APO-Keio Special Lecture Dale W. Jorgenson

Samuel Morris University Professor, Department of Economics, Harvard University hosted by Asian Productivity Organization (APO) and Keio Economic Observatory, Keio University

(May 22, 2014)

International Production Networks and a New Development Strategy in East Asia

Fukunari Kimura

Professor, Faculty of Economics, Keio University

Chief Economist, Economic Research Institute for ASEAN

and East Asia (ERIA) 1

1. The 1st to the 2nd unbundling

• The international division of labor: from industry-by-industry to production process/task wise

• The 2nd unbundling in East Asia, most advanced, particularly in manufacturing

– Dominance of machinery industries

– Fragmentation of production and the formation of industrial agglomeration

2

The 2nd Unbundling

2012/02/03 3

Bay B Bay A

Bay C

Bay B

Bay A

Bay C

1st 2nd

ICT

The 2nd unbundling, i.e., international division of labor in terms of production processes and tasks, has developed since the 1980s, based on drastic reduction in coordination costs due to ICT revolution.

The 2nd unbundling in the manufacturing sector is most advanced in East Asia.

Source: Baldwin (2011).

3

The fragmentation theory: Production blocks and service links

PB: production blocks

SL: service links

4

PB

PB PB

PB

PB

SL

SL

SL

SL

SL

After fragmentation

Before fragmentation

Large integrated factory

Tradeoff between the reduction in production costs in PB and the enhancement of SL costs. Fragmentation of production occurs particularly between countries at different development stages (Jones and Kierzkowski (1990)).

Two-dimensional fragmentation: An illustration

Source: Kimura and Ando (2005).

OEM contracts

Subcontracting

Internet auction Competitive spot bidding

Cross-border intra-firm

fragmentation

Disintegration

(National border) Distance

(Boundary of firm)

Origin

Domestic intra-firm

fragmentation

Domestic arm's length

fragmentation

Cross-border arm’s length

fragmentation

Outsourcing

EMS

Industrial agglomeration International fragmentation

5

The evolution of the 2nd unbundling

The United States

Mexico

Consumers

Headquarters or affliates

Unrelated firms with same firm nationality

Unrelated firms with different firm nationality

The United States

Consumers

Consumers

Japan

Korea

Vietnam

Malaysia

The Philippines

Taiwan

Internet

auction

Agglomeration

Agglomeration

Cross-border production sharing (back-and-forth; intra-firm)

Production networks (“networks”; fragmentation and agglomeration;

intra-firm in short distance, arm’s length in long distance)

6 Source: Ando and Kimura (2010).

36.4

36.1

29.7

20.6

15.3

12.3

10.5

10.4

0.8

0.0

18.0

10.1

2.6

1.2

0.9

0.6

9.6

10.9

11.2

1.4

3.2

12.3

50.8

0.0

2.7

5.2

0.2

0.1

19.6

15.6

10.1

19.6

24.8

21.4

31.4

25.6

12.1

21.6

14.9

32.5

30.3

19.7

1.0

0.6

4.0

4.2

0.8

3.6

2.8

2.5

0.8

1.6

1.8

2.4

2.0

2.9

4.6

6.4

5.3

7.0

10.3

6.1

2.8

3.2

3.1

4.2

8.2

6.6

6.3

5.5

19.7

14.5

20.2

18.4

13.7

17.4

17.6

14.2

3.7

20.8

17.2

10.9

10.9

13.8

13.8

8.1

4.8

4.4

6.6

6.5

6.9

6.5

3.4

12.3

7.3

7.0

8.2

10.3

0.1

7.4

6.4

5.6

7.2

17.8

11.8

12.9

6.1

28.8

16.0

10.9

19.3

16.8

4.0

10.7

10.0

9.3

10.2

13.4

13.1

12.3

19.3

10.6

14.0

14.4

20.1

29.7

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Myanmar

Cambodia

Laos

Vietnam

Indonesia

Philippines

Thailand

Malaysia

Brunei

Singapore

India

China

Korea

Japan

Industry shares of value added, 2010

Agriculture，hunting，forestry and fishing

Mining and quarrying

Manufacturing

Electricity, gas and water supply

Construction

Wholesale and retail trade, repair of vehicles and household goods, hotels and restaurants

Transport, storage and communications

Financial intermediation, real estate, renting and business activities

Community, social and personal services

Data source: APO Productivity Database by the courtesy of Koji Nomura. 7

15.5

46.6

29.1

22.3

11.8

3.2

9.5

13.9

4.1

63.7

5.9

7.8

8.2

1.7

0.3

15.1

1.4

4.2

1.6

1.1

5.0

0.9

3.3

0.1

2.1

1.3

0.4

2.3

1.5

4.1

2.3

3.1

2.8

2.7

5.4

2.6

3.2

14.5

24.4

21.5

30.7

26.7

21.8

15.8

15.7

3.6

2.7

2.8

3.9

3.2

0.8

6.7

3.1

3.3

1.8

3.4

1.7

2.0

2.8

0.3

11.3

9.5

17.2

8.3

21.3

24.4

34.1

42.6

62.4

30.9

44.8

51.1

0.0

3.1

0.7

4.8

0.9

3.4

0.1

4.9

1.4

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Cambodia

Philippines

Indonesia

Thailand

Malaysia

Singapore

India

Japan

Korea

Industry shares of value added in manufacturing, 2010

…Food products, beverages, and tobacco products

…Textiles and wearing apparel, and leather products

…Wood and products of wood and cork

…Paper, paper products, printing, and publishing

…Coke, refined petroleum products, nuclear fuel, chemicals, rubber, and plastic products

…Other non-metallic products

…Basic metals

…Machinery and equipment

…Other manufacturing

Data source: APO Productivity Database by the courtesy of Koji Nomura. 8

Source: Ando and Kimura (2013).

The 2nd unbundling

The 1st unbundling

Export shares of machinery parts and components in total exports indicate the degree of participation in international

production networks.

9

Source: Ando and Kimura (2013).

The 2nd unbundling

The 1st unbundling

10

Machinery exports and imports by regions (US$ millions)

Source: Chang and Kimura (2013). 11

0

500,000

1,000,000

1,500,000

2,000,000Ex

po

rts1

99

3

Imp

ort

s19

93

Exp

ort

s20

11

Imp

ort

s20

11

Exp

ort

s19

93

Imp

ort

s19

93

Exp

ort

s20

11

Imp

ort

s20

11

Exp

ort

s19

93

Imp

ort

s19

93

Exp

ort

s20

11

Imp

ort

s20

11

Exp

ort

s19

93

Imp

ort

s19

93

Exp

ort

s20

11

Imp

ort

s20

11

Exp

ort

s19

93

Imp

ort

s19

93

Exp

ort

s20

11

Imp

ort

s20

11

ROW EU27 ASEAN+6 LA NAFTA

Final Products

Parts andComponents

12

The size of industrial agglomerations in East Asia

Jakarta’s cluster size

Bangkok’s cluster size

Source: ERIA.

2. Fundamental changes in development strategies

• Latecomers: jump-start industrialization by participating in international production networks

– Reduction in three types of costs

• Middle-income countries: agglomeration, industrial upgrading, innovation

13

14

Reduction in network set-up cost

Reduction in service link cost

Reduction in production cost per se

High-level FTAs

• Investment liberalization

• IPR protection • Competition policy

• Tariff removal • Trade facilitation • Enhancing

institutional connectivity

• Liberalization of production-supporting services

• Investment liberalization

Development agenda

• Investment facilitation/promotion

• Enhancing physical connectivity (including hard and soft logistics infrastructure development)

• Reducing transaction cost in economic activities

• Upgrading infrastructure services such as electricity supply and EPZs

• Enhancing agglomeration effects through SME development

• Strengthening innovation

Policies for enhancing the 2nd unbundling

Border Development with Enhancement of Connectivity

GDP per capita (2005)

(source) Kudo and Kumagai (forthcoming) 15

1.5

2.0

2.5

3.0

3.5

4.0

4.5

300 3,000 30,000

LPI 2012 ASEAN 2012 CLMV 2007 Fitted line (LPI 2012)

Singapore

Malaysia

Thailand

Indonesia

Philippines

Viet Nam

Cambodia

Lao PDR

GDP per capita (2012, Nominal USD)

LPI 2012

Myanmar

Hong Kong

Korea

China

India

LPIs in forerunner ASEAN and East Asia are relatively higher compared with the indices obtained by regression

= higher LPI compared with GDP/GNI per capita

= better access between primary cities to primary ports

= high competitiveness in the global market

16

Source: Modified from ERIA (2010)

Correlation between LPI and GDP per capita

SMEs

Innovation in

industrial agglomeration

International production networks

Access to technology Access to finance Fostering human resources Establishing industrial organizations

SME-related policies reviewed by SME Policy Index

Technology transfer/spillover Managerial knowhow

Market access

Innovation in industrial agglomeration

17

Source: ERIA (2012).

18

3. Impact on developed countries

• International production networks, important sources of competitiveness of corporate firms

• Can be good for the whole country, too. – Relative expansion of domestic operations by

expanding multinationals (Ando and Kimura (2012a))

• Stability/resiliency of production networks – Ando and Kimura (2012b) on Japan’s exports with the

GFC and the East Japan Earthquake

– Todo, Nakajima, and Matous (2014) on factory operations with the East Japan Earthquake

19

1998-2002 2002-2006 2007-2009

Firms that do not have an affiliate in East Asia

32% 51% 41%

Firms that have affiliates in East

Asia: The number of

affiliates

Increases (including the

first direct investment)

33% 64% 52%

Keep the same number

25% 54% 43%

Decreases (including

withdrawal) 25% 50% 40%

All manufacturing firms 32% 53% 42%

Outward foreign direct investment and domestic employment by Japanese manufacturing firms: The ratio of firms that expand domestic employment

Source: Ando and Kimura (2012a). 20

4. Implication for productivity studies

• Industry-level productivity to be elaborated. – Different activities by production processes/tasks;

international relation-specific division of labor

– Mixture of multinationals and local firms

• Economic environment outside a firm matters. – E.g., service link costs crucial to production networks

– E.g., agglomeration effects (+/-)

• Evolving nature of technological progress – New type of middle-income countries

• Dependency on multinationals, tech. gaps, small R&D

21

References • Ando, Mitsuyo and Kimura, Fukunari. (2012a) “International Production Networks and Domestic Operations by Japanese

Manufacturing Firms: Normal Periods and the Global Financial Crisis.” RIETI Discussion Paper Series 12-E-047 (http://www.rieti.go.jp/jp/publications/act_dp.html).

• Ando, Mitsuyo Ando Fukunari Kimura (2012b) “How Did the Japanese Exports Respond to Two Crises in the International Production Networks? The Global Financial Crisis and the East Japan Earthquake.” Asian Economic Journal, 26, No. 3: 261-287.

• Ando, Mitsuyo and Kimura, Fukunari. (2013) “Production Linkage of Asia and Europe via Central and Eastern Europe” Journal of Economic Integration Vol.28 No.2, pp.204-240.

• Baldwin, Richard. (2011) “21st Century Regionalism: Filling the Gap between 21st Century Trade and 20th Century Trade Rules.” Centre for Economic Policy Research Policy Insight No. 56 (May) (http://www.cepr.org).

• Chang, Mateus Silva and Kimura, Fukunari. (2013) “The Evolution of Production Networks in Machinery Industries.” mimeo.

• Economic Research Institute for ASEAN and East Asia (ERIA). (2010) Comprehensive Asia Development Plan. ERIA Research Project Report 2009-7-1, Jakarta: ERIA (http://www.eria.org/publications/research_project_reports/the-comprehensive-asia-development-plan.html).

• Economic Research Institute for ASEAN and East Asia (ERIA). (2012) Phnom Penh Initiative for Narrowing Development

Gaps. Jakarta: ERIA.

• Jones, R. W. and H. Kierzkowski. (1990) “The Role of Service in Production and International Trade: A Theoretical Framework.” In The Political Economy of International Trade: Essays in Honor of Robert E. Baldwin, edited by In R. W. Jones and A. O.Krueger. Oxford: Basil Blackwell.

• Kimura, Fukunari and Ando, Mitsuyo. (2005) “Two-dimensional Fragmentation in East Asia: Conceptual Framework and Empirics.” International Review of Economics and Finance (special issue on “Outsourcing and Fragmentation: Blessing or Threat” edited by Henryk Kierzkowski), 14, Issue 3: 317-348.

• Todo, Yasuyuki; Nakajima, Kentaro; and Matous, Petr. (2014) “How Do Supply Chain Networks Affect the Resilience of Firms to Natural Desasters? Evidence from the Great East Japan Earthquake.” Mimeo. The former version of this paper is in http://www.rieti.go.jp/jp/publications/dp/13e028.pdf.

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