Industrial Specialization: Determinants, Processes and Consequences

This thesis examines the causes, processes and consequences of industrial specialization. Specifically, three sets of questions are addressed. First, how do trade and financial openness affect industrial specialization across countries? Second, how does trade openness affect industrial composition across industries and how do firm-level dynamics play an important role? Third, what are the macroeconomic consequences of specialization? In particular, how does specialization matter for economic growth and cross-border portfolio investments? Chapter 2 investigates the roles of trade and financial openness, separately and in conjunction with each other in affecting industrial specialization. The results show that both trade and financial openness have a positive relationship with industrial specialization. In addition, the effect of trade (financial) openness on specialization is enhanced by the level of financial (trade) openness, suggesting that they are complementary in their effects on specialization. Chapter 3 takes a closer look at which industries are driving the trade-specialization nexus, and how firm-level dynamics play a critical role. I argue and find that industries need 'room to move' in order for increasing trade openness to translate into increased specialization. The true drivers of the trade-specialization nexus are productive firms, who benefit from the increase in trade-openness and can appropriate resources from less productive firms. This causes the industry in which they operate to expand, at the expense of other industries, in which there is no room to make such moves. In order words, the intra-industry potential for reallocation determines whether there is a trade-specialization nexus. While chapters 2 and 3 focus on the determinants and processes of industrial specialization, chapters 4 and 5 examine its macroeconomic consequences. Chapter 4 first develops a proxy for the maturity of a country's export bundle based on the product life cycle theory. Then, the results show that the effect of export maturity on growth is very different across three clusters of countries. In the most developed cluster, countries tend to grow more rapidly when they export new and innovative products that are in an early stage of the product life cycle. In contrast, a cluster of emerging countries appears to grow faster by exporting more mature products that are in the later stages of their life cycle. Finally, the effect of export maturity on growth seems insignificant in the cluster of developing countries. While chapter 2 has established the finding that financial openness promotes specialization through risk-sharing, chapter 5 investigates the reverse linkage by examining the effects of ongoing changes in industrial structure on cross-border portfolio investments in a bilateral setting. The results reveal a strong negative relationship between structure dissimilarity and bilateral portfolio investments, indicating that investors tilt their foreign portfolio towards countries with similar industrial structures. The diversification motive therefore does not seem to play a role. These finds suggest that investors have a preference for familiarity when investing abroad. In other words, they prefer to invest in similar countri