Why is manufacturing trade rising even as manufacturing output is falling?
For the OECD as whole, as well as for the U.S., manufacturing exports have been rising, while manufacturing output (both expressed as a share of total GDP) has been falling. We examine the prevalence of this puzzling fact across individual OECD countries, as well as for particular sub-industries of manufacturing. We then address whether the standard international trade paradigms are capable of quantitatively resolving the puzzle. We extend the basic monopolistic competition-cum-Heckscher-Ohlin model to allow for non-homothetic preferences, non-unitary demand elasticities and for changing trade barriers and country-size distributions over time. In a calibrated version of the model, we find that while the extended model can replicate the puzzle qualitatively, it cannot do so quantitatively. We suggest that the unexplained part of the puzzle may be due to vertical specialization – the phenomenon by which countries specialize in particular stages of a good’s production sequence – leading to “back-and-forth” trade, and creating a distinction between ‘gross’ trade and value-added trade. The standard trade paradigms only include value-added trade.
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