The Growth and Determinants of Vertical Trade in Korea

This paper measures the volume of vertical trade in Korea and investigates its determinants. The contributions of this paper are as follow. First, the measurement method in this paper is related to Hummels et al. (2001), but it improves upon their method in that it uses information on intermediate goods trade as well as the input-output tables of trading countries. Second, this paper derives a functional form for the determinants of vertical trade from a monopolistic competition model of trade and multinational production. The empirical results show that Korea’s trade has been becoming more vertically specialized over last ten years. In particular, vertical exports to China have grown rapidly since the early 2000’s, and thus the surplus on vertical trade has widened dramatically in recent years. The empirical estimation with 32 trading partners during the period of 1995-2003 provides evidences that the determinants of Korea's vertical trade are broadly consistent with the theoretical predictions: it has been affected by relative labor costs and productivity, as well as by the gravity-related variables such as trade cost and market accessibility. Korea’s vertical trade was also indirectly affected by relative fixed costs through the change in the stock of FDI. Based on these results, it can be said that, for the last ten years, the growth of Korea’s trade has been largely attributed to the expansion of international production fragmentation accompanied with intermediate goods trade, and also that a monopolistic competition model of trade and production accounts quite well for the pattern of vertical trade in Korea