Analysis of Intra- and Inter-regional Trade in East Asia:Comparative Advantage Structures and Dynamic Interdependency in Trade Flows

July 2002
Takashi Isogai
Hirofumi Morishita
Rasmus Ruffer (ECB)

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Summary

- The rapid changes that occurred in the economic structure of the East Asian region over recent decades has resulted in stronger trade interdependencies between Japan, the US and East Asia and within East Asia. This is largely due to the role that East Asia plays as a production base for Japanese and US companies -especially in the field of information technology goods, where East Asia has become the "global supply center". This integration of East Asia into the international production process appears to have been driven to a large extent by the significant flows of foreign direct investment -especially from Japan -into the area over the past decade.

- Most of the countries of East Asia have a "revealed comparative advantage"(RCA) in product categories containing a high share of IT-related goods (especially "Office machines and automatic data-processing machines"and "Electrical machinery"). In many cases, an RCA is associated with a "revealed comparative disadvantage" on the import side. Thus in many East Asian countries imports and exports of IT-related product categories comprise a larger share of overall imports and exports than in average world trade flows. This suggests that rather than having a comparative advantage in the production of entire products and thus specializing in the production of that product, East Asian countries specialize in certain downstream stages of the production process, resulting in simultaneous imports and exports in the associated broadly defined product categories.

- This comparative-advantage pattern has become increasingly pronounced during the 1990s, as the East Asian countries have substantially increased their RCA on the export side, while at the same time often increasing their RCDA on the import side.

- The increasing participation of East Asian countries in the global production process is also reflected in the high degree of intra-industry trade. Among the East Asian economies, intra-industry trade, as measured by Aquino's generalized index of intra-industry trade -is highest in the newly industrialized economies (NIEs), followed by the ASEAN economies and China. In line with the increased trade and production integration the degree of intra-industry trade has increased throughout the 1990s, especially in the SITC 1-digit sub-category "Machinery and Transport Equipment", with the Philippines and China experiencing particularly large increases in intra-industry trade.

- The effects of the observed increasing internationalization of the production process on the international transmission of country-specific developments is likely to be rather complex, going beyond the mere effects of a diversion of trade to other trading partners. In order to study these transmission channels a VAR of inter- and intra-regional trade flows is estimated, yielding three main findings:

- First, the estimation results are consistent with quantitatively significant indirect shock transmission channels along the international production chain. For example, an increase in East Asian exports to the US is preceded by an increase in intra-regional trade, which in turn is preceded by an increase in exports of Japan to other East Asian countries.

- Second, an important asymmetry in the relationship between Japan and East Asia and between the US and East Asia exists. While Japanese exports to East Asia "cause" significant inter-regional trade and ultimately exports to the US by East Asia, the reverse pattern for US exports to East Asia receives relatively little support by the data. Only East Asian exports back to the US appear to be affected by changes in US exports to East Asia. Thus, it appears that Japanese companies utilize East Asian countries as a production and export platform, whereas for US companies they are a production platform.

- Third, the role of East Asia as a production base in combination with comparatively small independent domestic demand factors in the region creates a situation in which intra-regional trade flows within East Asia are largely driven by developments abroad, as indicated by the variance decomposition analysis. Furthermore, the effect of trade with Japan is considerably more pronounced than trade with the US, underlining the strength of the Japan-East Asia trade linkage.