The nature and growth of vertical specialization in world trade

Dramatic changes are occurring in the nature of international trade. Production processes increasingly involve a sequential, vertical trading chain stretching across many countries, with each country specializing in particular stages of a good's production sequence. We document a key aspect of these vertical linkages--the use of imported inputs in producing goods that are exported -- which we call vertical specialization. Using input-output tables from the OECD and emerging market countries we estimate that vertical specialization accounts for up to 30 percent of world exports, and has grown as much as 40 percent in the last twenty-five years. The key insight about why vertical specialization has grown so much lies with the fact that trade barriers (tariffs and transportation costs) are incurred repeatedly as goods-in-process cross multiple borders. Hence, even small reductions in tariffs and transport costs can lead to extensive vertical specialization, large trade growth, and large gains from trade. We formally illustrate these points by developing an extension of the Dornbusch-Fischer-Samuelson ricardian trade model.