The role of foreign value added in creating Poland's comparative advantage in world merchandise exports

Tomasz Białowąs, Monika Wojtas The role of foreign value added in creating Poland's comparative advantage in world merchandise exports Oeconomia - U N I V E R S I T A T I S VOL. XLVIII, 2 The role o f foreign value added in creating P o la n d ’s comparative advantage in world merchandise exports Rola zagranicznej wartości dodanej w tworzeniu przewagi komparatywnej Polski w światowym eksporcie towarowym Słowa kluczowe: Polska, eksport, przewaga kom paratyw na, zagraniczna i krajowa wartość dodana Introduction One o f m ajor trends in the world economy in the global era is international fragm entation o f production, which m eans dividing previously integrated process into separate stages localized in various parts o f the world. This allows to deepen specialization and achieve additional gains from trade especially in m iddle-income countries such as Poland. There have been many theoretical papers on international fragm entation of pro­ duction. The m ost significant are two that started two different approaches towards the issue. R. Jones and H. Kierzkowski [1990] view production process as fragm ents of production blocks that are located in different geographical locations linked with various services (adm inistration, transportation, finance). Since diversification of labour productivity and factor cost is higher between countries rather than regions in a single country - fragm entation will be international. According to the standard approach, labour-intensive stages of production will be located in labour-abundant countries and capital-intensive activity - in capital-abundant countries. The second trend was initiated with a paper by D. Hummels, J. Ishii and K-M. Yi [2001]. They introduce a concept o f vertical specialization with production tasks localized in various countries. This leads to the creation of global value added chain. A country accepts parts and intermediate goods that are processed and then passed on in a more advanced form to the next link o f the chain for further processing. Both approaches complement each other, but the latter emphasizes the problem o f value added in various countries. Development of offshoring significantly alters countries’ trade specialization and in consequence their revealed comparative advantage. However, the inadequacy of statisti­ cal data that relies mainly on the gross exports was a barrier to carrying out meaningful analysis. A turning point in research on fragm entation was construction o f an alterna­ tive method o f m easuring trade flows based on value added. The theoretical basis for the method was developed in 1930s by the Nobel Prize w inner W. Leontief [1936]. Existing papers using trade data in value-added terms revealed important discrepancies in comparative advantage, trade balance and geographical structure o f exports and imports. R.C. Johnson and G. Nougera [2012] proved that real value o f bilateral trade (depending on a country) was 3-50% lower than calculated using traditional measures. The m ain goal o f the paper is to evaluate the im pact of international fragm enta­ tion on Poland’s comparative advantage. The analysis will focus on: 1) level of internationalization o f production and share o f foreign value added in Poland’s gross exports, 2) Poland’s comparative advantage in international trade based on RCA indexes calculated according to the traditional (gross exports) as well as alternative method based on the concept of country’s value added. The calculations were carried out using data from O EC D -W TO Trade in Value A dd ed (TIVA) database and the tim e fram e o f the analysis, determ ined by the avail­ ability of data, was lim ited to 1995-2009. 1. Research method One o f the fundam ental m ethods to evaluate the internationalization level of cou ntry’s production and its engagem ent in international production networks is m easuring the share of foreign value added in gross exports. Basic assumption in value-added to gross exports analysis is a possibility to assess national share of final product’s value. We simplify by skipping taxes and subsidies. Then, final product value (Tp) is a summation o f all value-added (VA) in the process o f production in subsequent countries. The form ula is ( 1 ): Vp = Z , V A f ( 1 ) Net value added of country A (NVA) which constitutes its trade balance, is a d if­ ference between gross exports and im ports as presented in form ula ( 2 ). Gross exports is a sum m ation of direct and indirect domestic value added (DVA) that country A is exporting and foreign value added (FVA) which consists of previously im ported foreign parts and components used in the production process. Imports consists of 3 elements: 1) bilateral value added (BVA), 2) reim ported value added (RVA) and multilateral value added (MVA). BVA is imports to country A of products which value was added in 100% in country B. RVA means those im ported products which final value was added in country В as well as components coming from A. MVA is that part of imports from В that has value added from country C. NVA = (DVA + FVA) - (BVA+RVA+MVA) ( 2 ) Standard m easure used to assess comparative advantage in world exports is Balassa index [Balassa, 1965]. The Balassa index is defined as the ratio of coun­ try ’s share in world exports of a given industry divided by its share in overall world trade. More specifically, BIA] is country A ’s Balassa index for industry^ defined as in formula ( 3 ). That is a ratio of share of in dustryj in country A exports (U) and share of industry j in reference country R exports (A). If BI) >1, country A is said to have a revealed comparative advantage (RCA) in industry^, since this industry is more im portant for country A ’s exports than for the exports of the reference countries. BIJJA = \sR J ( 3 ) Poland’s comparative advantage in international trade based on RCA indexes can be calculated in a traditional way using value of gross exports or in an alternative way - using domestic value added. In the first approach RCA value is determined by country’s integration with international production networks and foreign value added. The second one allows to view in a more objective way the real comparative advantage in world exports. 2. Share of foreign value added in Poland’s gross exports C ountry’s export potential is dependent not only on domestic enterprises export capability, but also on the activities of international corporations and nation’s engage­ ment in international production networks. Poland, in comparison to other economies of similar potential, is among most dependent on foreign components and intermediate goods. Furthermore, a significant increase in share of foreign value added in gross exports was noted in 1995-2008 - it grew from 15.42% to 30.59%. Due to global financial and economic crisis all the countries with the available data experienced a decrease in 2009. In Poland it fell to 27.89% (see Table 1). Share of foreign input into the gross exports is highly diversified among sectors of the economy. In 2009 the following sectors were characterized by the highest share of foreign value added: transport equipm ent (38.93%), electrical and optical equipm ent (34.07%), basic metals and fabricated m etal products (32.67%), chemicals and non-m etallic m ineral products (32.50%). The sectors w ith the lowest share o f im ported parts and com ponents were low technology industries, dependent on labor and raw m aterials, such as: m ining and quarrying (15.85%), agriculture, hunting, forestry and fishing (16.64%) (see Table 1). Further analysis of foreign value added share in Poland’s gross exports in various industries revealed the following trends. Share o f foreign com ponents and parts kept grow ing until 2005 in all sectors, except: 1) agriculture, hunting, forestry and fishing and 2) m ining and quarrying. The highest grow th occurred in industries with the m ost fragm ented production processes. In 1995-2005 share o f foreign value added in electrical and optical equipment increased by 28.04 percentage points, and in transport equipm ent - by 26.1 percentage points (see Table 1). In 2005-2008 share o f im ported parts in exports o f the two aforem entioned industries dropped. Sim ilar tendencies characterized wood and paper, other m anufacturing, textiles and footw ear as well as food, beverages and tobacco. The remaining industries noted a steady growth until 2008. M ain sources o f foreign com ponents used to m anufacture exported goods were countries o f the European Union, m ostly Germany. In 1995-2009 they accounted for 1/5 o f the total foreign value added in Polish exports. A part from Germ any other countries w ith significant shares were: Italy, France, the United Kingdom and the Netherlands. Outside the EU m ost com ponents came from Russia, the United States, China, Japan and South Korea (see Table 2). New version o f the OECD database, updated in May 2013, increased its utility al­ lowing to calculate input of each country of origin into foreign value added by industry. The data confirms that in 2009 m ain contributor o f foreign components in all industries except chemicals and non-m etallic m ineral products was Germ any (see Table 3). The new data also revealed high concentration o f foreign value added origin. In transport equipment Germany, the United States and Italy accounted for 16.18% of foreign value added, and G erm any’s share was 9%. In electrical and optical equipm ent share of Germany, the United States and C hina was 10.43%, and in basic m etals and fabricated metal products Germany, Russia and Italy contributed 12.65% of foreign value added. One o f the industries highly engaged in international production netw orks was tran sp o rt equipm ent. However, only 35.4% o f foreign value added in gross exports in 2009 originated in the industry. O ther com ponents and interm ediate goods were m an u factu red in basic m etals (8.14%), chem icals (4.82%), m in in g and qu arryin g (3.12%), electrical and optical equipm ent indu stry (2.39%) [OECD, 2013]. Input o f various services was much m ore significant, w hich is in accordance w ith theo reti­ cal assumptions m ade by H. Kierzkowski and R.W. Jones [1990]. In 2009 services accounted for 40.94% of foreign value added in exports o f transport equipment, in particular: wholesale and retail trade - 17.9%, business services - 10.08%, trans­ port, storage and telecomm unication - 5.29%. In other industries share o f services in foreign value added didn’t surpass 40% and value added from the same industry amounted for a large share o f foreign value added, especially in low technology and raw m aterials industries [OECD, 2013]. 2. Poland’s comparative advantage in world merchandise trade In term s o f traditional approach based on gross exports Poland had comparative advantage in exports o f food products, beverages and tobacco, wood and paper, basic metals and fabricated metal products, other m anufacturing and transport equipment (see Table 4). The largest gap characterized trade in electrical and optical equipment, m achinery and equipment, chemicals and non-metallic m ineral products, also after the year 2000 - textiles and footwear. M ain trends in 1995-2009 were the follow­ ing. In low and medium -low technology industries Poland’s comparative advantage weakened. In contrast, there was a g a in in comparative advantage in industries using advanced technologies. The highest grow th o f RCA indicator occurred in transport equipment (Balassa Index grew by 0.74), electrical and optical equipment (0.33) and m achinery and equipm ent (0.30). These industries have the highest shares o f foreign value added, over 30% o f gross exports. Source: own com pilation based on: OECD [2013]. Using the alternative method of calculating Balassa indexes based on domestic value added significantly alters Poland’s comparative advantage in world trade. RCA indexes in the following industries are considerably lower: transport equipment, m a­ chinery and equipment, basic metals and fabricated metal products, wood and paper, textiles and footwear. All o f the above were characterized by a high share o f foreign value added, which proves its im portant role in creating comparative advantage and export potential. However, an assumption that high share of foreign value added in gross exports contributes to gaining comparative advantage in international trade is too far-fetched. The influence may be positive as well as negative. In case of transport equipment foreign value added caused an increase in comparative advantage. But in other cases the results were opposite. In electrical and optical equipm ent foreign value added amounted to 34% o f gross exports in 2009, but there was a high comparative gap. RCA indexes calculated in a traditional way were even slightly lower than those based on domestic value added. Conclusion Changes in the functioning o f the world economy, cooperation and creation of international production networks requires a new approach to m easuring trade and comparative advantage. It is necessary to assess share o f the product’s value that was added in the analyzed country to evaluate its position in international trade. The analysis carried out in this paper showed that foreign parts and components were an im portant element o f Polish m anufacturing exports and their role increased consider­ ably in 1995-2009. Foreign value added was particularly important in high technology industries such as transport equipment or electrical and optical equipm ent while its role in low technology industries was minor. Large part o f foreign value added was contributed by European Union countries and in particular Germany. The data also confirmed the theory that services sector is a significant source of foreign value added. There is still a considerable gap in Polish exports competitiveness compared to the old European Union countries [Mucha-Leszko, Kąkol, 2009] so naturally there is a valid question whether foreign value added can be used to close this gap. However, the relation between comparative advantage and foreign value added was not proved to be straightforward. The Balassa indexes calculated using two methods were d if­ ferent, but the role o f foreign input was not always positive. In some industries it allowed Poland to be more competitive (e.g. transport equipment) while in others it weakened the advantage/enlarged the gap. The role of foreign value added in creating Poland’s comparative advantage in world merchandise exports The paper deals with changing approach to m easuring trade an com petitiveness due to the widely spread process o f international fragm entation o f production process which m akes it m uch more difficult to assess origin o f products in international trade. Therefore a method was developed to use foreign and domestic value added in order to evaluate country’s role in world trade as well as its comparative advantage. A uthors apply this methodology to Polish trade in goods in 1995-2009 and reveal that for­ eign com ponents were an im portant part of its exports. Poland was highly dependent on foreign value added from European Union countries, especially Germany. Sectors with highest shares were: transport equipment, electrical and optical equipm ent, basic m etals and fabricated metal products, chem icals and non-m etallic m ineral products. Foreign value added also affected Poland’s comparative advantage - its im pact on various industries was adverse. In some cases it im proved RCA indexes while in others using dom estic value added for the calculations resulted in a larger com parative advantage. Internacjonalizacja produkcji sprawiła, że tradycyjne m etody m ierzenia udziału kraju w św iato­ wym eksporcie oraz przew agi konkurencyjnej w m niejszym stopniu odzw ierciedlają rzeczyw istość. W zw iązku z tym zaczęły rozwijać się alternatyw ne m etody m ierzenia strum ieni handlu zagranicznego - na podstaw ie w artości dodanej. Celem opraco w an iajest ocena w pływ u m iędzynarodow ej fragm entaryzacji produkcji na kształtow anie się pozycji konkurencyjnej Polski. Szczegółow a analiza obejmuje udział zagranicznej w artości dodanej w eksporcie brutto Polski oraz kształtow anie się przew agi kon­ kurencyjnej na bazie indeksu Balassy, obliczonego na podstaw ie m etody tradycyjnej (eksport brutto), ja k również alternatyw nej (krajow a w artość dodana). Z astosow anie nowego podejścia do analizow ania polskiego eksportu ujaw niło duży w zrost znaczenia zagranicznej w artości dodanej w badanym okresie. Z ró d łem jej pochodzenia były w znacznym stopniu kraje Unii Europejskiej, zw łaszcza Niemcy, a sek­ tory, w przypadku których FVA m iała najw iększe znaczenie, charakteryzow ały się dużym stopniem wykorzystania technologii. N ależały do nich środki transportu oraz m aszyny i urządzenia. Inne wartości przyjm ow ały także indeksy ujawnionej przew agi konkurencyjnej obliczone przy uw zględnieniu zagra­ nicznej wartości dodanej. Z ałożeniejednak, że wysoki udział zagranicznej wartości dodanej w eksporcie brutto powoduje poprawę pozycji kom paratyw nej kraju w handlu m iędzynarodow ym , je st zbyt daleko idącym uproszczeniem . Może m ieć ona pozytyw ny wpływ, ale w niektórych sektorach okazał się on bardzo niewielki albo nawet w artości w skaźników były nieznacznie w yższe przy uw zględnieniujedynie krajowej w artości dodanej. 1. Balassa B. 1965 . Trade Liberalization and R evealed Comparative Advantage, “M anchester School of Economic and Social Studies” , vol. 32 . 2. Hum m els D., Ishii J. , Yi K-M. 2001 . The nature and growth o f vertical specialization in world trade , “Journal o f International Econom ics” , vol. 54 , no. 1. 3. Johnson R.C., N oguera G. 2012 . A cc o u n tin g fo r intermediates: Production sharing and trade in value added , “Journal o f International Econom ics” , vol. 86 . 4. Jones R.W. , Kierzkowski H. 1990 . The Role o f Services in Production a n d International Trade: A Theoretical Framework , [in:] Jones R.W., K rueger A .O. (eds.), The P olitical Econom y o f International Trade: E ssays in H onour o fR o b e rtA .M u n d e ll , M IT Press, Cambridge. 5. Leontief W. 1936 . Quantitative Input-O utput R elations in the Econom ic System o f the U nited States, “Review of Econom ics and Statistics”, vol. 18 , no. 3. 6. M ucha-Leszko B. , Kąkol M. 2009 . Will the fin a n c ia l economic crisis o f 2008-2009 accelerate m onetary integration in the EU?, “Eurolim es” , vol. 8 . 7. OECD , O E C D -W TO Trade in Value A d d ed (TIVA), http://stats.oecd.org/, (access: Sepem ber 2013 )