Trade in parts and components across Europe

Abstract

Based on the factor-proportion gravity framework we build a model that identifies driving forces for trade in parts and components. We test our model empirically by using a detailed and large European data set. We show that trade in parts and components is driven by relative supply-side country differences, proxied by wages and capital labor ratios. The pattern is compatible with models of incomplete specialization and trade. We take our results as evidence for the existence of international East-West production networks in Europe, driven by trade-offs between wages, capital labor ratios and coordination costs. Our results also reveal that (i) in response to stronger relative wage differences trade in parts and components across Europe is predominantly realized along the extensive margin but (ii) potential to intensify the trade and international production network in new EU members is not exhausted yet.