The very rapid growth of international trade compared with world GDP is taken as perhaps the strongest evidence we have of the globalization of the world economy.  On this point Kei-Mu Yi's 2003 article is perhaps worth more of a read today than six years ago.

Yi sets out to explain the growth of world trade for the second half of the 20th century.  The very strong growth in trade, particularly trade in manufacturing goods, is assumed by most observers to be due to the reduction in tariff protection through the GATT trade rounds.  Yi observes however that since the early 1960s tariff protection has not fallen very much.  The tariff reductions coming from the Kennedy, Tokyo and Uruguay Rounds amounted to only about 10 percentage points.  And according to his calculations, this does not explain the acceleration in trade, relative to output.

What could be at play?  Yi hypothesises that there has been a change in the nature of trade through vertical specialisation, whereby a single production process might be split between a few different countries.  Tariff reductions provide not only an incentive to import from overseas, but also to fragment the production process through vertical specialisation to make cost savings.  Value is added at each stage, but the same item is traded several times.  A simple example is that of Japanese steel which is exported to Mexico, where it is stamped and pressed, and then exported to the US, where it is used to produce farm equipment, so of which is in turn exported.

Yi estimates that vertical specialisation accounted for about 30% of world trade in 1995, and grew by almost 40% between 1970 and 1995.  It also accounted for about one-third of the growth in world trade during this period.  It is also judged that there are major welfare gains from such vertical specialisation.  Opportunities to specialise in particular stages of a good's production sequence provide gains beyond the usual gains from specialisation and trade.

This story may seem a bit old.  But, in fact such vertical specialisation has only accelerated over the last decade through the expansion of fragmented supply chains in East Asia, between the US and Mexico and also to some extent between Europe and some Mediterranean countries.

So, world trade has not grown nearly as much as WTO statistics would have us believe.

The country whose exports are perhaps the most inflated by this phenomenon is China which is to a large extent the assembly point in the East Asian supply chain.  In fact, Professor Lawrence Lau of the Chinese University of Hong Kong has estimated that the direct domestic value added content of Chinese exports to the US stands at the very low figure of 17.7 per cent.  And that this share is much lower than the share for most other trading nations.  So, China is also not the export powerhouse that WTO statistics lead us to believe!

Reference:

Yi, Kei-Mu, 2003, "Can Vertical Specialisation Explain the Growth of World Trade Trade?" Journal of Political Economy, Vol.111, No.1, pp.52-102.    

"China's Consumption Market: Potential and Outlook", Professor Lawrence J. Lau, The Chinese University of Hong Kong.