Vertical Specialization and the Changing Nature of World Trade
David Hummels, Dana Rapoport, and Kei-Mu Yi

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he world’s economies have become increasingly integrated and increasingly global. Among the most important and often cited features of the rise in globalization is the enormous growth in the export and import shares of GDP since World War II. In the United States, international trade— that is, exports plus imports—accounted for 23.9 percent of GDP in 1996, up from 9.2 percent in 1962.1 Worldwide, the merchandise export share of production has more than doubled over the last forty-five years, while the manufactured export share of production has almost quadrupled (Chart 1). Most countries—emerging nations as well as highly developed economies—have experienced increases in their export share of GDP (Chart 2). Clearly, a greater number of countries are trading more today than in the past.

David Hummels is an assistant professor of economics at the University of Chicago’s Graduate School of Business; Dana Rapoport is an assistant economist and Kei-Mu Yi an economist at the Federal Reserve Bank of New York.

Another significant feature of increased globalization is the internationalization of production. Rather than concentrate production in a single country, the modern multinational firm uses production plants—operated either as subsidiaries or through arm’s-length relationships—in several countries. By doing so, firms can exploit powerful locational advantages, such as proximity to markets and access to relatively inexpensive labor. There are currently more than 39,000 parent firms and 279,000 foreign affiliates worldwide, with a total foreign direct investment (FDI) stock equal to $2.7 trillion in 1995, compared with $1.0 trillion in 1987. Moreover, the value added of foreign affiliates—that is, their sales less materials costs— accounted for 6