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Malaysia-China Network Trade: A Noteon Product UpgradingEvelyn Devadason aa Department of Economics , University of Malaya , Kuala Lumpur,MalaysiaPublished online: 14 Jan 2009.

To cite this article: Evelyn Devadason (2009) Malaysia-China Network Trade: A Note on ProductUpgrading, Journal of Contemporary Asia, 39:1, 36-49, DOI: 10.1080/00472330802506774

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Malaysia-China Network Trade:A Note on Product Upgrading

EVELYN DEVADASONDepartment of Economics, University of Malaya, Kuala Lumpur, Malaysia

ABSTRACT This article addresses the importance of network trade between Malaysia and Chinaand assesses the extent of product upgrading in components traded. The study brings to the forethe following points. First, China is emerging as an important market for component importsrelative to component exports. As such, the increase in two-way flows of parts and componentsfor further processing and development, implying a shift away from assembly-end operations,remains insignificant. Secondly, network trade appears to have improved the quality of exportsdestined to China (reflecting a ‘‘moving up of the value chain’’), but the gaps between the unitvalues of export and imports have narrowed in the recent past, implying less product development.

KEY WORDS: Network trade, two-way trade, unit values, relative unit values, productupgrading

China has emerged as the fourth largest trading partner of Malaysia since 2001.Malaysia’s trade with China has grown tremendously, to account for 8.8% of totaltrade in 2005. In fact, Malaysia’s trade ties with China have grown faster than thosewith the rest of the world, particularly since the financial crisis in 1997-98 (Kwek andTham, 2005; Li, 2006). The spectacular expansion in trade with China is attributedlargely to China’s success in integrating into the regional and global/internationalproduction networks.

Though networks can be established at various phases of the entire commoditychain, which include research and development, product design, supply of inputs,production and distribution, China’s role in the network structure is inherentlydominant from the production perspective. China’s rising importance, particularly inproduction networks/sharing, is further gleaned from Srholec’s (2006) study of theextent of countries’ integration within the network structure of trade in intermediateinputs and capital goods. His clustering of countries into ‘‘core’’ (centre) and‘‘periphery’’ (three tiers – first, second and third peripheries, of which the thirdperiphery are countries referred to as network isolates) of international productionnetworks clearly indicates that China has shifted its role from the first periphery tothe core of network trade between 1995 and 2004. This implies that China now has

Correspondence Address: Evelyn Devadason, Department of Economics, Faculty of Economics &

Administration, University of Malaya, 50603 Kuala Lumpur, Malaysia. Email: evelyns@um.edu.my

Journal of Contemporary AsiaVol. 39, No. 1, February 2009, pp. 36–49

ISSN 0047-2336 Print/1752-7554 Online/09/010036-14 � 2009 Journal of Contemporary Asia

DOI: 10.1080/00472330802506774

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a high density of connections/links with other countries via trade in intermediateinputs and capital goods. In short, China has become more embedded in theproduction network structure over the last decade and thus no longer remainsperipheral to international production sharing. Malaysia, however, remained firmlyat the ‘‘core’’ of trade in intermediate inputs and capital goods over the same period.Since Malaysia and China are both positioned at the ‘‘core’’ of network trade, it isnot surprising that international production systems dominate in merchandise tradebetween both countries, resulting in the expansion of trade in intermediate inputsand capital goods vis-a-vis that in finished goods. This development in trade does notonly characterise Malaysia-China bilateral trade flows, but is also unique to the EastAsian experience relative to other major regions.

China’s rise at the centre of global production systems (Gill and Kharas, 2007)also resulted in some reconfiguration of the networks. First, since China’s trade inintermediate goods has been concentrated heavily in East Asia, more economieswithin the region have become integrated closely at the level of production.Production networks have thus increasingly become a regional process. China’sgrowing influence on the region’s production networks is also indicative of someshifts in trading power from Japan to China, as the former is no longer considered alead player in the region (Gaulier et al., 2007). Secondly, China’s deeper integrationinto the network structure, from that of an assembler to component subcontracting,has heightened competition within the region. Countries within the region, who arealso suppliers of components, have to contend with the rapid product imitation byChina, in addition to the cost competitiveness of Chinese-produced components, tomaintain market shares within the region and also with external markets.

In the context of the above developments, there are two key concerns forMalaysia. First, there are mounting fears that China, in particular, would eventuallycompete with Malaysia to become a more favourable location for developedcountries, particularly in outsourcing activities (Kwek and Tham, 2005) or even forprocurement purposes. These fears were manifest already in mid-2003, whenelectrical and electronic firms in Malaysia (particularly Penang) employed 17% fewerworkers than in 2000 (Woo, 2004; see also Kit et al., 2005; Chin, 2007), due to thereallocation of the production base towards China.1 Secondly, there is a concern thatChina may outperform Malaysia in terms of product quality, given that the exportstructure of China (reflected in the import share from the Malaysian perspective) hasrapidly shifted into complex high technology products (Engardio, 2007; Lall andAlbaladejo, 2003; Rodrik, 2006; Rumbaugh and Blancher, 2004).

There are, however, those who claim that the above fears are baseless. Forexample, Li (2006) stated that the Malaysia-China trade reflects comparativeadvantage in different technology-intensive manufactured goods (see also Kit et al.,2005), which are complementarities (instead of substitutes) in heterogeneousintermediate products. Conversely, Wong (2004) argued that product competitiondoes exist between Malaysia and China as the index of commodity overlap betweenboth countries has increased from 41% to 50% between 1997 and 2001. However, heascertained that the rising similarities in products of Malaysia and China are not anissue, as the index of geographical overlap of their exports to the rest of the world ishigher, at 72%. Both countries may therefore be able to expand their market sharessimultaneously in third markets, mainly developed markets, as they are selling

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somewhat different products to these markets. In actual terms, no such threat exists,as there are enough differences in products of Malaysia and China to ensure marketexpansion.

Despite the mixed arguments on the ‘‘China effect,’’ or rather the ‘‘China fear’’ forMalaysia, trade ties with China remain relevant for Malaysia. China has become aregional production base, importing intermediate goods for further processing andexport to developed countries. It is also poised to become the world’s biggest exportbase. Further, China is amongst the world’s most important consumer market (onethat is not monolithic but diverse). Networks with China are thus important forMalaysia to tap directly into the domestic market and to gain market accessindirectly in advanced markets outside the region.

This article first examines the extent and shifts in network trade (referring only totrade in parts and components) between both countries; and, secondly, the relativeposition and strengths of Malaysia’s component exports in the quality ladder withChina. The article draws evidence from the analysis of trade flows for the period1990 to 2005.

Internationalisation of Production

Economic globalisation does not merely entail greater trade levels, but theinternational exchange of some factors and inputs into the production process (seeGereffi, 1999a). Trade development in the East Asian region, in particular, points toa rapid expansion in international production networks throughout the 1990s (Andoand Kimura, 2003; Athukorala and Yamashita, 2006; Gaulier et al., 2004; Jones andKierzkowski, 2005; Jones et al., 2005; Ng and Yeats, 2003).2 This translates into therising importance of trade in parts and components. In fact, component trade(‘‘middle products,’’ ‘‘intra-product,’’ ‘‘intermediates’’ or ‘‘fragments of finalproducts’’) has grown at a faster pace than trade in final manufactured goods(Athukorala and Yamashita, 2006; Jones et al., 2005).

The ‘‘disintegration of production’’ processes, as identified by Feenstra (1998: 31),across borders can arise due to large factor price differentials or factor productivitydifferences between countries, which allow for some of the production segments to beproduced more cheaply in another country (Findlay and Jones, 2001; Jones andManjit, 2001). Findlay and Jones (2001) stated that such outsourcing is a naturalconcomitant of scale, in addition to reduction in service links (transportation,communication and co-ordination) brought about by technical progress.

Put simply, industries across the globe are now characterised by segments withvarying skill requirements. The structure and composition of trade thus changes withthe unskilled abundant country abandoning the production of the finished good, andinstead assembling the imported skilled segment with domestic production (thisreasoning follows the Heckscher-Ohlin lines for the basis for trade, see Jones et al.,2005) or even manufacturing certain components (segments) of the product. Thestriking feature of this structure of trade is the increasing interconnectedness ofproduction processes in a sequential, vertical trading chain that stretches acrosscountries, with each country specialising in a particular node/stage of a good’sproduction. The vertical integration of production across borders therefore does notmerely allow unskilled labour-intensive countries to gain a comparative advantage in

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low-end industries but also provides opportunities for them to be involved in low-end production stages of high-end industries (Arndt, 2004).

The structure of the networks has important implications for industrial upgrading.It shapes the capacity to upgrade production activities as the export role shifts. Thismay involve either product shifts, changes in economic functions, intra-sectoralprogression or inter-sectoral shifts (Gereffi, 1999a, b). Product shifts involve amovement from cheap to expensive items and simple to more complex goods, whilechanges in economic functions refer to shifts towards phases of the production chainthat include raw material supply, production, marketing and design. Intra-sectoralprogression is a movement from simple assembly of imported inputs to higher value-added goods and services, involving forward and backward linkages along thesupply chain and inter-sectoral shifts involving a movement from low-value labour-intensive industries to capital- and technology-intensive industries or massproduction of standardised goods to flexible production of differentiated goods.

The various forms of industrial upgrading iterated above imply that it is a complexand dynamic phenomenon, involving an interaction of a host of factors. Networksprovide the opportunity for industrial upgrading and have thus contributed to thedevelopment of new comparative advantages (‘‘recycling comparative advantages’’),which is said to be at the core of East Asian industrialisation (Gaulier et al., 2004).

Extent of Production Networks

Component Trade

Since industries based on the Standard International Trade Classification (SITC)scheme do not separate component trade from finished goods, the study adoptsAthukorala’s (2003) classification of intermediate goods,3 inferred from tradestatistics (of the SITC, Revision 3) for the industries in sections SITC 7 and 8.4 Forthe study, only items termed as ‘‘parts and accessories’’ at the 5-digit level SITC5 arecounted as components, while others are treated as finished goods. The data aresourced from the United Nations (UN) COMTRADE database.

Data on trade in parts and components are compiled for 212 components in sixindustries (including electrical and electronics, machinery manufacturing, transportequipment and scientific and measuring equipment, furniture and fixtures andmiscellaneous items). These six industries are fairly representative of trade flows withChina as they constitute a combined trade share of 68% in 2005, with combinedexport and import shares of 53% and 78%, respectively.

The electrical, electronics, machinery manufacturing and transport equipmentindustries are highly structured. In the electrical industry, components refer to wires,conductors, power cables, telecommunication cables and fibre optic cables, whilstelectronic components comprise semiconductor components, passive componentsand other components (printed circuit board, metal-stamped parts and precisionplastic parts). As for machinery manufacturing, the parts and components form anintegral part of the industry since they include moulds and dies, jigs and fixtures,actuators, motors, gear boxes and control systems for the four main categories ofmachinery (power-generating machinery and equipment; specialised machinery andequipment for specific industries; metalworking machinery and equipment; and

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general industrial machinery and equipment). Components for the transportequipment industry include parts and components for motor vehicles (passengerand commercial vehicles) and aircraft.

Figure 1 compares the development of network trade between Malaysia and Chinaover the period 1990-2005 for six manufacturing industries in Malaysia. FromFigure 1, we can see that there was hardly any production sharing between bothcountries in 1990. Component trade represented only 2% of total trade with Chinain 1990. However, in 2005, trade shares in parts and components for the sixindustries had increased to 55%, recording an annual average growth rate of 34%.The increase in networks between Malaysia and China is much larger from theimport relative to the export side. The share of components in total imports hadincreased remarkably from 2% in 1990 to 64% in 2005.6

By industry, Malaysia is a net importer of components in electrical and electronicsand machinery manufacturing, whilst she remains a net exporter of components forthe remaining four industries. In 2005, China remained as Malaysia’s fourth majorsource of imports, which mainly comprised parts and accessories for office machines,transistors and valves and automatic data processing equipment (Ministry ofFinance, 2005). Similar to the upward trend in component imports, the share ofcomponents in total exports had increased from 2% to 43% for the period of review.In fact, trade in components recorded a higher annual average growth rate than thatof total trade with China.

The trends outlined above do not only signify the importance of networks in tradein manufactures with China, but also indicate that networks with China are nolonger driven just by cost considerations. The increase in component exports (thoughlagging behind component imports) to China clearly indicates that market expansionstrategies are also important. The findings concur with the belief that Chinacomplements Asian exports in intermediates, thus any exogenous increase in itsexports will result in an associated increase in the partner countries’ exports of the

Figure 1. Extent of Malaysia-China network trade (in percent). Ftot, share of trade in partsand components in total trade; Fx, share of exports of parts and components in total exports;

Fm, share of imports of parts and components in total imports.Source: Computed from the UN COMTRADE

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same product (Eichengreen and Hui, 2005).7 This is particularly true given thatChina’s foreign trade heavily relies on processing operations; imports of goods intoChina are assembled or transformed and re-exported within international assemblyand subcontracting operations.

Network trade with China is of very different importance for the six selectedindustries. Overall, component trade with China is highest in the electrical andelectronics industry, followed by machinery manufacturing. From the exportperspective, network trade is found to be highest in the transport equipment,followed by the electrical and electronics and machinery manufacturing (see alsoLemoine and Unal-Kesenci, 2002). Export shares of components in transportequipment increased substantially in the late 1990s. The high shares of componentexports in electrical, electronics and transport equipment is hardly surprising sinceChina is the world’s third largest car market and on pace to become the biggestmarket for personal computers, broadband telecommunication services and digitaltelevisions. At present, China is already the world’s biggest consumer of wirelessphones, with 350 million cellular subscribers (Engardio, 2007).

In contrast to the above industries, the importance of component trade remainsrelatively low in scientific and measuring equipment, furniture and fixtures andmiscellaneous products. The small component trade shares with China in furnitureand fixtures are expected given that China has already established its own largefurniture makers such as Lacquer Craft, Fine Furniture and Starcorp. Thesecompanies import most of their components, including wood, from the USA.Nevertheless, production sharing with China has increased in most industries, withthe exception of miscellaneous items. The decline in production sharing formiscellaneous items plausibly reflects that China records a comparative advantagein such items (Lemoine and Unal-Kesenci, 2002) and the recent decline in exportshares of these items in China’s trade (see Rumbaugh and Blancher, 2004).

The above discussion highlights a key point. Malaysia is essentially a net importerof components from China. Malaysia also specialises in assembly similar to thatundertaken in China (see Gaulier et al., 2004; Huang, 2007; Lemoine and UnalKesenci, 2002), whereby imported components are assembled into finished productsfor the domestic and export markets. The growing networks with China from theimport perspective clearly indicate that Malaysian industries have becomeincreasingly reliant on suppliers in China for essential manufacturing inputs.Conversely, China’s appetite for Malaysia’s component exports seems to haveslowed down as China is becoming increasingly dependent on developed markets forcomponent supplies. Lemoine and Unal-Kesenci (2002) noted that China has nostrong bias in favour of Asian sourcing, particularly in machinery. Further, the shiftby Taiwanese and South Korean multinationals to manufacture in China hasresulted in China becoming more self-sufficient in key materials and components(Engardio, 2007; see also Gill and Kharas, 2007).

This poses a challenge for Malaysia to step up into a higher level of integrationwith China by strengthening its network ties from the export perspective,particularly in electrical and electronics, machinery manufacturing and transportequipment. Market shares in China will ultimately depend on how fast Malaysiagoes through the middle-income status. The growing similarities of both countries,arising from the emphasis on assembly-like operations, is a bane to Malaysia, as

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China, with its cheaper labour costs, is undeniably a more attractive location forsuch activities. Malaysia, therefore, needs to stay ahead of China by progressingbeyond an assembler to that of a key component supplier.

Two-Way Trade in Components

Figure 2 presents the extent of trade overlap (two-way trade) in parts andcomponents, as measured by the aggregate Grubel-Lloyd (AGL) index (see Grubeland Lloyd, 1975). The extent of overlap in network trade has increased from 3% to38% of total trade between 1990 and 2005. The numbers do not suggest that two-way trade in components between the two countries is significant. Trade overlap withChina only surpassed the 50% benchmark in 1998, soon after the financial crisis and,in 2002, just after the downturn in the global electronics industry. Since then, two-way trade in components has been on the decline.

The decline in two-way trade in components in the recent past is noted across allsix industries. However, though the global slowdown in electronics has exposed thedownside of network trade with China in this industry, sales in semiconductors aresaid to have picked up in the second half of 2005 (Bank Negara Malaysia, 2006;Ministry of Finance, 2005). Similarly, exports of automotive parts and components,such as oil filters, wipers, absorbers and suspension systems, had also reached newerheights in 2005. In fact, the increase in two-way trade in parts and components of thetransport equipment sector after 2001 may be attributed to the phasing out ofprotection in the automobile sector with China’s accession to the WTO and theabolishment of the local content programme in the automotive sector by theMalaysian government in 2002.

Generally, two-way trade in components has increased with time, except forfurniture and fixtures and miscellaneous items. However, in the electrical andelectronics industry, the extent of trade overlap still remains below 50%. A possiblereason for this is that massive foreign and domestic investments in China have

Figure 2. AGL index for Malaysia-China component trade (in percent). The aggregate Grubel-Lloyd (AGL) index is calculated based on the 5-digit level of aggregation.

Source: Computed from the UN COMTRADE

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resulted in some milestones in science and technology. Of significance is the increasein semiconductor plants producing chips, putting China on track to be the world’ssecond largest chip producer (Engardio, 2007). China has also developedcompetency in heavy machineries. Recent evidence indicates that China has alreadybecome an important auto supplier to the USA (Lum and Nanto, 2007). China isexpected to gain further strength in heavy industries, under the tutelage of foreigncompanies that have invested in China (Engardio, 2007).

Overall, the upward trend in overlap in component trade implies that Malaysia isnot just a receiver but also a sender of network links in trade with China. Prior to2000, the trends in two-way trade depicted a gradual change, albeit small, inMalaysia’s role from a ‘‘sink’’ (receive links in the network; import inputs andassemble into finished products for the export market) to a ‘‘transmitter’’ (send andreceive links; import components and export the same product further down thevalue chain) of intermediate inputs into the production network with China. Thisgradual shift towards component-supply subcontracting (production of componentparts or sub-assemblies for exports) to China, however, seems to be diminishingsince 2000. Of importance to the Malaysian economy is whether component exportswith China are sustainable over the medium to long term.

Product Development for Selected Components

The quality of components traded becomes a key issue, as products belonging to thesame category may be characterised by different qualities. Further, the scope forproduct diversification occurs more in components than in finished goods.

Product development in components is confined generally to that of the electricaland electronics industry due to it being the fastest-growing commodity in worldtrade, given the scope for scale economies and vertical specialisation. The electricaland electronic components are also reflective of network trade between Malaysia andChina as they command the largest shares in total component trade. Specifically,Malaysia is said to exceed other Asian electronics producers in terms of its exposureto network trade (Ernst, 2003). Similarly, from the perspective of China, networksplay an outstanding role in this sector since parts and components of electricalmachinery make up more than two-thirds of China’s imports (Lemoine and Unal-Kesenci, 2002).

To capture one aspect of industrial upgrading from the production side,represented by shifts from a low quality (cheap) to a high quality (expensive)product of the same type, the unit values of exports (UVX8) and imports (UVM) arecalculated at the 5-digit SITC to reflect the respective prices/quality. Productdevelopment through higher quality of exports is then assessed via the relative pricesof exports to imports (RUV¼UVX/UVM) of the same product. If the RUV is aboveunity, it can be inferred that Malaysia exports higher quality components, of which itimports lower quality varieties, and vice versa if the RUV is below unity. Growingvalues of RUV above unity reflect a widening gap between UVX and UVM, whichfurther implies that there is some form of product development taking place in thecomponents traded via increments to value-added.

Prior to describing the trends in unit values for the selected components, threelimitations in the data are worth mentioning. First, there is a large proportion of

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bilateral export-import pairs with zero trade. Thus, the pairs with zero-trade are notconsidered for quality comparison. Secondly, the quantity data are missing fornumerous products prior to 1998, thus limiting the time series. Thirdly, themeasurement units for quantity differ, shifting from number of items to kilogramme.The choice of measurement unit is based on that which represents the componentmost heavily traded.

Figure 3 plots the unit values of exports and imports and the relative unit valuesfor components of four SITC categories, SITC 776 (thermionic valves, tubes,photocells etc.), SITC 764 (telecommunications equipment), SITC 778 (electricalmachinery and apparatus) and SITC 759 (office machines and automatic data-processing machines and units thereof). Based on a study by Kit and colleagues(2005), China outperformed Malaysia in categories 764, 778 and 759, which areconsidered as low and mid-end electrical and electronics. Thus, it is interesting toidentify if the same holds in the case of components within those categories.

For all four categories in Figure 3, the RUVs are above unity in most years. This isa positive indication that components exported to China have a higher value-addedcontent than their corresponding imports. This is not surprising as the electrical andelectronics industry has remained the key sector in Malaysian manufacturing and, ifimprovements in product quality were to take place, this sector is the most probablecandidate given its high levels of export orientation dominated by multinationals.9

The findings of Norlela and Figueiredo (2004) also indicated a steady progression inthe electronics industry of Malaysia, involving the production of complex and highervalue products since 2000. There is even a move from assembly of electronic andsemiconductor devices to sub-assembly and component assembly of more complexdevices. Rodrik (2006) added that, in the case of China, the export unit values formost of its electronic products in 2003 were lower than those of Malaysia (see alsoAzhar et al., 2008). Rodrik claimed, therefore, that there is some truth to theargument that Chinese exports of electronic products tend to be low cost withoutmuch technological sophistication.

However, the trends in unit values of exports should not be misconstrued to implythat Malaysia is doing relatively better than China in terms of product development.For example, though the RUV of components within SITC 759 (see Figure 3)remains above unity for the entire period of review, it has been on a downward trendsince 2000. Clearly, this indicates that the quality gap between exports and importshas reduced for this category of components. This implies that value-addedincrements have not been realised and Malaysia is losing out in terms of productdevelopment, which concurs with Huang’s (2007) assertion that China has madesubstantial gains in automated data-processing machines.

In the context of product development, the critical question therefore is: are theresignificant amounts of domestic value-added in component trade with China? Theanswer is no. Malaysia can no longer rest on its laurels, given that the gap betweenUVM and UVX is narrowing in the recent past. Best (2007) emphasised that thesuccess of the Malaysian electronics industry in the past lies in the growth of outputbut not value-added. Conversely, the value-added realised in China has increased asit now includes more stages of production, which used to be made abroad. Theincreased integration of production in the mainland reflects the rapid escalation ofparts transactions among foreign affiliates (Lemoine and Unal-Kesenci, 2002).

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Figure 3. Unit values and relative unit values for selected parts and components. UVX, unitvalue of exports; UVM, unit value of imports; RUV, relative unit value of exports to unit valueof imports. UVX and UVM are on the left axis, whilst RUV is on the right axis. UVX andUVM for SITC 776 are measured as price per item, whilst that for SITC 764, 778 and 759 are inprice per kilogramme. For SITC 764 and 759, quantity data are not available for the years prior

to 1997, whilst for SITC 778 quantity data are not available for the years prior to 1998.Source: Computed from the UN COMTRADE

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Thus, China’s emerging capabilities in high-volume production will intensify thetendency of mass production manufacturing to be commodified. According toMcKibbin and Woo (2003), much needs to be done, given that China ranks almostas high as Malaysia in the indigenous innovation index. Furthermore, Lemoine andUnal-Kesenci (2001, 2002) noted that the specialisation pattern of China is becomingalmost similar to that of Malaysia, given the rapid rate of imitation in the latter,which has shortened the product cycle tremendously (Tham, 2005).

China is also fast gaining strength in producing sophisticated products atcompetitive prices. China’s accession to the WTO has brought about reductions inits export prices and thereby enhanced her appeal as an efficient supplier ofintermediate inputs. Prices of Chinese produced goods are generally 30-50% belowthat of the USA (Engardio, 2007). Product development is undeniably an importantissue for Malaysia or it may face the reality of being squeezed out by China (see Best,2007). The scope for greater network trade with China can be harnessed if Malaysiaspecialises in higher quality components.

Concluding Remarks

The study has three conclusions. First,Malaysia’s participation in production networkswith China has increased, while Malaysia remains a net importer of components.Secondly, although there is an increase in two-way flows of parts and components forfurther processing and development, implying a shift away from assembly-endoperations, the numbers remain insignificant. Thirdly, network trade appears to haveimproved the quality of exports (reflecting the ‘‘moving up of the value chain’’) destinedto China, but the trends remain indeterminate in the recent past.

It is thus crucial for Malaysia to capitalise on China’s booming demand for high-end parts and components that feed into its assembly plants, to maintain China as itsbig customer. The intensity of competition for market share in China will be basedon goods exported on the quality ladder. Engardio (2007) argued that China has thecapacity to accelerate industrial upgrading, forming horizontal differentiatedproducts at a more advanced technology level. In this context, Woo (2004) addedthat technological versatility becomes necessary for countries like Malaysia tocapitalise on the lengthened production chains (see Rajan, 2005) in manufacturingactivities, or face the dismal possibility of de-industrialisation (see also Lall andAlbaladejo, 2003) or a hollowing-out of the sector (Tham, 2005).To reap benefitsfrom mutual trade dependence, Malaysia needs to enhance its technological capacity(see also Tham, 2001, 2005), which is to innovate indigenously, particularly toupgrade exports.

In short, given that Malaysia’s competitiveness will be based on product quality,moving up the value chain becomes an inevitable option. Malaysia needs to ensureconstant product upgrading to remain an important cog in network trade withChina, particularly through component supply subcontracting, lest it loses out to thenewly industrialising economies, such as Taiwan, South Korea and Singapore. Thenetwork links with China are also important, given that if China displacesMalaysia’s export share in advanced markets for a particular product, the netwelfare effect experienced by Malaysia will depend on the extent to which Chinaresorts to sourcing components for that product from Malaysia.

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Notes

1 The leading export product category to China from the rest of the world is electrical and electronic

products, particularly key components (electronic integrated circuits and micro-assemblies) used in the

assembly of electronic products (Li, 2006).2 Alternative terms have been given to reflect the same concept, such as segmentation, integrated

production, outward processing (Lall et al., 2004), intra-product specialisation, super-specialisation

(Helg and Tajoli, 2004), multi-stage production (Hummels et al., 2001), de-localisation, disintegration

(Hijzen et al., 2003), production sharing, vertical specialisation, slicing the value chain and outsourcing

(Feenstra and Hanson, 1996; Athukorala and Yamashita, 2006), kaleidoscope comparative advantage

and intra-mediate trade (Rajan, 2005).3 Athukorala’s (2003) classification of ‘‘parts and components’’ is found to be more comprehensive than

that of Ng and Yeats (1999), given that the latter does not include semiconductor products in their

classification. Therefore, the Ng and Yeats classification will understate the true importance of this

exchange. However, it is acknowledged that this classification is not an exhaustive measure of the

phenomenon of international fragmentation.4 There is no comprehensive relevant statistics that allow for measuring the role of international

production and trade networks precisely. Various ways have been adopted in the literature to identify

trade in parts and components. Athukorala and Yamashita (2006) identified 225 products at the 5-digit

level SITC as parts and components belonging to sections SITC 7 (machinery and transport equipment)

and SITC 8 (miscellaneous goods), while Lall and colleagues (2004) concentrated on the 4-digit SITC 7.5 See Lall and colleagues (2004) for the limitations in capturing fragmentation (partially) by merely

separating finished goods from parts and components.6 The UNDP (2006) report also underlines similar changes in the patterns of imports that reflect a

growing share of intermediate goods with a concurrent decline in the share of consumption goods.7 The study by Eichengreen and Hui (2005) indicated overall positive effects for Malaysia due to trade

with China, reflecting the specialisation of Malaysia in exports of components and other capital goods,

which are much demanded by the latter.8 Average unit values are used as a proxy for determining the quality of goods traded (see Appelbaum (2004)

for other measures that tap into dimensions of the production side of industrial upgrading). Unit values

measured at the finest level of aggregation, for which data are available, minimise the incidence of

composition problems (Hallak, 2006). See Silver (2007) for the unreliable use of unit value indices, given

biases arising from compositional changes in quantities and quality mix of what is exported and imported.9 See also Ministry of International Trade and Industry (2006) for discussion on the high value and higher

technology content of electrical and electronic parts and components exported byMalaysia to the rest of the

world.

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