International Fragmentation of Production

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Table of Contents

Introduction
Ways in which Fragmentation of Production takes place
Reasons for Fragmentation of Production
Importance of fragmentation of products to producers and consumers
Conclusion
References

Introduction

Over recent decades, a more heightened integration of the world economy has been developed. An overall surge in the trade quotient has been realized in most developed countries. This is because of the trade liberalization and a greater willingness to participate in the global economy. According to Shenkar and Luo (2004), the other reason cited is that the production has now largely been affected by trade.

This is in the sense that production of goods is done in more than one sequential stage where two or more countries are involved in providing a value added advantage during the production. Hence, both import and export are involved in the process.

On a similar note, surging competition in the global economy has compelled producers of some products, to look for alternatives beyond their borders to lower the costs of production.

According to Grimwade (2000) perspective, the increasing integration of global markets has compelled the separation of the production process in that service or manufacturing performed abroad have become part of a joint production process, meshing with complementary activities performed in the home country. This has brought about fragmentation of production.

Ways in which Fragmentation of Production takes place

Hummels and Yi (2001) define fragmentation as a process whereby a previously integrated production procedure or process is sliced and spread over a global network of production sites. Production tasks are synchronized in a fragmented segment. Therefore, this creates additional costs for services such as transport of goods between production locations and quality control, among others.

The process in which fragmentation of production takes place globally is varied. Perhaps, this is why the concept has been described using various terms such as outsourcing, delocalization of production and vertical specialization among other terms. However, as Shenkar and Luo (2004) argue, the concept behind fragmentation is that countries are increasingly connected to produce goods.

Hence, through this process, goods are produced in more than one sequential stage. And, more than one country may provide a value added during the production process. At some point, the producing country must utilize the imported inputs during the stages of production.

Reasons for Fragmentation of Production

Fragmentation of production is not a new phenomenon. The practice began during the industrial revolution or even earlier. However, in recent time, the practice has become global. The reasons for its widespread use are varied. According to Arndt and Kierzkowski (2001) fragmentation has not only altered the trade flow quantitatively, but also qualitatively.

This has occurred because of various reasons. The first reason is that, goods are produced in two or more sequential stages; second, two or more countries are involved during the process of production. Hence, involving more than one country during the production process strengthens value and quality of the final product.

And lastly, in production, at least one country need to import the inputs in the production stage and some of the resulting output must be exported. They further contend that vertical specialization is a factor which has led to the increase in world trade (Yi, 2003).

This happens because fragmentation serves as a growth instrument that aims at reducing the trade tariff. In this sense, fragmentation erases the linearity of trade growth by decreasing the tariffs.

Vertical specialization has encouraged the growth of off- shoring and global outsourcing in manufacturing; this has been encouraged by decreased non-tariff and tariff trade barriers. A Tariff cut produces a higher ratio of non-linear response of trade in a form of multiple phases of production since trade liberation affects distinct stages of production.

According to Yi (2003) this is because the vertical specialization becomes viable and expands quickly when tariffs decreases below the low-level. The fall creates a nonlinearity reaction of trade to tariffs as companies fix more trade intermediaries once the tariffs fall below the critical level.

Wage rate difference between the developed and developing worlds is contributing reasons to the fragmentation in production. For example, Arndt and Kierzkowski (2001) argue that in 1970s wages in the Caribbean, and Latin America ranged between sixty and eighty percent below those of the United States. A similar trend was reflected in Eastern Europe countries where the labour force was skilled and educated.

Despite the lower labour productivity in these countries, the unit labour costs remained below the figures in industrialized economies. Also, in spite of the rising demand of labour in developing countries such as China, a huge flow of labour from inland has been holding wages low.

This situation has contributed to upholding the production cost disparity. Increasing labour productivity above the rate of wage increase continues to drive unit labour costs downwards. Most high wage countries have utilized this trend; hence, it is easy to reap the benefits of lower production costs and access emerging markets by moving labor-intensive production and assembly to low-wage countries.

In the recent past, transport costs have decreased thereby making the world a global village. The decrease in transport costs has made it feasible to fragment production. For example, in comparison to ocean shipping, the air transport price has continued to decline (Cairncross, 1997). Thus, the long-distance freight costs have become affordable compared to short distance.

Besides, land transport costs have fallen reasonably to maritime transport this has made it possible for fragmentation to occur at any place in the world (Arndt and Kierzkowski, 2001). Transport systems embrace the GPS technology. The technology allows organizations to oversee their road consignments and win efficient logistical control. This aids the fragmentation of value chains of countries involved in fragmentation.

The role of government in strengthening fragmentation of production has been far reaching. They have provided trade policies and development that improves institutional frameworks. This has happened most in developing countries. The governments in these countries grant exceptional incentives to exporters.

The incentives are given in rebates, export credits, tax holidays, tax refunds and political risk insurance among other incentives (Wolfgang, 1984). In industrialized countries, there is the promotion of vertical integration.

According to Grimwade (2000) the vertical integration strategy is achieved by embracing various programs and instruments such as tariff terms for international production sharing, outward FDI promotion and tariff escalation among other strategies. All these strategies are aimed at reducing the costs of production besides encouraging friendly environment for investment.

Additionally, free trade zones have been widely encouraged to attract foreign entrepreneurs. A free trade zone is an institutional phenomenon that grants reduced bureaucratic regulation, lessens foreign exchange checks and provides appropriate infrastructure. According to ILO documents, globally, there were about 5,174 zones in 2004 (Welch et al, 2007).

These zones employed 42 million people. The size and pace of free trade zone increase is also remarkable. Welch et al (2007) contends that, in 1986, only 176 free trade zones existed globally, but overtime, they rose up to 500 in 1995.

Firms are sensitive on matters about property rights protection and process for contract enforcement in foreign countries. Most government has harmonised the legal environment in which international transactions occur, thus; the present legal environment is more predictable. Largely speaking, the political conditions globally have stabilized after long decades of crises; it has become more business friendly.

More countries have embraced democracy. The viability of fragmentation of product needs low risk of supply in a foreign country otherwise problems could bring the whole global production system to a standstill. These disruptions can be caused by failing legal disputes, political instability, shipping delays, strikes and lack of quality controls, among others.

Hummels and Yi (2001) also note that the fragmentation of production may be increased competition. With the globalization of markets, easy access to information, reduced distances and political boundaries, business firms are increasingly feeling the impact of global competition. These pressures exerted on local industries have spurred increased off shoring as they are finding new ways to remain competitive (Krugman, 1995).

Businesses have noted the advantages connected to first movers of the global transfer process. Therefore, they are compelled to reduce the functions that are carried out in high wage countries, thus reducing costs. This strategy also grants them an opportunity to concentrate on their core competencies.

Opportunities granted by global markets also increase trade openings for local- specialized industries; this makes fragmentation even finer.

The growth of information and communication technologies over the last fifteen years has created more opportunities for fragmentation of a product. The technological shift, especially the reduction of communication costs, has contributed to shortening of distance.

This has enabled the integration of distant operations, ship products and components around the globe to attain efficiency (Krugman, 1995). It has facilitated Just-In-Time production on an international scale, simplified management of global production standards and lessened communication costs.

On an organizational perspective, logistics has been eased because of the developments in information and communication technology. The ICT has increased creation of warehousing and material handling, inventory management, real time shipment of finished products and planning and organization of supply chain activities.

It is pertinent to note that besides promoting global fragmentation of goods production, ICT has simplified the tradability of services (Hummels and Yi, 2001).

This is because, information can be readily digitized for storage while cheap and quick transportation facilitates real time exchange of digitized information as voice communication allows people located anywhere in the world to interact. ICT has allowed services that were considered normal to be disconnected and situated elsewhere.

Importance of fragmentation of products to producers and consumers

Fragmentation entails organization of production into different stages of production. Hence, different stages are shared among suppliers who are dispersed in different countries. Often, the products traded between organizations in different countries are typically components rather than the final products.

In this sense, producers benefit by selling their products outside the home country where these products are assembled (Brakman, 2006). Thus, they benefit from selling the finished products at a higher price gaining a higher foreign exchange. For example, in China where fragmentation occurs on a high scale, their finished products are often sold to USA and Europe. These are potential markets which permit higher prices.

Fragmentation strengthens the finished product through internationally recognized body. For example, Europe has notified standardization bodies such as the AFITI-LICOF. The body simplifies fragmentation process by performing tests basing on given standards. These standards allow the producers reduce product export and import time besides enhancing profit rise of host countries (Hummels and Yi, 2001).

Fragmentation allows producers to decentralize their production processes. This strategy allows producers to reach more consumers and markets. Besides consumers benefitting from readily available products, producers through decentralization of the production activities reduces costs whereas increasing the profit (Brakman, 2006).

Additionally, since production stages occur in more than one country, producers can create a trading bloc. This allows them to move phases of production beyond their borders. When different stages of production are located in places where each stage can be performed efficiently, then a producers profit is maximized.

Fragmentation of products provides convenience for consumers to obtain a customized end product without the costs of handling at a traditional retail channel. For example, Cairncross (1997) illustrates that Levi- Strauss allows customers to order jeans tailored to an individual measurement at a click of a button.

Davis & Meyer (1998) also offers a similar customer experience with Dell. They argue that Dell computers accept its customers to skip the retail outlet and embrace the internet to request a customized computer. It is delivered in a matter of days thus saving a customers time.

Conclusion

A production procedure is said to be fragmented when it is divided into two or more stages that can be performed in different places, but leads to a similar product. The decision of some manufacturers locating production phases across the globe has been determined by several reasons.

This has included the relative merits offered by the chosen countries. Among the reasons calling for this process is the difference in technology, labor cost, trade barriers and ready market among other reasons.

When fragmentation does occur, the delocalization of the production slices is not necessarily persuaded by variation in technology, but it can take place because of the differences in the fixed labor overheads.

Generally speaking, when the responsibility of intermediary goods is measured, trade course can emerge by the presence of a fixed cost-benefit and the definite permutation of stages of the production process occurring in diverse countries.

References

Cairncross, F., 1997. The Death of Distance. Boston: Harvard Business School Press

Grimwade, N., 2000. International Trade: New Patterns of Trade, Production and Investment, New York, Routledge

Hummels, D., J., and Yi, K.M. 2001. The nature and growth of vertical specialization in world trade, Journal of International Economics, 54(1):75-96.

Krugman, P., 1995. Growing world trade: Causes and consequences, Brooking Papers on Economic Activity 1: 327-377.

Shenkar, O., and Luo, Y., 2004, International Business, New Jersey, John Wiley

Stan,D., and Meyer, C., 1998. Blur. Massachusetts: Addison-Wesley Reading

Welch, L.S., Benito, G.R., & Petersen, B., 2007. Foreign Operations Methods: Theory, Analysis, Strategy. Chelterham: Edward Elgar Publishing

Wolfgang, M.,1984. Endogenous Tariff Formation. American Economic Review 74(5): 970985.

Yi, K.M. 2003. Can Vertical Specialization Explain the Growth of World Trade? Journal of Political Economy, 111 (1): 52102.

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