The Rise of Vertical Specialization Trade

Vertical specialization (VS) trade, trade in goods that incorporate imported inputs, has grown rapidly since the 1960s. While the share of trade in inputs has not increased, the types of inputs traded have shifted from raw materials to manufactured parts. I argue that declining trade costs are an important explanation for these facts. I present a three stage vertical specialization trade model, with raw materials, manufactured parts and final goods sectors. In the simulated model, falling trade costs explain much of the observed growth in overall and VS trade. Manufacturing trade grows twice as fast as overall trade. Raw materials trade was more important in the 1960s when trade costs were high, since their production is more strongly linked to endowments than manufacturing. Therefore, materials will be traded even when trade costs are high. Trade costs have fallen more for manufactured goods over the last 40 years, leading to a rapid expansion of manufactured parts trade relative to materials. JEL classification: F1.