wth Jones and Kerzkowsk (1990). Accordng to these authors, fragmentaton nvolves a place where producton costs can be substantally reduced. Jones and Kerzkowsk (2001) argue that changes n the prce of producton factors permt us to explan the ncrease of fragmentaton. The outsourcng place/outsourced destnaton presents comparatve advantages n low wages and a favorable stablty n economc polcy. Recently, researchers of nternatonal fragmentaton or outsourcng, such as Ando (2006), Clark (2006), Kmura et al. (2007) and Wakasug (2007), have explaned the determnants of fragmentaton by gravty models (economc dmenson, geographcal dstance, shared borders and cultural proxmty). 3

5 The study of Clark (2006) demonstrated that globalzaton wll contnue to renforce the dea that there are locatons that are more effcent (.e., wth low producton costs), whch s lnked to vertcal specalzaton. Clark used a tobt and probt specfcatons at country and ndustry level. Fragmentaton of producton among East Asan countres s wdely supported by emprcal evdence. Ando (2006) studed the fragmentaton and vertcal ntra-ndustry trade (VIIT) n East Asa. The author concluded that vertcal nternatonal producton became an essental part of each economy n East Asa. In the 1990s, an ncrease n the vertcal specalzaton n machnery parts and components took place. Kmura et al. (2007) analyzed the determnants of fragmentaton and machnery parts and components of among East Asan, European and other countres. In the gravty model, the trade n parts and components s regressed on the dfference of GDP per capta, n addton to the ncomes of tradng partners and the geographcal dstance between them. The authors fnd that a larger ncome gap ncreases the components trade among East Asan countres, whle smlar ncomes promote greater components trade among European countres. They conclude that the trade n components among East Asan countres s more a case of vertcal trade drven by the fragmentaton of machnery producton. Yoshda (2005) examned the regonal trade of automoble parts and components among Asan countres. By usng Japanese FDI, dstngushng automoble makers such as Toyota and Honda from automoble components supplers such as Denso, emprcal results support that FDI by automoble supplers promotes the component trade among Asan countres. Ths s regardless of whether a host country s an mporter or an exporter, whereas FDI by an automoble maker only contrbutes to promotng regonal trade n components when a host country s an mporter. Wakasug (2007) constructed an ndex of vertcal ntra-ndustry trade to measure the fragmentaton of producton. The author used a gravty model and analyzed the mpact of VIIT n East Asa, NAFTA, and the European Unon. The author concluded that fragmentaton ncreased wth ntra-ndustry trade. Whle emprcal evdence on fragmentaton n Asa s substantal, I s less so wth regard to the European regon. In ths paper, we attempt to fll ths gap. We provde emprcal evdence on fragmentaton among European countres, partcularly 4

6 from the perspectve of a small, medum-ncome country,.e., Portugal. It s of nterest to dscover whether the effect of an ncome gap on the components trade s postve, as found n Kmura et al. (2007). In addton, departng from the use of un-drectonal trade flows, as found n the exstng lterature, we use a vertcal ntra-ndustry trade ndex for automoble components as a dependent varable. Our paper, focusng on the automoble sector n the EU, and takng nto account othe blateral partners such as the USA, Brazl, Chna and Inda, s also a complmentary study to Yoshda (2005), whch examnes the automoble components trade n Asa. III. Fragmentaton and vertcal ntra-ndustry trade When the producton of the fnshed good requres multple stages, we have fragmentaton, or outsourcng 2. As Turkcan (2003) ponts out, before the 1960s, frms produced themselves all of the components used n assemblng the fnal good. However, the costs of producng the fnal product and the ntermedate goods have ncreased as tme has progressed. Wth globalzaton, the world economy presents new clusters of ndustres. For example, Inda (see Eteam and Moffett, 2007) has developed a hghly effcent, low-cost software ndustry. In Chna, the prncpal actvtes are chemcal, mechancal and petroleum-engneerng servces. Russa has developed software and engneerng servces and R&D centers. Japan and Mexco are hghly effcent n car manufacturng and electronc servces. Accordng to Kol and Rayment (1989) the exchange of ntermedate goods can be dvded nto horzontal IIT and vertcal IIT. Kol and Rayment (1989) suggest the unt values of exports and mports of ntermedate goods to separate total IIT nto ts horzontal and vertcal components. Horzontal ntra-ndustry trade n ntermedate goods cannot be explaned by the factor proportons theory, because we have the same qualty, costs and factor proportons (K, L) employed n the producton. 2 Hummels et al. (1998), examnng the mportance of trade n ntermedate goods, used a vertcal specalzaton ndex as a measure of fragmentaton. Based on ther approach, vertcal specalzaton occurs when a country uses mported ntermedate goods to produce goods that wll later be exported. If the country does not export them later, outsourcng has occurred, but vertcal specalzaton has not.occurred 5

7 Vertcal ntra-ndustry trade n ntermedate products s explaned by the HO (Heckscher-Ohln) model, assocated wth multple stages of producton. Grubel and Lloyd Indexes Grubel and Lloyd (1975) defne IIT as the dfference between the trade balance of ndustry and the total trade of ths same ndustry. In order to make comparsons easer between ndustres or countres, the ndex s presented as a rato, where the denomnator s total trade. IIT t = 1 X ( X + M ) M ( X + M ) X M IITt = (1) X + M ) ( The ndex s equal to 1 f all trade s ntra-ndustry. If IIT t s equal to 0, all trade s nter-ndustry trade. Grubel and Lloyd (1975:22) proposed an adjustment measure to the country IIT ndex (IIT calculated for all ndvdual ndustres), ntroducng the aggregate trade mbalance. Aquno (1978: 280) also consdered that an adjustment measure s requred, but to a more dsaggregated level, but for ths, the Grubel and Lloyd method s nadequate. Followng Aquno, we requre an approprate mbalance effect. The mbalancng effect must be equ-proportonal n all ndustres. So, the Aquno at the 5-dgt level estmates what the values of exports and mports of each commodty would have been f total exports had been equal to total mports. HIIT and VIIT Indexes To determne the horzontal and vertcal ntra-ndustry trade, Grubel and Lloyd ndexes and the methodology of Abd- el Rahaman (1991) and Greenaway et al. (1994) are used. HIIT t RH = (2) ( X + M ) HIIT- horzontal ntra-ndustry trade ndex; 6

8 RH- total horzontal ntra-ndustry trade; TTj - relatve unt values of exports and mports are used to dsentangle HIIT and VIIT; If TTj [0.85;1.15], we have horzontal IIT; VIIT t RV = (3) ( X + M ) VIIT- vertcal ntra-ndustry trade ndex; RV- total vertcal ntra-ndustry trade; If TT < V TT > 1. 15, we have vertcal IIT. When TT < 0. 85, we have nferor j j VIIT (lower qualty). When TT > 1. 15, we have superor VIIT (hgher qualty). j j IV. The Recent trend n Portuguese vertcal ntra-ndustry trade: the car ndustry As shown n fgure 1, automoble components account for more than 40% of Portuguese VIIT n the perod Fgure 1. Vertcal Intra-ndustry Trade n the Portuguese Components Sector and n the Total Car Industry 70% 60% 50% 40% 30% 20% 10% 0% Car VIIT Components VIIT 7

9 Ths s also the case for the year For the perod , car components account for more than 30%. When we compare these values wth the total car ndustry, we note that the ndex of VIIT decreases. For the perod , total car VIIT ndustry dd not account for more than 20%. V. Econometrc model The dependent varable used s vertcal ntra-ndustry trade (VIIT) n car components. It s calculated wth the dsaggregaton of fve dgts CAE (Economc Actvtes Classfcaton) of the automoble components. The data for the explanatory varables s sourced from the World Bank, World Development Indcators (2005). The source used for the dependent varable was INE the Portuguese Natonal Insttute of Statstcs. V.1. Explanatory varables and the testng of hypotheses Hypothess 1: There s a postve relatonshp between dfferences n per-capta ncome and VIIT LogDGDP s the logarthm of absolute dfference n per-capta GDP (PPP, n current nternatonal dollars) between Portugal and the tradng partner. Falvey and Kerzkowsk (1987) suggest a postve sgn for the VIIT model. Turkcan (2005) and Wakasug (2007) found a postve sgn when they studed the fragmentaton of producton n transactons of parts and ntermedate goods. Hypothess 2: VIIT occurs more frequently among countres that are dfferent n terms of factor endowments LogEP s a proxy for dfferences n physcal captal endowments. It s the logarthm of the absolute dfference n electrc power consumpton (Kwh per capta) between Portugal and ts partners. Based on Helpman and Krugman (1985), we expected a postve sgn for the coeffcent of ths explanatory varable. Zhan et al. (2005) found a postve sgn for the Chnese case. 8

10 Hypothess 3: There s a negatve correlaton between trade mbalance and VIIT LogTIMB s the trade mbalance n logarthmc form. Followng Lee (1993), we consder the trade mbalance as a control varable, where TIMB s defned as: X j M j LogTIMB = (4) ( X + M ) j j Ths varable represents the net trade as a share of trade and takes a value of zero at the lower extreme f there s no trade mbalance and a value of one f there are nether exports nor mports. Accordng to the theory, a negatve correlaton between ths control varable and VIIT s expected. Hypothess 4: The trade ncreases f the transportaton cost decreases LogDIST s the logarthm of geographcal dstance between Portugal and the partnercountry. The cost of transports s mportant as a trade polcy varable. Accordng to the lterature, a negatve sgn s expected. LogNAUTIC s the nautcal dstance between Portugal and the partner-country. It s used as the second proxy for the transportaton cost. Balassa (1986) argues that ntra-ndustry trade wll be greater when tradng partners are geographcally close. Clark (2006) analyzed the nternatonal fragmentaton of producton of parts and components and found a negatve sgn for ths dstance varable. Hypothess 5: There s a postve relatonshp between BORDER and VIIT BORDER s a dummy varable that equals 1 f the partner-country shares a border wth Portugal (.e, Span) and 0 otherwse. A postve sgn s expected. V.2. Model Specfcaton 9

11 VIIT t = β 0 + β1x t + δt + η + ε t (5) Where VIIT t s the Portuguese VIIT ndex, X s a set of explanatory varables. All varables are n the logarthmc form; η t s the unobserved tme-nvarant specfc effects; δt captures a common determnstc trend; ε t s a random dsturbance assumed to be normal and dentcally dstrbuted (IID) wth E ( ε t )=0; Var ( ε t ) = σ 2 f 0. The model can be rewrtten n the followng dynamc representaton: VIIT t = ρ VIITt 1 + β1x t ρβ1x t 1 + δt + η + ε t (6) Snce VIIT s an ndex varyng between zero and one, we apply a logstc transformaton to VIIT, as n Hummels and Levnsohn (1995). VIIT=Ln[VIIT/(1-VIIT)]. We decded aganst usng the fxed-effects estmator, because some relevant varables such as geographcal and nautcal dstance do not vary along the tme. We control for the tme effects by ncludng a tme dummy varable and the regresson coeffcents are estmated usng OLS wth tme dummes, and a GMM-System estmator. VI. Estmaton Results Table 1 presents the estmaton results usng OLS estmator wth tme dummes. All explanatory varables are sgnfcant at 1% and 10% level. The general performance of the model s satsfactory; the results are accordng to the hypothess formulated wth the excepton of nautcal dstance. Table 1: Fragmentaton and Vertcal Intra-Industry Trade Varables Coeffcent Expected Sgns LogDGDP (1.77)* (+) LogEP (3.26)*** (+) LogTIMB (-1.92)* (-) LogDIST (-5.09)*** (-) LogNAUTIC (7.38)*** (-) BORDER (3.09)*** (+) C (-0.888) Adj. R Observatons

12 OLS estmator wth tme dummes. T-statstcs (heteroskedastcty corrected) are n round brackets. ***/*- statstcally sgnfcant respectvely at the 1% and 10% levels. The varable LogDGDP s statstcally sgnfcant, wth the expected sgn. As the varables are n the log form, the coeffcent of LogDGDP gves the elastcty. So, when the dfference n per-capta GDP ncreases by 1%, the VIIT n car components ncreases by 1.065%. As expected, the varable BORDER has a sgnfcant and postve effect on VIIT. The coeffcent of LogDIST (Dstance) s negatve as expected. Ths result confrms the gravtatonal model and the mportance of the proxmty of the tradng partners. The varable electrc power n logs (LogEP) presents a postve sgn, confrmng the theoretcal forecast. The control varable (TIMB) n logs s statstcally sgnfcant at 10% wth a correct sgn. The dynamc panel data model, presented below n Table 2, s vald f the estmator s consstent and the nstruments are vald. The Sargan test of over-dentfyng restrctons tests the valdty of nstruments used. The frst- and second-order seral correlaton n resduals s tested by M 1 and M 2 statstcs. The GMM system estmator s consstent f there s no second-order seral correlaton. The Sargan test and M 2 statstc verfy that the nstruments used are vald. Comparng the GMM estmates wth OLS, we note that TIMB becomes nsgnfcant. The varable DGDP s statstcally sgnfcant, wth an expected postve sgn. Our result s n accordance wth Turkcan (2005) and Wakasug (2007). As n Zhan et al. (2005), the logarthm of the dfference n electrc power consumpton has a postve effect on the VIIT varable. Thus, we can say that the dfference n relatve factor endowments explans the VIIT n car components. BORDER has been used as a typcal gravty model varable. A postve effect of a common border on blateral ntra-ndustry trade was expected and the results are n conformty wth ths expectaton, as n Kmura et al. (2007): 11

13 Table 2: Fragmentaton and Vertcal Intra-Industry Trade Varables Coeffcent Expected Sgn LogVIIT t (0.624) (+) LogDGDP (1.70)* (+) LogEP (3.01)*** (+) LogTIMB (-1.24) (-) Log DIST (-1.90)* (-) LogNAUTIC (4.50)*** (-) BORDER (1.73)* (+) C (-2.32)** M [0.734] M [0.918] Wjs [0.824] df=8 Sargan [1.000] df=152 Observatons 106 Parameters 9 Indvduals 18 The nstruments n levels used by GMM estmator were: LogVIIT t (2,6), LogEP(2,6), and LogTIMB(2,6), LogLNAUTIC(2,6) for frst dfferences. For levels equatons, the nstruments used are frst dfferences of all varables lagged t-1.the null hypothess that each coeffcent s equal to zero s tested usng one-step robust standard error. T-statstcs (heteroskedastcty corrected) are n round brackets. *,**,***, means statstcally sgnfcant, respectvely at the 10%, 5% and 1% level. P-values are n square brackets. Year dummes are ncluded n all specfcatons (ths s equvalent to transformng the varables nto devatons from tme means). M1 and M2 are tests for frst-order and second order seral correlaton n the frst-dfferenced resduals, asymptotcally dstrbuted as N(0,1) under the null hypothess of no seral correlaton (based on the effcent two-step GMM estmator). W JS s the Wald statstc of jont sgnfcance of ndependent varables (for frst-steps, excludng tme dummes and the constant term). Sargan s a test of the over-dentfyng restrctons, asymptotcally dstrbuted as under the null of nstruments valdty (wth two-step estmator). 2 χ VII. Conclusons In ths paper, we have analyzed the evoluton and man determnants of vertcal ntrandustry trade (VIIT) n the automoble components sector. In the case of Portugal, there s evdence of the growng mportance of fragmentaton of producton n the automoble sector, usng the VIIT ndex n car components as a measure of fragmentaton. In the statc and dynamc panel data analyss ths study confrms that fragmentaton can be explaned by the Heckcher-Ohln theory (HO) the dfference n relatve factor 12

14 endowments and factor proportons used to produce the goods explan the VIIT n ntermedate products, whch n ths specfc case s car components. The Lnder hypothess that dfference n per-capta ncomes can explan ntra-ndustry trade s also found to be statstcally sgnfcant n explanng the VIIT n car components. The hgher the dfference n per-capta GDP, the hgher wll be the fragmentaton of producton measured by the VIIT ndex. However, although our paper fnds a postve coeffcent for per-capta GDP dfference, Kmura et al. (2007) estmated a negatve coeffcent for Europe. The gravty model also contrbutes very well to explanng the fragmentaton of automoble producton. The varable Dstance s statstcally sgnfcant and the negatve coeffcent confrms that the transportaton cost s an mportant explanatory varable of trade n components. In the Portuguese case, outsourcng n the car ndustry s negatvely affected by the dstance between Portugal and other countres. Outsourcng and fragmentaton s generally dscussed n the context of multnatonal corporatons (MNC) theory and the role of these frms n nternatonal trade and globalzaton. It s well known that MNCs are always seekng to purchase cheap nputs from abroad. Wth globalzaton, the role of MNCs n nternatonal trade s ncreasng. Outsourcng has grown because these frms have sought to reduce ther labor costs. The MNCs are advocates of free trade and, as such, strongly favor outsourcng. However, there are wnners and losers from free trade. As ncome dstrbuton s affected by trade, there s always controversy n relaton to outsourcng and fragmentaton. Some emprcal studes estmate that 70% of the ncome gans from outsourcng go to the outsourcng country and the remanng 30% go to the country that carres out the outsourced actvty. All trade theorsts agree that outsourcng promotes trade. The effects of fragmentaton and globalzaton on ncome dstrbuton are a matter of emprcal evdence and ths topc merts further research. Portugal, gans from the outsourcng of ts car ndustry and t s to be hoped that eventually, when the economc clmate mproves, outsourcng may also generate much-needed employment gans for the country.productvty may ncrease and the ncrease of profts can lead to the expanson of the sector. However, ths hypothess must be tested. 13

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