The Changing Pattern of Production Fragmentation in Singapore and its Economic Consequences

Abstract

The slicing up of the value chain, to use the term coined by Krugman (1995), or the phenomenon of production fragmentation, the term preferred by Jones and Kierzkowski (1990, 2001a, 2001b), is a major factor behind the growth of world trade in the postwar era. Because of the importance of intermediates or “middle products” in the production of final goods whose production characteristics can be differentiated by varying factor intensities, it is economically attractive for firms to base different production blocks in different countries based upon their relative factor endowments. Consequently, in the absence of significant trade barriers, relatively labor-abundant countries produce labor-intensive parts and components, while relatively capital-abundant countries concentrate on producing capital-intensive items. Such vertical fragmentation of the production process based upon countries’ comparative advantage, however, requires the crucial function of service links (see Jones and Kierzkowski 1990). Determining whether firms choose to outsource part of the value chain or to engage in the whole vertically integrated process within national borders requires a comparison of the total cost involved in the two modes of organization. Crucially, the lower marginal cost of production made possible by taking advantage of international specialization must be balanced off the higher fixed cost of providing service links to coordinate activities across nations.

This perspective uses a Heckscher-Ohlin framework to predict where each production block along the value chain will be based. An alternative perspective predicts the international allocation of activities using the Ricardian comparative advantage framework.