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International Trade and Finance

Notes in a single country at a particular point of time, the author has used these indicators to make
comparisons over time and among countries.
The purpose of this section is to discuss the methodological aspects of the measurement of intra-
industry trade, rather than a documentary study of intra-industry trade applied to a country, or
group of countries. Most of the references in this section, as well as the section below on the
determinants of intra-industry trade, contain documentation of intra-industry trade levels for the
countries under study that are too numerous to mention here in this review.
But before we can discuss any measurement of intra-industry trade, we must decide what we are to
measure. This is not a philosophical question, but a practical one as the history of empirical intra-
industry trade has been mired by allegations of being a "statistical phenomenon" (Lipsey, 1976). The
charge of being a statistical phenomenon is not an idle one. At the 3-digit SITC level of aggregation,
canoes and 200,000 tonne tankers are in the same "ships and boats" industry; at the same level of
aggregation, table model radios and airport flight control equipment are in the "telecommunications
apparatus" industry (Lipsey, 1976). Also, Finger (1975) notes that trade overlap is not inconsistent
with classical trade theory if empirical product groups do not correspond with the appropriate
factor proportions groupings. Industry/product categories have become sufficiently disaggregated
to disregard these early claims of intra-industry trade being a statistical phenomenon. The Harmonized
Tariff Schedule (HTS) has a 10-digit classification system with over 20 000 entries that not only separate
canoes from 200 000 tonne tankers, but also from any other boat not designed to be used with motors
or sails-a classification that is even distinct from a rowboat. However, aggregation should not be
forgotten since it may still be an issue for other reasons. Nevertheless, we will now move on to the
various measures.

Intra-industry trade is defined as the simultaneous export and import of goods in
the same industry.

7.1 Models of Intra-Industry Trade: Basic Theoretical Underpinnings

So far as the historical source is concerned, IIT was identified while trying to find what culminated
into the formation of European Economic Community (EEC). Early research by Dreze (1961) and
Balassa (1965) found evidence of increasing intra-industry specialization in the decade following the
customs union formation. This led to the work of Grubel and Lloyd (1975) where detailed documentary
evidence of IIT at the 2 and 3 digit levels of the SITC for all the major industrialized countries have
been provided. Although by the mid-1970s some theorizing has been done [for example, Gray (1973),
Grubel (1970), Pelzman (1978)], there was no formal theoretical model. In addition, by the mid-1970s
there were few serious attempts at econometric explanation [Pagoulatos and Sorensen (1975), McAleese
(1979)-to mention a few]. In particular, theoretical work has become fashionable following some of
the theoretical formulations by Dixit and Stiglitz (1977) and Lancaster (1979).
Demand and its Importance in the Determination of Trade Structure:
Linder Hypothesis
As mentioned, according to the Linder hypothesis, while the composition of trade in primary products
may be explained by the factor proportions theory, the pattern of trade in manufactured goods is
mainly determined by the demand characteristics of a country. Specifically, Linder argues that the
structure of relative prices of industrial goods in each country is determined by the "representative
demand", and that income per capita is the most important single factor influencing the representative
demand. Linder claims that "the production functions of goods demanded at home are relatively more
advantageous" and he justifies this assertion on the reasons based on the unfamiliarity of the producers
with foreign markets as compared with the domestic market and on the existence of scale effects.

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