External imbalances in the European Union and international fragmentation of production

The aim of this paper is to explore the relationship between the persistent trade imbalances of the European countries within the EU area in the past decade and the expansion of the phenomenon of international fragmentation of production (IFP), especially among them. The growth of trade in intermediate goods is a direct result of the expansion of international fragmentation of production, i.e.  the development of international production chains stretching across different countries, where the various production phases and the creation of value added for a given final good is taking place in different locations. A priori, this expansion of international trade has no clear effect on a country trade balance: on the one hand, considering a specific country pair in the global value chain, exporting intermediate and semi-finished goods and re-importing finished and assembled goods can give rise to a trade deficit (both in gross terms and in value added terms, but with different values) for the country in the upstream parts of the international production chain, while it can originate a trade surplus for downstream countries. On the other hand, if this international re-organization of production allows countries to improve their competitiveness (both in terms of cost reduction and in terms of technological improvements) and to gain access (even indirectly) to new export markets, the effect on trade balances can be positive.

Using different  indicators of international fragmentation of production obtained from the recently WIOD database on international production linkages, we test empirically the relationship between these indicators and the current account balance for the EU countries (controlling for other factors that have affected international trade flows), to assess which effect prevails.

Our results show that the indices used to measure the involvement of a country in IFP are generally associated with positive trade balances’ effects, supporting the existence of a relationship between the two, and the presence of a pro-competitiveness effect.