Intraindustry Trade

1. Intraindustry Trade

2. INTRODUCTION • What is intraindustry trade? • What are the reasons for intraindustry trade? • How does it differ from interindustry trade? • What are the welfare effects of intraindustry trade?

3. Test of the Heckscher-Ohlin Model W. Leontief (1951) Built input-output model for 200 U.S. industries for 1947 Assumed U.S. was the most K-abundant country Used U.S. exports and import substitutes

4. Input-Output Table A table that details the sales of each industry to all other industries in an economy. A spreadsheet with column entries showing purchases made by a specific industry from all other sectors, and row entries showing sales by a specific industry to all other sectors. Also contains the labor and capital requirements for a fixed amount of output of a given industry.

5. Leontief Paradox The finding that U.S. exports tend to be more labor-intensive than U.S. imports, while U.S. imports are relatively more capital-intensive than U.S. exports.

6. INTRODUCTION • Intraindustry trade occurs when countries trade essentially the same goods with one another • The trade of autos and auto parts between the U.S. and Canada • Interindustry trade occurs when a country either exports or imports goods in different industries

7. INTRAINDUSTRY VERSUS INTERINDUSTRY TRADE • The factor-proportions theory • States that each country exports goods in which they have a comparative advantage • Tests of the theory raised some questions and stimulated development of new theories • Factor-proportions does not explain intraindustry trade • Intraindustry trade implies that a country has a comparative advantage and disadvantage in the same good

8. INTRAINDUSTRY VERSUS INTERINDUSTRY TRADE • Explaining intraindustry trade is more complicated than interindustry trade • Several theories have been proposed addressing narrower and narrower groups of goods • It is first necessary to define intraindustry a little more carefully

9. DEFINING INTRAINDUSTRY TRADE • Measuring intraindustry trade is not as straightforward as measuring interindustry trade • Intraindustry trade is two-way trade in the same good • A numerical measure of intraindustry trade is necessary

10. The intraindustry trade index is DEFINING INTRAINDUSTRY TRADE Where for a particular industry or product group X = the value of exports M = the value of imports

11. Consider the case of only interindustry trade The U.S. imports $100,000 in cloth from India and doesn’t export anything DEFINING INTRAINDUSTRY TRADE • The U.S. exports $100,000 of machines to India and doesn’t import anything

12. Consider the case when the U.S. exports $50,000 of food to India and imports $50,000 of food from India DEFINING INTRAINDUSTRY TRADE • This indicates that 100% of the trade in the food industry is intraindustry trade • The closer the index is to 1, the more intraindustry trade there is relative to interindustry trade

13. The major shortcoming to this index is that results vary depending on how an industry or industry group is defined The more broadly a group is defined, the more likely we are to find intraindustry trade and the higher the intraindustry trade index will be The more narrowly a group is defined, the less likely we are to find intraindustry trade and the lower the intraindustry trade index will be DEFINING INTRAINDUSTRY TRADE

14. Suppose the U.S. imports $100,000 of men’s pants and export $100,000 of ladies pants All pants in one group DEFINING INTRAINDUSTRY TRADE • Men’s and women’s pants in different groups

15. DEFINING INTRAINDUSTRY TRADE Table 5.1 Intraindustry Trade Examples: Selected U.S. Exports and Imports, 2006 ($ Millions)

16. THE INCREASING IMPORTANCE OF INTRAINDUSTRY TRADE Table 5.3 Average Shares of Intraindustry in Manufactured Goods by Country Group and Change in Intraindustry Trade

17. INTRAINDUSTRY TRADE IN HOMOGENEOUS PRODUCTS • Homogeneous goods • One product is identical to every other product produced within an industry, production of S & T in A & B are identical. • Interindustry trade in these goods is explained by the factor-proportions theory • Intraindustry trade can occur as a result of one or more possible circumstances

18. INTRAINDUSTRY TRADE IN HOMOGENEOUS PRODUCTS • Intraindustry trade can occur because of • High transportation costs • It may be cheaper to purchase a bulky material with high transportation costs, such as cement, from a foreign supplier who is closer than the nearest domestic supplier • Services are produced jointly with another traded product • Insurance, shipping, and banking services may be necessary to facilitate the completion of trade in product. A shipment of computers Japan to Palestine must be transported, insured, and financed. The export and import of these goods represent interindustry trade, but the goods would show up as intraindustry in trade in services.

19. INTRAINDUSTRY TRADE IN HOMOGENEOUS PRODUCTS • Countries engage in substantial entrepot and re-export trade • Entrepot trade is when goods are imported into a country and later the same goods are exported to another country • Only storage and distribution facilities are being provided • Re-export trade is when goods are imported into a country and later the goods are exported with only a small transformation • Often the small transformation is sorting, repackaging, labeling, and reshipping

20. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Most intraindustry trade is in differentiated goods between countries. • These goods have features that make them appear different from competing goods in the same market or industry • Goods can be differentiated in two ways • Horizontally differentiated goods differ in some slight way but are similarly priced • Vertically differentiated goods have different physical characteristics and different prices

21. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Most international trade in differentiated goods occurs under conditions of imperfect competition • This generally has to do with the number of firms in the market • Under perfect competition a firm cannot affect market price as they are only one of many firms making identical products

22. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Under imperfect competition a firm is able to influence price by changing the quantity of goods offered for sale • Imperfect competition can occur under three different market structures • Monopolistic competition • Oligopoly • Monopoly

23. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • In monopolistic competition many firms produce slightly differentiated goods and each firm maintains some control over its own price • In an oligopoly there are few firms and a firm has some control over its own price due to the small number of competitors and high barriers to entry • In a monopoly a firm’s market power exists because they supply the entire demand for a particular good and there are no close substitutes

24. Intraindustry Trade Horizontally Differentiated Products Vertically Differentiated Products Homogeneous Products Same Price Identical Products (Wheat, Concrete, Petroleum) Similar Prices Slightly Different Product Characteristics (Gasoline, Chocolate, Perfume) Varying Prices Widely Different Product Characteristics (Automobiles, Watches) Associated Processes Associated Processes Reduction of Transportation Costs Economies of Scale Product Cycle Overlapping Demands Provision of Homogeneous Services (Insurance, Shipping, Finance Associated with International Trade Provision of Uninterrupted Flow of Seasonal Products (Tomatoes) THE WELFARE IMPLICATION OF INTRAINDUSTRY TRADE Figure 5.5 Types of Intraindustry Trade and Associated Processes

25. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Three theories that serve to explain intraindustry trade in differentiated products. • Economies of Scale • Economies of scale means that as the production of a good increases, the cost per unit falls • This phenomenon is known as decreasing costs or increasing returns to scale

26. Average Cost A AC0 B AC1 C AC 0 50,000 200,000 250,000 Number of Cars INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS Figure 5.2 Economies of Scale as a Basis for Trade

27. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Economies of scale can occur between countries but the pattern is indeterminateغير محدد - غامض • As a practical matter it makes little difference which country produces which product • Often the determination is based on historical accident or the original tastes and preferences within the domestic economy

28. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • There are two sources of economies of scale • Economies of scale are internal when an increase in a firm’s output causes a decrease in its average cost • This often occurs in firms that use a lot of capital relative to labor or where there are high fixed costs for R&D • External economies of scale occur when a firm’s average costs fall as the total industry output rises • A larger industry may mean larger and less expensive suppliers or a bigger pool of labor

29. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • The Product Cycle ( Raymond Vernon) • In the product cycle, changes in technology or new product design can change the pattern of imports and exports • Developed countries tend to specialize in new goods based on technological innovation • Developing countries tend to specialize in well-established goods • As goods move through the product cycle there will be changes in how and where the good is produced

30. U.S. 150 140 130 120 110 100 90 80 70 60 50 40 30 20 10 0 Imports Exports Production Consumption New Product Maturing Product Standardized Product Stages of Product Development INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS Figure 5.4 The Product Cycle

31. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Stage 1 • New products need high-income markets to receive consumer feedback • Design and production process will still be evolving • Usually this development requires specialized scientific and engineering inputs available only in developed countries • Both production and consumption are likely to occur in high-income and high cost-of-production country • Over time may export to other developed countries

32. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Stage 2 • Product becomes more standardized in size, features, and production processes • Production may move to other developed countries instead of exporting to those countries • Country where product was developed may begin to import the good from the new production country

33. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Stage 3 • Production has become so standardized that profit maximization leads firms to produce in the lowest cost production site • Standardized production can be moved to developing countries to utilize semi-skilled labor to lower costs • Innovating country becomes an importer of the product • Innovating country moves production focus to new products and the cycle starts over

34. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Overlapping Demands – theory of Similar Taste ( Staffan Linder) • The overlapping demands theory says that trade in manufactured goods is likely to be greatest between countries with similar tastes and income levels • Domestic countries produce goods targeted at tastes and income levels of the domestic market • Most promising export market is countries with similar tastes and preferences • Within a country, consumers’ average income level will determine their general tastes and preferences • The theory explains the large and growing trade in similar but differentiated goods

35. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • In general these trade patterns not based on or predicted by the factor-proportions theory • Theory suggests that trade will be more active between countries with similar tastes, preferences and income levels • However, there is large amount of intraindustry trade between developed and developing countries • This can be explained by a combination of vertical differentiation and overlapping demands

36. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS • Some consumers in developing countries may have tastes/preferences similar to the developed countries • Their needs will not be served by their domestic market • They would look to developed countries to satisfy demand by importing goods • The opposite could be true for developed countries

37. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS Table 5.4(a) Automobile Manufacturers and Products Sold in the U.S.

38. INTRAINDUSTRY TRADE IN DIFFERENTIATED PRODUCTS Table 5.4(b) Automobile Manufacturers and Products Sold in the U.S.

39. Human Skills Theory Donald Keesing (1966) Emphasizes differences in endowments and intensities of skilled and unskilled workers. Explains the Leontief paradox: Since the U.S. has highly trained, educated workers relative to other countries, U.S. exports tend to be skilled-labor intensive.