Intra-industry trade

Intra-industry trade refers to the exchange of products belonging to the same industry. The term is usually applied to international trade, where the same kinds of goods and services are both imported and exported.

Examples

Examples of this kind of trade include automobiles, foodstuffs and beverages, computers and minerals.

Europe exported 2.6 million motor vehicles in 2002, and imported 2.2 million of them. Japan exported 4.7 million vehicles in 2002 (1 million of which went to Europe, and 2 million to North America), and imported 0.3 million.

Explanation

Why do countries at the same time import and export the products of the same industry, or import and export the same kinds of goods?

According to Nigel Grimwade, "An explanation cannot be found within the framework of classical or neo-classical trade theory. The latter predicts only inter-industry specialisation and trade" [Grimwade, "International Trade: New Patterns of Trade, Production & Investment", second edition 2000, p. 71] . However, this is far from the case.

The traditional model of trade were set out by the model of David Ricardo and the Heckscher-Ohlin model, which tried to explain the occurrence of international trade. Both models used the idea of comparative advantage and an explaintion of why countries trade. However, many economists have made the point of claiming that these models provide no explanation towards intra-industry [Krugman & Obstfeld (1991)] trade as under their assumptions countries with identical factor endowments would not trade and produce goods domestically. Hence, over the past three decades as intra-industry trade has developed many economists have looked at other explanations.

One attempt to explain IIT was made by Finger (1975), who thought that occurrence of Inter-industry trade was “unremarkable” as existing classifications place goods of heterogeneous factor endowments in a single industry. However, evidence shows that even when industries are disaggregated to extremely fine levels IIT still occurs, so this argument can be ignored.

Another model to look at would be Flavey & Kierzkowski (1987). They produce a model that tried to get rid of the idea that all products are produced under identical technical conditions. Their model showed that on the demand side goods are distinguished by the perceived quality of that good and high quality goods are produced under conditions of high capital intensity. However, this model as also been dismissed [Brander, James.A, 1987, Book Review of Greenaway and Milner (1986), "Journal of International Economics" 23:1/2, 182-185] as the model is brought into question as to whether it addressing IIT as offers no answer to trade between goods of similar factor endowments.

However, the most comprehensive and widely accepted explanation, at least within economic theory, is that of Paul Krugman's new trade theory. Krugman argues that economies specialise to take advantage of increasing returns, not following differences in regional endowments (as contended by neoclassical theory). In particular, trade allows countries to specialise in a limited variety of production and thus reap the advantages of increasing returns (ie, economies of scale), but without reducing the variety of goods available for consumption.

Yet, Donald Davis [Davis, D.R 1995, Intra-indstry trade: A Heckscher-Ohin-Ricardo approach, "Journal of International Economics" 39 (1995), 201-226] believed that both the Heckscher-Ohlin and Ricardian models were still relevant in explaining intra-industry trade. He developed the Heckscher-Ohlin-Ricardo model, which showed that even with constant returns to scale that intra-industry trade could still occur under the traditional setting. The Heckscher-Ohlin-Ricardo model explained that countries of identical factor endowments would still trade due to differences in technology, as this would encourage specialisation and therefore trade, in exactly the same matter that was set out in the Ricardian model.

Measurement

Intra-industry trade is difficult to measure statistically because regarding products or industries as "the same" is partly a matter of definition and classification.

For a very simple example, it could be argued that although a BMW and a Ford are both motor cars, and although a Budweiser and a Heineken are both beers, they are really all different products.

Various indexes of IIT have been created, including the Grubel-Lloyd index, the Balassa index, the Aquino index, the Bergstrand index and the Glesjer index. Research suggests that

*IIT is not simply a fiction or artifact produced by statistical classifications and definitions, but very much a reality.

*the share of IIT in total international trade is growing all the time, at about 4-5% a year. Thus, more and more, countries are importing the same kinds of products they are also exporting.

"Intra-industry trade has been considered in international trade literature as the explanation of the unexpectedly large expansion of industrial trade among OECD countries, for which it represented more than two-thirds of their total international trade by the beginning of the seventies." Bela Kadar, Review of Herbert Giersch, On the economics of intra-industry trade, in "Journal of economic Literature", Vol. 19 No. 3, September 1981, p. 1109

References

See also

inter-industry trade