G-SEC WORKING PAPER No.8
The Growth of Trade under Heterogeneityin East Asia: An Empirical Evidence *Ryuhei Wakasugi
Keio University
Current version, May 7, 2006

Abstract
It is notable that the trade in East Asian countries has increased more than proportionately to thegrowth of economy. The purpose of the paper is to test statistically that the recent trade expansion is
induced by development of international fragmentation of production. This paper constructs anindex of Vertical Intra-industry Trade (VIIT) as a proxy to measure the fragmentation of production.
The paper, using the indices, presents that the share of VIIT has been rising in East Asian countries
as well as NAFTA and EU countries. Based on Gravity equation, it also presents that a rising shareof VIIT is an indispensable factor for explaining the recent expansion of trade among East Asian
countries. The estimated results in the paper suggest that the agreement to remove and harmonize
institutional impediments among East Asian countries is important for further expansion of trade
within the region.

JER Classification: F10, F14, F15, F20
Key Words: Fragmentation, Intra-industry Trade, Vertical IIT, Heterogeneity
Correspondence: Ryuhei Wakasugi, Keio University, Faculty of Economics
2-15-45 Mita, Minatoku, Tokyo 108-8345, Japan.
Email: wakasugi@econ.keio.ac.jp* I thank Prema-chandra Athukorala, Sohn Chan Hyun, Kaliappa Kalirajan, Wing Thye Woo andparticipants at the Asian Economic Panel Meeting in Seoul for their insightful comments andsuggestions, and Taichi Etoh for excellent research assistance.

1. Introduction
In recent years, international trade is increasing more than proportionately to theincrease in economic size. The increase in trade has particularly been pronounced since 1990
among East Asian countries. In 2003, the ratio of intraregional trade to total trade of East Asian
countries was higher than the North American Free Trade Agreement’s (NAFTA’s) 45% andclose to the EU’s 60%. Such a drastic expansion of the intraregional trade among East Asian
countries is a noteworthy feature characterizing the international economy in recent years.
Many theoretical analyses have found that the fragmentation causes the expansion ininternational trade in recent years. It is thought that fragmentation of the international locationof production plants causes the expansion of intra-industry trade, and in turn causesinternational trade to grow at a higher pace than the increase in income levels 1 . The expansionof trade between the U.S., Canada, and Mexico under NAFTA, and between West European
countries and East European countries under the expanding EU gives evidences that support
such theoretical analysis. Many previous studies including Athukorala (2006), Ng and Yeats(2001) and Yeats (2001) analyze the causes of trade expansion and fragmentation, They haveprovided statistical evidences to present that the increase of fragmentation is a cause of recent
increase of trade volume in the world. Empirical studies present statistical data that the
expansion of trade in East Asia accompanies with a rise of “Vertical Intra-industry Trade”(VIIT). Some studies demonstrate that VIIT of East Asian countries closely related to foreign

1 Refer to Jones and Kierzkowski (2001), Jones and Marjit (2001), and Yi (2003).

1

direct investment (FDI). Others studies, for the case of the machinery industry, present that evenapart from FDI, a broad production - distribution network formed among East Asian countries isa major cause of the expansion of VIIT. 2
While several studies have analyzed the causes of the expansion of trade by taking up
EU countries, NAFTA countries, and East Asian countries separately, they have not made acomparison of East Asian countries with NAFTA and EU countries. In other word, few studies
made a comparative analysis to test whether the factors causing the increase of trade in East
Asia are different from those for the other regions. There exists a great disparity in restrictive
measures on trade as well as goods and factor prices among East Asian countries. In short, East
Asian countries are more heterogeneous in economic and legal conditions than EU or NAFTA
countries. A large heterogeneity in factor prices among East Asian countries is a driving force toexpand the trade through international production fragmentation in the region. It is different
from homogeneous factor prices among EU countries.
It is difficult to measure the effect of international fragmentation of production oninternational trade by a single numerical index since the trade under fragmentation consists ofdifferent trade in parts and components and is determined by quite different factors. VIIT, which
is defined by simultaneous import and export of parts, components and final goods withdifferent factor intensity within the same product category, constitutes an intermediate category
between “horizontal intra-industry trade” (HIIT) defined by simultaneous import and export of2 Refer to Ishido et al. (2003, 2005) and Kimura and Ando (2005) for the studies based on Japanesefirm-level data.

2

final goods with same factor intensity in the same product category and inter-industrial trade.
Although VIIT is not exactly same as fragmentation, the former is useful as a proxy tocharacterize the latter in a numerical figure since the fragmentation accompanies thesimultaneous import and export of products in the same category with different factor intensity.
The main purpose of this paper is to construct the indices of VIIT between two major trading
partners in the world and examine statistically by using them what effect fragmentation has on
the expansion of trade in East Asian countries.
We also find that East Asian countries have a disparity of institutional factors which
impede the fragmentation of production across the countries. Unlike NAFTA and EU, East
Asian countries as a whole have not formed a regional trade arrangement yet. The lessinstitutional impediments are important to provide conditions that are more favorable for VIIT
than for HIIT or inter-industry trade within East Asian countries
This paper consists of the following sections. Section 2 constructs VIIT index between
major trading partners in the world and compares VIIT of East Asian countries with that of thecountries in other regions. Section 3 statistically tests whether the expansion of world traderelates to the expansion of VIIT, and whether any additional effect of VIIT on the trade can beobserved in East Asian countries. Section 4 discusses the importance of East Asian countries toeliminate institutional impediments and develop fragmentation of production. The last section
mentions pros and cons of East Asian countries to form regional economic integration.

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2. Structural Change of Trade in East Asia
2.1 Fragmentation and Vertical Intra-Industry Trade
The modularization of production processes and international fragmentation of
production are mentioned as causes for the drastic increase in international trade in recent years.
FDI, which has become brisk in recent years, is a cause for the increase in such fragmentation.
Empirical studies indicate that the increase in Japanese trade closely relates to the increase inoverseas production based on direct investment from Japan 3 . It is not necessary, however, thatfragmentation is caused only by FDI. It is pointed out that the fragmentation within the East
Asian region in recent years has been accelerated by various cost-reducing factors. 4 . Such cost
reductions will be achieved through technological innovation, liberalization of trade and capitaltransaction, and harmonization of institutional factors as well as a rise of production efficiency
due to the industrial development in East Asian countries.
It is thought that an increase of fragmentation of production is a cause for expanding
trade volume in the following process. First, it increases international transactions of parts andintermediate goods. As shown in Figure 1, when the production processes, which used to be

3 Ishido et al. (2003) show that there is a significant positive relationship between the production by
local enterprises based on direct investment from Japan and the VIIT in the trade with that country,
using the data of 43 countries of Japan’s trade partners.
4 They refer to “Service Link Costs”, meaning the cost required for linking the divided production
processes. This includes transportation and communication costs, customs duties, and various
expenses for overcoming institutional differences.

4

completed within one plant or one country, become divided across the boarder, parts andintermediate goods are necessarily traded across the national boundary.

Figure 1

Second, there is an increase in trade volume due to the specialization of production
through the realization of economy of scale. In most cases, modularized production processes
achieve economy of scale. Consequently, the division of labor in manufacturing the parts andintermediate goods according to the comparative advantage raises the efficiency of production.
Parts and intermediate goods produced in the most efficient region are supplied for a greaternumber of users in the world market. Those used to be supplied before only for specific trading
partners in the specific regions become goods supplied for several types of users in the world
market. This generates an opportunity to expand the trade volume.
Two-way trade in parts and intermediate goods belonging to the same industry isdefined as intra-industry trade (IIT). The traditional argument concerning IIT has been used as atheory to explain the expansion in trade volume among developed countries. Typical case of IITconcerns trade in final goods belonging to the same industry category with different brand andquality. This type of IIT, however, is not adequate in explaining the recently increasing volumeof trade. It refers to the value chain between the countries as depicted in Figure 1. We find someattempts to characterize the recent trade pattern by dividing IIT into HIIT that is defined by the5two-way trade of differentiated final goods belonging to the same industry category and VIIT
that is defined by the two-way trade in parts, intermediate goods and final goods belonging to
the same industrial category with different factor intensity.
IIT between country j and country k is denoted as follows:

IIT jk =2∑ min( X jk i , M jk i )
i

∑(X

jk

i

(1)

+ M jk i )iwhere i refers to industrial category. X jk i means export of goods belonging to industry i fromcountry j to country k, and M jk i means import by country j of goods belonging to industry ifrom country k.
In this paper, we divide IIT into HIIT and VIIT: the former is the trade of goods
belonging to the same industrial category whose unit values are very similar between exported
and imported goods, and the latter is the trade of goods belonging to the same industrial
category whose unit values are somewhat different between exported and imported goods. Morespecifically, we define HIIT if the ratio of the unit value of export goods to that of import goods
belonging to the same industry category is within the range from 1/(1+0.25) to (1+0.25), and
VIIT if the ratio is either smaller than 1/(1+0.25) or larger than (1+0.25) 5 . That is,(i)

The two-way trade of goods belonging to industry i is defined as HIIT,

5 The definition here of HIIT and VIIT is based on Greenway, Hine, and Milner (1994, 1995), andFontagne and Freundenberg (1997)

6

if

(ii)

1
UVi E
≤
≤ 1 + 0.25
1 + 0.25 UVi M

The two-way trade of goods belonging to industry i is defined as VIIT,

if

UVi E
1
UVi E
or
≥ 1 + 0.25≤
UViiM 1 + 0.25
UVi M

E

M

where UVi and UVi express the unit values of export goods and import goods belonging to
the industry i. If traded goods defined as HIIT are denoted by the number [1,m] and thosedefined as VIIT are denoted by [m+1,n], The shares of IIT, HIIT and VIIT are expressed
respectively as follows:m

IIT jk =n

2∑ min( X jk i , M jk i ) + 2 ∑ min( X jk i , M jk i )i =1

i = m +1

n

∑( X

jk

i

+M

jk

(2)
i

)

i =1

m

HIIT jk =2∑ min( X jk i , M jk i )
i =1
n

∑(X

(2’)
jk

i

+M

jk

i

)

i =1

n

VIIT jk =2 ∑ min( X jk i , M jk i )i = m +1
n

∑( X

(2”)
jk

i

+M

jk

i

)

i =1

Although VIIT refers to trade of goods belonging to the same industrial category, we
7can assume that, reflecting the different intensity of production factor between different
production stages, international division of labor is in place even within the same industry
category. In this case, unit value between export and import goods will be different since theyreflect their different factor intensity.
We find some studies that used VIIT as an instrument to measure the change of tradepattern. Aturupane, Djankov, and Hoekman (1999) presented an intra-industry trade index
between East European countries and the EU. Hu and Ma (1999) calculated IIT between China
and its major trade partners, and Durkin and Krygier (2000) showed HIIT and VIIT between the
U.S. and OECD countries. They ascertained that VIIT has increased in and after the 1990s.
It is difficult to measure in what degree the development of production fragmentationis actually proceeding. Although fragmentation and VIIT are not exactly same, both are closely
related. A part of international trade caused by fragmentation is included in VIIT as well as apart of VIIT is included in the trade caused by fragmentation. Here, we regard VIIT as a proxyvariable to denote numerically the share of international trade caused by fragmentation.

2.2 Measurement of VIIT in East Asia
We compare VIIT of East Asian countries with VIIT of NAFTA or EU countries. For
the statistical comparison, we will take up major trading countries in the world and calculate
three types of index: IIT, HIIT, and VIIT. It is not easy tasks to measure IIT, HIIT and VIIT
since quantity figures are not necessarily available for some categories of parts and components

8

in trade data of many countries. Our measurement of the indices is underestimated in someextent because we excluded such unavailable categories from measurement. The statistical data
for measuring the indices are based on value and quantity of imports and exports in six digits of
HS Classification from “UN ComTrade”. Table 1, showing the indices of HIIT and VIIT ofAustralia, Canada, China, Germany, France, Hungary, India, Indonesia, Italy, Japan, Korea,
Malaysia, Mexico, Singapore, Sweden, UK, and the U.S. measured by trade data in two periods:
1995/96 and 2003/04. It shows that VIIT in most countries has increased between two periods,
and that VIIT in East Asian countries is as high as NAFTA and EU countries in 2000s.

Table 1

3. VIIT and the Growth of Trade
3.1 Equation for Estimation and Hypotheses
Previous studies suggest that it is difficult to explain the expansion in trade of East
Asian countries by the increased import demand accompanying the increased income in the
countries. It is expected that a large increase of trade among those countries has been
accelerated by the structural change of trade pattern due to fragmentation. The purpose of thissection is to measure how largely the trade between two countries is increased by fragmentation.
We assume that a rising share of VIIT caused by an increase of fragmentation has a significant
effect on the increase of trade. To test it, we use the gravity equation that is a traditional model

9

for estimating bilateral trade volume. According to the gravity equation, we define the tradevolume between countryｊand country k by equation (3):TTVt jk = A0

where TTVt

jkγ
(GDPt j GDPt k )α 1 ⋅ ( PGDPt j ⋅ PGDPt k )α 2
⋅ S jkjk α 3( Dis tan ce )

[ ]

(3)

denotes the summation of exports and imports between country j and country k,jkjkthat is X jk i + M jk i . GDPt , GDPt , PGDPt and PGDPt indicate the size of economy

and GDP per capita of country j and country k, respectively. Dis tan ce jk indicates the distance
between country j and country k. S jk expresses the factors to characterize the trade cost andtrade pattern between two countries including the existence of a bilateral agreement, thedifference in language, and the geographical adjacency of boundary, and the share of VIIT
between two countries. We assume that the figures of VIIT used for estimation hold a time lagfrom the period t to avoid the problem of endogeneity of explanatory variables.
We statistically test whether the coefficient of VIIT, a proxy variable showing thestructural change in trade, is positive with a statistical significance and whether the effect ofrising share of VIIT on the increase of trade volume is peculiar to East Asian countries incomparison with other countries. To this end, from equation (3) we derive the model for
estimating the bilateral trade volume between two countries as follows:

10ln TTVt jk = α 0 + α1 (ln GDPt j + ln GDPt k ) + α 2 (ln PGDPt j + ln PGDPt k )+ α 3 ln Dis tan ce jk + (γ 0 + ∑ r =1 γ r Drjk ) ln VIIT jk + u jk + ε t jk
3

(4)

where Drjk represents a dummy variable showing the region-specific factor between country j
and country k. Here, we assume that if both countries belong to East Asia, NAFTA, or EU, thedummy variable takes the following value, respectively:⎧1, if j & k both are East Asian countries
D1jk = ⎨⎩0, otherwise⎧1, if j & k both are NAFTA countries
D2jk = ⎨⎩0, otherwise⎧1, if j & k both are EU members
D3jk = ⎨⎩0, otherwise

In equation (3) u jk shows the fixed effects on the trade volume between country j and country kwhich includes all other factors peculiar to the bilateral relationship, such as a bilateral trade
agreement, adjacency of boundaries, difference in language than the share of VIIT.
Taking into account the stylized nature of the gravity equation, α1 > 0, α 2 > 0,

α 3 < 0 are expected. After having controlled the trade volume by traditional explanatory
variables, we assume the following hypotheses:

Hypothesis 1: γ 0 > 0 ．It is expected that the rising share of VIIT in bilateral trade is the factor
explaining the increase of the trade volume in recent years.

11Hypothesis 2: γ 1 , γ 2 , γ 3 > 0 . It is expected that the rising share of VIIT in intra-regional trade
among East Asian countries, NAFTA members, and EU members has an additional effect on theincrease in trade among these countries.

In addition, the comparison of the estimated coefficients identifies whether or not theeffect that VIIT among East Asian countries has on trade volume is greater than the effect that
VIIT among NAFTA members and EU members has on trade volume.
Next, we estimate the effect of the changed share of VIIT on the change of tradevolume between two periods. The estimation is carried out by using the following equation:⎛ < TTVt jk ⎞< (GDPt j ⋅ GDPt k )< ( PGDPt j ⋅ PGDPt k )
⎟
ln⎜⎜
=
β
+
β
ln
+
β
ln
0
1
2
jk ⎟
(GDPt j ⋅ GDPt k )( PGDPt j ⋅ PGDPt k )⎝ TTVt ⎠< VIIT jk
3jk+ (δ 0 + ∑ r =1δ r Dr ) ln
+ ηt jk
jk
VIIT

(5)

Hypothesis 3: δ 0 > 0 . It is expected that the elasticity of the trade volume to the increase in
VIIT is positive.

Hypothesis 4: δ 1 , δ 2 , δ 3 > 0 . It is expected that the elasticity of trade volume to the increase in
VIIT in among East Asian countries, NAFTA members, or EU members is larger than thatamong other countries.
12In addition, we compare the estimated coefficients to identify whether or not theelasticity of the increase in trade to the increase in VIIT among East Asian countries is greaterthan the elasticity among NAFTA and EU countries.

3.2 Data and the Estimated Results
For the estimation, we construct the data set of VIIT between two countries. The
available statistical data here consist of GDP and GDP per capita in 1996 and 2004, and 402
indices of VIIT calculated by the bilateral trade of 21 countries in two periods of the late 1990s
and the early 2000s 6 . The source of trade data is “UN ComTrade”. In our data set, East Asian
countries include China, Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore,
Thailand, and Vietnam. NAFTA include Canada, Mexico, and the U.S., and EU include France,
Germany, Hungary, Italy, Sweden, and the UK.
We estimate the coefficients in equation (4) based on both OLS and panel data. The
terms of fixed effects absorb two country-pair specific factors such as the distance, the nationalboundary, the difference in language and so on. Only OLS estimation is conducted for equation(5). Table 2 and Table 3 present the estimated results.

6 The data cover 21countries; Australia, Brazil, Canada, China, Germany, France, Hungary, India,

Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Philippines, Singapore, Sweden, Thailand, UK,
U.S.A. and Vietnam. The total number of the share of VIIT between two countries is 402 because of
the unavailability of value and quantity data in industry categories of some country pairs.

13

Table 2 and Table 3

They are summarized as follows:(i) After having controlled the standard variables such as the size of economy and the per capita
GDP, the effect of a rising share of VIIT has on the world trade volume is positive with astatistically high significance. The estimated results support that a rising share of VIIT leads toan increase in trade volume. (Hypothesis 1)(ii) The results show with a statistically high significance that the share of VIIT in trade among
East Asian countries, NAFTA countries, and EU countries has an additional effect on theincrease of the trade volume (Hypothesis 2). With this respect, although the additional effectthat the share of VIIT among East Asian countries has on the trade volume (0.6) is not as large
as the additional effect in NAFTA countries (0.9), it is larger than the additional effect in EU
countries (0.4). That is, the effect that the share of VIIT in East Asian countries has on the tradevolume is comparable to the effect on trade caused by the rising share of VIIT in the countries
that have achieved regional trade arrangements.
(iii) The elasticity of the increase in the trade volume to the increase in VIIT is positive andsignificant (0.11). It is certain that the increase in trade volume due to the increase in VIIT is afeature to characterize the world trade in 1990s and 2000s. (Hypothesis 3)(iv) As to whether the elasticity of the increase in trade to the increase in VIIT is different
among East Asian countries, NAFTA countries, and EU countries, a statistically significant

14result is not obtained. (Hypothesis 4) The structural change in trade expressed by the increase in
VIIT is common, meaning there is no difference between East Asian, NAFTA and EU countries.
Empirical studies in this section present that the expansion of trade due to the increasein VIIT is observed widely in the world trade, and that the effect of a rising share of VIIT on
trade volume among East Asian countries in recent years is almost same as among NAFTA
countries, and greater than that among EU countries. As a rising share of VIIT reflects thedevelopment of international fragmentation of production, the estimated results suggest that a
recent increase in trade among East Asian countries is caused by the development offragmentation.

4. Impediments to Fragmentation
The international fragmentation of production means that the production process up to
final goods is decomposed into a number of production processes having different factor
intensities that are located in geographically different countries. As the share of VIIT is definedby the trade in goods in halfway between the trade of goods belonging to different industries
with different factor intensity and the trade of differentiated goods within the same industry.
Therefore, it is expected that a certain disparity in factor abundance among countries isnecessary for VIIT. Larger heterogeneity in factor endowment among East Asian countries is adriving force for a higher share of VIIT. From statistical data we find that the disparity of wage
rate and per capita income in East Asian countries is larger than NAFTA and EU countries. In

15this sense, the heterogeneity in factor abundance among East Asian countries holds a necessary
condition that induces an increase in VIIT.
Needed for increased VIIT is not only the heterogeneity in factor endowment but also
low service link costs defined by the cost for connecting the different production plants locatedin different regions. High service link costs impede the fragmentation of production processes
and then lower the share of VIIT. Factors influencing service link costs include both hardware
and software. The former refers to the development of infrastructure, such as airports, ports,
roads, electric power, telecommunication network etc. The latter refers to (1) such factors as theexistence of customs duties, restrictions on imports, and technical barriers for import inspection
to impede market access, (2) government restrictions on FDI that impede the internationaltransfer of capital, technology and management know-how, (3) the degree of protection of theintellectual property rights, (4) the lack in better educated human resources. While
heterogeneous factor prices induce the fragmentation of production and raise the share of VIIT,
the heterogeneity of hardware and software among countries that constitutes a factor raising
service link costs conversely impedes the fragmentation and lowers the share of VIIT.
In comparison with NAFTA and EU countries, there still exist high customs duties,
restrictions on imports, and technical barriers accompanying inspection procedures for exports
and imports impede trade. In addition, at the same time, trade related investment measures(TRIMs) such as foreign exchange restriction, remittance control, export performancerequirement, local content requirement and restriction on share holdings in the host countries

16exist. For example, Malaysia, Philippines and Thailand hold Local Contents Requirement,
Philippines hold Exchange Control. They impede FDI of multinational firms and generate
unfavorable environment to local production. Wakasugi (2005) and Fung, et al. (2005) point out
that the improvement of software is important for inducing the local production by multinationalfirms in China. The generation of favorable environment for FDI is necessary for accelerating
fragmentation.
It is pointed out that inappropriate protection of intellectual property rights (IPRs) is
inclined to impede fragmentation. In theoretical studies, Glass and Saggi (2002) presents thatthe inadequate protection of IPRs in the South causes the North to give up efforts for generating
new technology and the South to use its production factors for imitation. As Table 4 shows, The
index of patent protection by Park and Wagh (2002) presents that the enforcement of IPRs isheterogeneous among East Asian countries. In empirical studies, Smith (2001), Maskus andPenubarti (1995), Wakasugi (2005), and Branstetter (2006) point out that the weak protection of
IPRs has a possibility to impede not only technology transfer from North to South, but also the
expansion of trade and local production through FDI. East Asian countries hold problems to be
improved for further developing fragmentation.

Table 4

As for welfare implication of fragmentation, Jones (2003) and Kierzkowski (2003)

17

mention the changes in price of production factors caused by the increase of fragmentation.
They assert that the specialization to manufacturing parts and intermediate goods along with acomparative advantage realizes the change of factor prices of trade partners in two ways. First,
it increases the wage rate in countries where labor is a relatively abundant production factor,
while it lowers the wage rate in countries where capital is abundant. This eventually equalizes
the wage rate between two countries in the long term. The expansion of trade among East Asian
countries through a rising share of VIIT is expected to have a positive effect on the income
levels in labor abundant countries in East Asia, and on the equalization of income level among
these countries. Second, the development of fragmentation compatible to the comparativeadvantage raises the productivity through a realization of the scale economy, which in turnraises the marginal product of factor. Even assuming that the fragmentation is induced byforeign direct investment, and that a part of the benefit from FDI is refluxed to the investing
country as reward of capital, the fragmentation still contributes to a rise of income through theincrease in wage rate and job opportunities. In these ways, it is expected that a rising share of
VIIT that reflects the development of international fragmentation is beneficial to theimprovement of economic welfare in East Asian countries.

5. Concluding Remarks
This paper presents statistical evidences that the share of VIIT has been rising in theseyears among East Asian countries, although there remain problems in measuring VIIT, in

18

particular measuring unit value of exports and imports. It also presents that the rising share of
VIIT has a significant impact on the expansion of trade among these countries, and that the
expansionary effect on trade among East Asian countries is comparable to the effect for NAFTA
countries and greater than the effect for EU countries. Since international fragmentation of
production leads to a rise of the share of VIIT, we can assume that the recent increase in trade
among East Asian countries has been induced by the development of fragmentation.
As the development of fragmentation not only leads to the increase of trade, but also arise of production efficiency and factor reward, the policy to provide a favorable condition fordeveloping fragmentation will be common goal for East Asian countries. The improvement ofmarket access alone is not sufficient to this end. It is desirable to eliminate such institutional
factors as impediments for efficient market transactions, restrictions on FDI, and inadequate
IPRs that undermine fragmentation of production. In comparison with NAFTA and EU
countries, East Asian countries are heterogeneous in these institutional impediments.
In recent years, a number of bilateral FTA negotiations have been conducted among
East Asian countries. To date, more than 25 free trade agreements (FTAs) have been concluded
or taken effect. Moreover, those under negotiation or being proposed number are more than 35.
The elimination of institutional impediments is accelerated by concluding bilateral Economic
Partnership Agreements (EPA) among East Asian countries. On the other hand, EPA between
two countries may give rise to a complicated trade system vis-à-vis third countries. When these
FTAs become effective, it is worried about that bilateral FTAs might constitute a spaghetti bowl

19

of “Rule of Origin”. To eliminate factors that complicate trade, it is more desirable to push amultilateral agreement under the WTO framework than to accumulate complicated bilateralagreements. In this regards, the formation of East Asian economic integration, while it creates a
better environment for fragmentation that leads to further trade expansion and economic
development in East Asian countries, will be thought as a second best policy to be explored by
the countries in the region.

20

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22

Rights?” Journal of International Economics, 39, 227-248.
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whom, and Why?” in Leonard K. Cheng and Henryk Kierzkowski (eds.), Global
Production and Trade in East Asia, Kluwer Academic Publishers, 63-109.
Park, Walter G. and Smita Wagh (2002) “Index of Patent Rights” in Economic Freedom of theWorld: 2002 Annual Report, Chapter 2, pp. 33-43.
Smith, Pamela J. (2001), “How Do Foreign Patent Rights Affect U.S. Exports, Affiliate Sales,and Licenses?” Journal of International Economics, 55, 411-439.
Wakasugi, Ryuhei (2005), “The Effects of Chinese Regional Conditions on the Location Choiceof Japanese Affiliates,” Japanese Economic Review, 56 (4), 390-407.
Wakasugi, Ryuhei and Banri Ito (2005), “The Effects of Stronger Intellectual Property Rights
on Technology Transfer: Evidence from Japanese Firm-level Data,” KUMQRP
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Figure 1. Value Chain after Fragmentation<Before Fragmentation: Value Chain within a plant/country>

Country A

Boarder
Parts/Intermediate Goods<After Fragmentation: Production across countries >BoarderCountry B

Country A

Country D
Country C

Trade in Parts/Intermediate Goods

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Table 1. The Changes in Shares of Horizontal and Vertical Intra-industry Tradebetween Two period: 1995/96 and 2003/04
1995-96
HIIT

2003-04
VIIT

HIIT

VIIT

Australia

14.0

10.8

14.0

12.3

Canada

32.0

17.3

28.4

22.4

China

8.7

18.3

7.9

31.2

France

32.5

27.5

30.9

30.6

Germany

29.2

30.0

30.6

32.4

Hungary

9.7

25.7

16.9

29.9

India

2.6

12.7

9.0

13.2

Indonesia

6.7

7.3

11.3

11.0

Italy

16.9

28.2

17.1

30.4

Japan

6.7

23.9

7.8

24.1

Korea, Rep.

16.8

19.4

17.8

20.1

Malaysia

n.a.

n.a.

9.1

39.1

Mexico

7.1

29.9

3.6

39.1

Singapore

n.a.

n.a.

17.8

49.9

Sweden

16.1

29.0

22.5

28.5

U.K

34.6

29.8

29.1

36.2

U.S.A
22.9
28.6
17.5
30.8
(Notes)
1. HIIT and VIIT denote the share of horizontal intra-industry trade and the share of verticalintra-industry trade, respectively.
2. The figures are calculated by the available data of value and quantity of exports and imports
in 1995-96 and 2003-04 from “UN Comtrade”.

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Table 2. The Effects of Rising Share of VIIT on Increase in Trade: Estimated Results
OLS(1)

OLS(2)

Panel: Fixed Effecfs (1)Panel: Fixed Effecfs (2)GDP

0.637 **

(23.801)

0.696 **

(26.053)0.574 **

(11.390)0.607 **

(11.723)

PGDP-0.022(-0.804)

0.058(2.248)0.015(-0.240)

0.086(1.424)VIIT

0.317 **

(6.724)

VIIT*East Asia Dummy

0.636

**

VIIT*NAFTA Dummy*

0.231 **

(4.193)**(8.914)0.792 **

(11.377)(12.103)

0.806

**

(16.596)0.660

0.619 **

(5.505)0.683 **

(5.777)0.930 **

(7.145)1.030 **

(7.724)

VIIT*EU Dummy

0.351(6.519)0.441(8.021)

0.420(6.638)0.455**(6.954)

Time Dummy=1 for 2003/04

0.051(0.622)0.142(1.665)0.088(1.263)0.151 *

(2.120)(-9.658)-17.102

Constant-12.964

N. of Obs

402

**

**

**

**

402

**

(-13.595)
402

402

0.808
0.786
0.941
0.861
Adjust-R2(Notes)
1. PGDP denotes per capita GDP.
2. VIIT*East Asia Dummy denotes the multiplication of the VIIT share and the dummy variable for East Asian countries, as same for VIIT*NAFTA Dummy and
VIIT*EU Dummy.
3. As for regional dummy, East Asia includes China, Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, Thailand and Vietnam, NAFTA includes
Canada, Mexico and the U.S., and EU includes France, Germany, Hungary, Italy, Sweden and the UK.
4. The figures in the parentheses are t-statistics. * and ** present the statistical significance level of 5% and 1%, respectively.
5. The results estimated on random effects model are omitted.

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Table 3. The Elasticity of the Increase in Trade to Rising Share of VIIT: Estimated Results
OLS(1)

OLS(2)∇GDP/GDP

0.548

**

∇PGDP/PGDP

1.537

**

(5.787)∇VIIT/VIIT

0.113 *

(2.298)(∇VIIT/VIIT)*East Asia Dummy

0.103(1.217)0.183 *

(2.352)(∇VIIT/VIIT)*NAFTA Dummy-0.267(-0.313)-0.259(-0.303(∇VIIT/VIIT)*EU Dummy

0.202(0.490)0.187

Constant-0.366(-4.678)-0.340N. of Obs

190**

(4.271)0.550 **

(4.234)1.590**(5.939)(0.448)**(-4.344)

190

2

0.529
0.508
Adjust-R(Notes)1. ∇GDP/GDP denotes the rate of changes in GDP, as same for∇PGDP/PGDP and∇VIIT/VIIT.
2. PGDP denotes per capita GDP.
3. VIIT denotes the share of vertical intra-industry trade.
4. ∇VIIT/VIIT *East Asia Dummy denotes the multiplication of the rate of changes in VIIT and the dummy
variable for East Asian countries, as same for ∇VIIT/VIIT *NAFTA Dummy and ∇VIIT/VIIT *EU Dummy.
5. As for regional dummy, East Asia includes China, Indonesia, Japan, Korea, Malaysia, the Philippines,
Singapore, Thailand and Vietnam, NAFTA includes Canada, Mexico and the U.S., and EU includes France,
Germany, Hungary, Italy, Sweden and the UK.
6. The figures in the parentheses are t-statistics. * and ** present the statistical significance level of 5%
and 1%, respectively.

Table 4. Index of Patent Protection
1990

1995

2000

China

n.a.

1.55

2.48

Indonesia

0.33

1.24

2.27

Japan

3.94

3.94

4.19

Singapore

2.57

3.9

4.05

Thailand
1.85
2.24
2.24
(Source) Park and Wagh (2002)(Note) The score ranges from 0 to 5; a high score implies a stronger IPR system.

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