Auto Parts Trade: Elasticity of Substitution in a Third Market

This study attempts to examine whether an automobile part exported from Japan is a kind of special and hardly replaced by the same part exported from other countries by estimating the elasticity of substitution between Japan and competing countries in a third market. The recent literature on foreign outsourcing and incomplete contract suggests that international transaction of intermediate inputs take place through one or any combination of the following three forms: intra-firm trade, international outsourcing with a contract, or international outsourcing at arm’s length. I focus on the last two options in this paper, that is, a “how-to-buy” decision problem. In general, a maker would choose outsourcing with a contract over market purchases, when the desired part is specific enough to be assembled together with particular parts and components for a car. However, when there are other countries who can supply the same part at relatively lower cost, and a contract agreement with a supplier breaks down, a maker would outsource the part at arm’s length. Assuming the Armington’s hypothesis on the production location, one can postulate that lower elasticity of substitution for a part from a particular country should mean a higher level of uniqueness of that country’s part. I set up a regression model based on the two-level constant-elasticity-of-substitution (CES) production function and estimate it to examine how unique Japanese auto inputs are in a third market. It appears that some auto parts exported from Japan are less substitutable, explaining the temporal disruption of a global supply chain functioning for a motor vehicle industry, even causing a decline of U.S. automobile production right after the earthquake on March 11th., in 2011. JEL Classification Numbers: F12, F14, F23, L23, L24 Keyword: trade in intermediate inputs, elasticity of substitution, vertical network, contracting environment, U.S. auto parts imports 1 Contact address is 1-26-3, Hongo, Bunkyo-ku, Tokyo Japan [113-0033], and +81-3-3811-1828 (Phone). E-mail address is [email protected].