Vertical Trade, Trade Costs and FDI

Firms find advantages in sourcing inputs from abroad and in fragmenting their production process. Onaverage, vertical trade represents about one third of total trade among OECD countries. This reportdescribes and illustrates new firm strategies of vertical specialisation and explores the policy implicationsof new patterns of trade and FDI. It is in services industries that vertical trade has increased the most inrecent years. While vertical trade seems to respond to the same determinants as the rest of exports andimports, distance-related trade costs play a more important role in explaining the volume of bilateral tradeflows resulting from vertical specialisation. Distance-related costs have a lower impact on foreign directinvestment and sales of foreign affiliates but there is a complementary relationship between trade and FDI.Vertical specialisation networks have created new challenges for trade policymakers. In particular, growthof bilateral exchanges between countries depends increasingly on barriers to trade and investment in therest of the world. Moreover, the impact of a country’s own trade barriers on domestic firms is significant inthe context of vertical specialisation. The analysis stresses the importance of multilateral negotiations fortrade and investment liberalisation.