This paper proposes the concept of two-dimensional fragmentation and empirically analyzes the international production/distribution networks in East Asia. Two dimensions of fragmentation are in terms of geographical distance and controllability of a firm for fragmented production processes. The increase in service link cost comes from physical separation of production processes and uncontrollability while the reduction of production costs comes along location advantages and the counterparts' ownership advantages. Our empirical investigation using disaggregated international trade data and micro-data of Japanese corporate firms reveals the development of production networks in East Asia with active back-and-forth transactions of parts and components. It also emphasizes their development with sophisticated combination of intra-firm and arm's length transactions along flexible de-internalization decision-making for outsourcing and with more developed industrial clusters. The paper suggests that policy environment in East Asia has an important role in reducing the service link cost due to uncontrollability as well as physical distance.
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