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 Grim wade, "An explanation cannot be found within the framework
of classical or neo-classical trade theory. The latter predicts only inter-industry
specialization and trade”. However, this is far from the case.

The traditional models 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 explanation of why countries
trade. However, many economists have made the point of claiming that these models
provide no explanation towards intra-industry trade as under their assumptions countries
with identical factor endowments would not trade and produce goods domestically. [2]
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
intra-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 potential explanation is provided by Flavey & Kierzkowski (1987). They

produced 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 explanation has also been
dismissed. It is questioned whether the model applies to IIT at all, as it does not address
directly trade between goods of similar factor endowments.
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
specialize to take advantage of increasing returns, not following differences in regional
endowments (as contended by neoclassical theory). In particular, trade allows countries
to specialize 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 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 specialization and therefore trade, in
exactly the same matter that was set out in the Ricardian model.

Types: There are three types of intra-industry trade

1. Trade in Homogeneous Goods.

2. Trade in Horizontally Differentiated Goods.
3. Trade in Vertically Differentiated Goods.

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."