Trade patterns and global value chains in East Asia: - IDE-JETRO

Box 2. About the verticality of production and tradeBasically, vertical integration is a synonym for corporate ownership and control. One of the pioneers was Henry Ford, who soughtto minimize costs and industrial risks by acquiring various firms involved in the production process of his cars. This businessmodel was adopted by other large companies with the emergence of mass production in the early 20 th century. The aim was toincorporate into a single industrial structure the production of raw materials, the machines needed for their transformation, andtransportation to and from the factories. Vertical integration was at the core of Japan’s industrialization, with conglomerates knownas “Zaibatsu” containing holding companies controlling banks and industrial subsidiaries.Vertical integration is about corporate strategy and relates to the “make” or “buy” decision 7 companies invariably face. Whileoutsourcing is an example of the “buy” approach (act of purchasing from an external supplier), vertical integration involves an“insourcing” or “make” option (choice of producing an item or keeping a specific activity internally). Reduced operational costsand better coordination of the supply chain are the key benefits sought by vertically integrated enterprises.Vertical integration can be achieved not only through direct ownership, but also by means of contractual relationships (at “arm’slength”) with suppliers.In Figure 3 below, the orange zone highlights the different functions that have been gathered within the same company. Allcorresponding activities are controlled and managed internally. The assembly operation may be executed by a secondary companyowned by the main firm, or by one contractually dependent upon it; however, they both act as one unique entity within the supplychain.While vertical integration relates to structural linkages between industrial firms and key business processes, the concept ofvertical specialization, as developed by Hummels et al. (2001), outlines the degree of specialization of the different economiesinvolved in the international production chain. It is characterized and measured as the import content (in goods and services)embodied in exported goods (see Chapter IX for more details).Figure 3An example of vertical integrationI. From massdemand to globalsupply chainsII. Organizationof the globalproduction processIII. Infrastructureservices in globalvalue chainsIV. The evolutionof tariff policiesV. Foreign directinvestmentMaterialsComponentssuppliersVI. IntegrateddiversityProcurementResearch andDevelopmentVII. An evolutionaryperspective onproduction networksin the Asia-US regionOperations:• Intermediate manufacturing• AssemblyMarketingInternalsupplychainVIII. Trade inintermediate goodsSalesIX. Vertical tradeand trade invalue addedMarket exchangeInternal processSource: WTO Secretariat.FinishedproductscustomersX. Cross-regionalspillover ofeconomic growth13