The last few decades were characterised by large increases in world trade, which was in large part caused by an increasing exchange of parts and components between countries as a consequence of the international fragmentation of production (IFP)(Arndt & Kierzkowski, 2001). Traditional theoretical approaches for explaining this phenomenon have been limited, especially concerning the trade of intermediate products.(Krugman, 1995)
The following essay focuses on IFP by first defining and explaining the background of this strategy. The second section of this paper analyses the causes for the trend of IFP by showing the general framework changes and by addressing various theories.
The third section of this essay critically assesses whether IFP has been beneficial to producers and consumers.
1. Definition of international fragmentation of production
David Ricardo already showed in 1817 that some countries have experienced comparative cost advantages in the production of certain goods in comparison to other countries due to different production factor costs and -intensities. This divergence allowed those companies to produce with lower relative costs. About 100 years later E.Heckscher and B.Ohlin added in their factor proportions theory that countries will end up specialising into those factors of production they have in abundance. This leads to a further decrease in the relative costs of producing certain goods. (Piggott & Cook, 2006)
As a consequence, specialised companies are able to penetrate foreign markets with lower prices. Production and service processes that were once provided only nationally become increasingly traded internationally. Companies located outside of countries with product specific cost advantages wanted to partake in those conditions and began to spread their previously integrated production activities over an international network to achieve the same competitive advantages throughout their value chains.
This process of dividing the value chain into separate sections in which parts of a product (so-called fragments) are not fully integrated into the production process is defined as fragmentation of production. (Jones & Kierzkowski, 2001)
Fragmentation of production drives international trade in two ways: Firstly by increasing imports of processed goods. Secondly, by exporting final goods or intermediate parts which incorporate the formerly imported processed components. The more internationally distributed the production process of a company is, the more borders will be crossed and the more trade will be achieved.
According to Ando this phenomenon can occur in three different forms: (1) Outward processing trade (OPT), which means that goods are temporarily exported to be processed abroad and eventually reimported, (2) vertical specialisation, as a form of international division of work and (3) outsourcing. (Ando 2006).
Other authors enlarge the literature with further terminology like 'slicing up the value chain’ (Krugman 1995), 'disintegration of production' (Feenstra 1998) or 'intra-product specialisation' (Arndt 1997).
International fragmentation of production is especially prevalent between the U.S. and Mexico, in Europe between Eastern European countries and the old EU-Member States and within East Asia. An increasing correlation between the exports and imports of these countries has been observed, suggesting that IFP plays an important role in their trade development. (Kaminski & Ng, 2001)
Since reasons for IFP can be manifold the following sections further explore the causes for the vast development of IFP in recent decades and the associated consequences for a typical company and its customers.
2. Reasons for international fragmentation of production
During the last few decades the…