Evolutionary perspective of international production networksin the Asia-Pacific region1

(submitted for the 19th International Input-Output Conference, Alexandria, USA, 13-17 June 2011)

Satoshi Inomata, Institute of Developing Economies, JETRO

1. Introduction

The last few decades have witnessed the rapid development of vertical production

networks within the Asia-Pacific region. Production processes are fragmented into several stages and

countries specialize in each production stage according to their own comparative advantages.

In particular, as Pitigala (2009) points out, emerging economies in East Asia have

benefited considerably from the development of vertical production networks. These networks have

enabled them to join at the production stage that best corresponds to their level of technology, with

the result that they have enjoyed rapid trade and output growth.

2. Evolution of regional production networks

In order to investigate the backdrop to the rapid development of vertical production

networks, cross-border supply chains in the Asia-Pacific region will be evaluated from the

perspective of the ”strength” and ”length” of their linkages.

Figure 1 describes the evolution of regional networks over the last two decades. Arrows

represent selected supply chains among the countries of the region, with the direction of the arrows

corresponding to the flow of intermediate products. Each arrow has two features: thickness and

length. The thickness indicates the strength of linkages between industries, while the length, as

measured against the rings in the background, indicates the level of technological fragmentation of

that particular supply chain (see Appendix for the visualization method.)

In 1985, there were only four key players in the region: Indonesia (I), Japan (J), Malaysia

(M) and Singapore (S). The basic structure of the production network was that Japan built up supply

chains from resource-rich countries like Indonesia and Malaysia. In this initial phase of regional

development, Japan drew on a substantial amount of productive resources (natural resources) from

neighbouring countries to feed to its domestic industries.

By 1990 the number of key players had increased. In addition to the four countries already

mentioned, Japan had extended its supply chains for intermediate products to Korea (K), Taiwan (N)

1 This is a modified paper of Chapter VII from WTO and IDE-JETRO (2011).

and Thailand (T). While still relying on the productive resources of Indonesia and Malaysia, Japan

also started to supply products to other East Asian countries, especially to the country group known

as newly industrialized economies (NIEs). This is the phase when the relocation of Japanese

production bases to neighbouring countries, triggered by the Plaza Agreement in 1985, was

accelerating. It saw the building of strong linkages between core parts’ suppliers in Japan and their

foreign subsidiaries.

Then in 1995, the United States (U) came into the picture. It drew on two key supply

chains originating in Japan, one via Malaysia and the other via Singapore. These two countries came

to bridge the supply chains between East Asia and the US. Also to be noted is the length of the

arrows between Malaysia and Singapore. Compared to others, their shortness indicates that the

supply chains involve fewer production stages, suggesting that the degree of processing is relatively

low. It is considered that the product flows between these countries are distributional rather than

value-adding.

In 2000, on the eve of its accession to the WTO, China began to emerge as the third

economic giant. The country entered the arena with strong production linkages to its geographical

neighbours, Korea and Taiwan, and then gained access to Japanese supply chains through the latter.

The United States also brought a new supply chain from the Philippines (P). So the basic structure of

the tri-polar production network in the Asia-Pacific region was completed.2

The regional production networks thereafter showed dramatic development. By 2005, the

centre of the network had completely shifted to China, pushing the United States and Japan to the

periphery. China became the core market for intermediate products, from which final consumption

goods were produced for export to the US and European markets. Also of note is the nature of the

supply chains that China develops with others. The notable length of the arrows surrounding China

indicates that the supply chains towards China are characterized by a high degree of fragmentation

and sophistication, incorporating substantial amounts of value-added from each country involved.

The competitiveness of Chinese exports, therefore, is not only attributable to its cheap labour force,

but also stems from the sophisticated intermediate products it receives from other East Asian

countries, as embedded in goods labelled “Made in China”.

2 Interestingly, none of the poles, i.e. the USA, Japan and China, shows a direct linkage to either of the others. Instead, they are mutually connected only through the supply chains of other East Asian countries. This feature persisted even in 2005.

Figure 1: Evolution of regional production networks, 1985-2005

Source: Drawn by the author.

Figure 1: Evolution of regional production networks, 1985-2005 (continued)

Source: Drawn by the author.

3. Cross-border transfer of value-added in the Asia-Pacific region

The evolution of regional production networks as illustrated above has fostered a

distinctive structure of the production system in the Asia-Pacific region, i.e. the “tri-polar trade

through China” (Figure 2), whereby: (1) East Asian countries, except China, produce

sophisticated parts and components and export them to China, and (2) China assembles them

into final products, (3) these are further exported to the US markets for consumption.

Figure 2: “Tri-polar trade” through China

CHINA

USAOtherEastAsia

Final Consumption Goods

Parts and Components

Source: Drawn by the author.

The development of “tri-polar trade through China” has significantly enhanced China’s

presence in the region, as demonstrated in Figure 3. The figure shows cross-border transfers of

value-added for the years 1985 and 2005 (see the technical notes for the calculation method.) The

vertical axis indicates the degree of value-added that each country is able to obtain from a given

level of final demands of other countries in the region (the value-added gain potential). The

horizontal axis shows the degree of value-added that each country can “give out” to others in the

same fashion (the value-added give-out potential). It is apparent from the figure that China’s

presence has dramatically increased over the last two decades, while the influence of the United

States and Japan shows a sharp decline.

Figure 3: Cross-border transfer of value-added in the Asia-Pacific region, 1985 and 2005

ChinaJapan

USA

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0

1985 2000

VA G

ainPotential

VA Give-out Potential

Sources: The Asian International Input-Output Table, 1985 and 2005 (preliminary), IDE-JETRO

Due to their relative size, other economies in the region are less significant players in

terms of shaping the structure of value-added distribution. Nevertheless, if we look more closely at

the cluster by origin (Figure 4), it turns out that most of them have advanced in at least one of the

two “potentials”, indicating that they have become more involved in regional production networks

over the decades. It is considered that these emerging economies, as a group, now have a significant

influence on the distribution of regional value-added.

Figure 4: Cross-border transfer of value-added in the Asia-Pacific region, 1985 and 2005,

Small economies

China 1985

Indonesia

Korea

Malaysia

Taiwan

Philippines

SingaporeThailand

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0

1985 2000

VA Gain

PotentialVA Give-out Potential

Sources: The Asian International Input-Output Table, 1985 and 2005 (preliminary), IDE-JETRO

4. Conclusion

This paper investigated the evolution of the production networks in the Asia-Pacific region

using the Asian International Input-Output Tables constructed by the Institute of Developing

Economies, JETRO.

Firstly, the vertical production network was evaluated from the perspective of the

“strength” and “length” of linkages. Two-dimensional visualisation of regional supply chains

showed the expansion of networks among increasing number of key players, as well as an

incremental shift of the regional core towards China over the last two decades. It is also revealed that

the supply chains in East Asia are characterised with a high degree of fragmentation and

sophistication, incorporating substantial amounts of value-added from the countries involved. The

formation of the “tri-polar trade” structure is envisaged therein.

In order to verify the emergence of the “tri-polar trade” structure, cross-border transfer of

value-added within the region is calculated for the year 1985 and 2005, and the result clearly

elucidated the growing presence of China and a relative decline of the USA and Japan. It is also

shown that other emerging East Asian economies have significantly increased the degree of

integration into the regional production system, contributing to the deepening economic

interdependency in the Asia-Pacific region.

References

Dietzenbacher, E., L. Romero, N.S. Bosma, 2005, “Using Average Propagation Lengths to Identify

Production Chains in the Andalusian Economy,” in Estudios de Economia Aplicada, 23.

Pitigala. N., 2009, ‘Global Economic Crisis and Vertical Specialization in Developing

Countries’, Prem Notes No.133, World Bank.

WTO and IDE-JETRO, 2011, From Trade in Goods to Trade in Tasks: Regional Networks in Global

Supply Chains, WTO, IDE-JETRO

Technical note: Cross-border transfer of value-added

Transfer of value-added from country s to country r can be defined as follows.

TVArs=u '⋅V̂ r⋅L⋅ys

where V̂r

is a diagonal matrix with value-added coefficients of country r in its corresponding

diagonal elements and zeros elsewhere, L is the Leontief inverse of the entire region, and ys is a final

demand vector of country s, and u is a summation vector. The calculated results are then

standardised by taking a deviation of each country’s total figure from the regional grand average, to

give indices of value-added gain potentials and give-out potentials.

Appendix: Visualisation of supply chains

The conventional approach to this kind of problem-settings is the linkage analysis, which

generally concerns to measure the “strength” of interconnectedness among industries. The

magnitude of backward and/or forward linkages is calculated between countries, using a

Leontief/Ghosh Inverse matrix of an international input-output table. In this paper, however, a new

perspective for the evaluation of cross-border production networks has been introduced in addition

to the above-mentioned traditional apparatus, by employing the input-output model of Average

Propagation Length (Dietzenbacher et al. 2005).

Average Propagation Lengths (APL) is defined as:

vij = 1*aij /(lij – δij ) + 2*[A2]ij /(lij – δij ) + 3*[A3]ij /(lij – δij ) + ...

=∑k=1

∞

k ([ Ak ]ij /∑k=1

∞[ Ak ]ij)

where A is an input coefficient matrix, aij is its element, lij is a Leontief Inverse coefficient, δij is a

Kronecker delta which is δij =1 if i=j and δij =0 otherwise, and k is a number of production stages

along the path. We also define vij =0 when (lij – δij ) =0.

The first term in the right-hand side of the upper equation shows that the impact delivered

through one-step paths (k=1), i.e. direct impact, amounts to an aij / (lij – δij) share of the total impact

given by the Leontief Inverse coefficient (less unity for diagonal elements). Similarly, two-step paths

(k=2) contribute an [A2]ij / (lij – δij ) share, and three-step paths (k=3) an [A3]ij / (lij – δij ) share of the

total impact. This is evident from L = I + A + A2 + A3 + ... (L: the Leontief Inverse matrix) which is

rearranged as L – I = A + A2 + A3 + ..., and hence (L – I) ij = Aij + [A2]ij + [A3]ij + ....

As an illustrative example, consider the following hypothetical supply chain.

Figure A1: Calculation of Average Propagation Lengths

Ind EInd DInd CInd BInd A

(4)

(4)(2)(1) (3)

Ind C

Ind B

Ind C

Ind E

Ind D

Ind D

Ind E

Ind E

Ind D

(1)(2)

(1)

(3)(3)

(2)

Industry A →Industry E lae = 0.20 (100%)

l(2) =0.10 (50%)

l(4) =0.02 (10%)

l(3) =0.06 (30%)

l(4) =0.02 (10%)

Source: Drawn by the author.

When the share of an impact for each path is calculated as given at the ends of the branches, the APL

between Industry A and Industry E is derived as:

vea = 1 x 0% + 2 x 50% + 3 x 30% + 4 x (10+10)% + 5 x 0% + …= 2.7.

That is, APL is formulated as a weighted average of the number of production stages which an

impact from industry j goes through until it ultimately reaches industry i, using the share of an

impact at each stage as a weight. It represents the average number of production blocks lining up in

every branch of all the production chains, or, in short, an industry’s level of fragmentation.

Using these two types of information, namely, the “length” and “strength” of linkages, the

supply chains can be visualised in the following manner. Table A1 shows the cross-national APL of

Asia-Pacific region in 1985, by country of origin (the left column) and country of destination (the

top row). The values of APL have been first calculated at the level of seven industrial sectors

classification, and then aggregated into one sector per one country by taking weighted averages with

output shares as weights.

Table A1: Average Propagation Lengths in the Asia-Pacific region, 1985

China Indonesia Japan Korea Malaysia Taiwan Philippines Singapore Thailand USAChina 1.8674 3.4504 3.2107 4.5588 3.0997 4.5971 2.8015 2.7277 2.9738 3.2772Indonesia 3.3393 1.5864 3.2786 3.2314 3.0524 3.3527 2.6780 2.6759 3.1936 3.2678Japan 3.8466 3.4879 1.9692 3.7480 3.3585 3.9038 3.5763 3.3932 3.5235 3.7607Korea 5.2438 3.1869 3.3571 1.8375 3.0942 3.6302 3.0966 3.0196 3.3535 3.4505Malaysia 3.4133 3.1973 3.3019 3.2717 1.5866 3.3001 2.5959 2.4819 2.8529 3.2000Taiwan 3.7009 3.1685 3.3291 3.6398 3.1440 1.9199 3.2786 3.0062 3.2946 3.3756Philippines 3.3918 3.0556 3.4123 3.3396 2.8393 3.4527 1.6927 2.8753 3.0280 3.2244Singapore 3.3371 2.4422 3.1020 3.1589 2.6082 3.2849 2.9755 1.5075 2.8025 3.0902Thailand 3.4312 2.9161 3.4696 3.4831 2.7493 3.4509 3.0413 2.7434 1.7218 3.1804USA 3.8256 3.2629 3.7400 3.6222 3.4416 3.6820 3.4055 3.3424 3.3078 1.8417

Source: The Asian International Input-Output Table, 1985, IDE-JETRO

Then, we refer to the “strength” of linkages, as defined as a simple element-to-element

average of Leontief inverse coefficients (less unity for diagonals) and Ghosh inverse coefficients

(less unity for diagonals). If the strength of linkage is less than 0.018, this particular supply chain is

omitted from the picture (=> a blank cell in the APL table). If, on the other hand, the strength

registers more than 0.025, this supply chain is considered as a cardinal path (=> a bold number in the

APL table). The result of the operation gives the following new APL table. Note that we only

consider cross-national linkages (= off-diagonals), and that the values have been rounded up into

integers.

Table A2: Screened-out Average Propagation Lengths in the Asia-Pacific region, 1985

China Indonesia Japan Korea Malaysia Taiwan Philippines Singapore Thailand USAChina 3Indonesia 3JapanKoreaMalaysia 3 2TaiwanPhilippinesSingapore 3ThailandUSA

Source: The Asian International Input-Output Table, 1985, IDE-JETRO

The information given in Table A2 is mapped into the diagram in Figure 1, for the supply

chains among Indonesia, Japan, Malaysia and Singapore in the case of the year 1985.