The Impact of Free Trade Agreements on Vertical Specialisation

The concurrent international fragmentation of production structures and propagation, in recent decades, of FTAs suggests the presence of a link between these processes. In this paper, the impact of an FTA on this type of trade is investigated through a theoretically augmented gravity model of input trade. Controlling for the endogenous formation of trade agreements, through a set of country-year fixed effects, the empirical results suggest that an FTA increases the value of intermediate imports by 25%. However, when a more targeted measure of bilateral value chain activity is considered, capturing the value of intermediate imports used to service exports to the same country of origin, the FTA effect more than doubles to 65%. The results also suggest the presence of magnification effects which see value chain activity being more sensitive to changes in trade costs than traditional trade flows. They highlight that trade policy may play an active role in the propagation of such modes of production.<//span><//span>