Vertical Gravity

We use a newly developed indicator of production sharing and processing trade to investigate the determinants of such trade in the context of a gravity model. The Network Trade Index measures countries' interdependence through the extent of trade in parts and components for further processing and assembly of final exports goods. The intensity of processing trade among 75 countries between 1998 and 2005 is then assessed against the typical gravity determinants of trade, such as distance and joint income, jointly with bilateral foreign direct investment stocks and trade policy measures, such as applied bilateral tariff levels and the existence of preferential trade agreements. We find that trade policy plays a significant role in facilitating the intensity of production sharing and vertical trade. Joint adherence to a preferential trade agreement increases processing trade substantially, and a fall of 10% in average applied tariffs is estimated to increase vertical trade integration by 6.2% on average