Cost Competition, Fragmentation and Globalization

Abstract

This paper proposes a model in which the removal of barriers to trade and factor mobility is associated with endogenous fragmentation of the value-added chain. Fragmentation is the outcome of cost competition – the profit-maximizing choice of cost structure by monopolistically competitive firms. An expansion of the integrated trading area can induce globalization not only in the horizontal dimension associated with love-of-variety preferences, but also vertically as firms vary specialization of production stages. While increased trade is likely to induce fragmentation when the number of firms is fixed, free entry can either reverse or intensify this result.