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The Growth and Determinants of Vertical Trade in Korea

Economic Research Institute (+82-2-759-5425) 2008.03.10 4810

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-

2005 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