infonet-economy

We analyze the role of Domestic Value Chains (DVCs) for Global Value Chain (GVC) integration. In the presence of industry specific fixed costs of fragmenting production and of switching across input suppliers, DVCs can either be stepping stones or stumbling blocks for GVCs. Focusing on backward linkages, that is the sourcing of intermediates, we provide robust empirical evidence in favour of the stepping stone hypothesis. In our benchmark specification a one standard deviation increase in DVC integration raises subsequent GVC integration by about 0.4%. To identify the mechanisms at work, we exploit two dimensions of industry level heterogeneity: product differentiation and relationship specificity. Product differentiation can be taken as a proxy of fragmentation costs, while relationship specificity can be taken as a proxy of the costs of switching between suppliers. We find that DVC integration is less conducive to GVC integration in industries that are characterized by relatively high switching costs and relatively low fragmentation costs. This finding supports our hypothesized mechanism.