External Imbalances in the European Union and International Fragmentation of Production: Is There a Link?

In this paper we assess whether the expansion of international fragmentation of production (IFP) and the creation of production link- ages among European countries contribute to the trade imbalances registered within the European Union (EU) area in the past decade. Exporting intermediate and semi-finished goods and re-importing finished and assembled goods can give rise to a trade deficit, but such international reorganization of production allows countries to improve their efficiency and competitiveness (both in terms of cost reduction and higher quality of goods) and to gain access to new export markets. The net effect on the trade balances is therefore ambiguous. We test empirically the sign of this effect, using the recently released WIOD database on international production linkages. We find that the current account in EU countries worsens the higher the offshoring to low-income partners. By contrast, the current account improves by offshoring to high-income partners. This asymmetry suggests that when countries offshore to high-income partners the gains in competitiveness overcome the potentially negative effect of importing intermediate inputs.