Page 83 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 7 : Causes of Emergence and Measurement of Intra-Industry Trade and Its Impact on Developing Economics

Many empirical studies have been done to analyse the empirical links between the structure of Notes
industrial exports and the level of income per capita. Hufbauer tested the relationship between income
per capita and the composition of trade. The story of Linder is a controversial alternative to factor
proportions theory. As regards the bilateral trade intensity, Linnemann has made explicit reference
to distance variable which is absent in Linder. Johnson suggested that the positive relationship
between trade intensity and "Linder variable" (international similarity in per capita GNP) could be
the result of the reality of geographical proximity among countries with similar wealth levels. Thus,
Linder variable is a surrogate for distance and distance between partners is deterrent to trade.
Following Bergstrand (1985) & Linneman (1986), Hanink has developed a gravity model [Bergstrand
(1985)] and analyzed Linder's theme as a "spatial interaction model" i.e., model based on mutual
attraction between places.
So far as the empirical testing of Linder corollary relating to the commodity composition of trade in
manufactured goods is concerned, the statements is "Potential exports and imports are--when they
are manufactured--the same products. An actual import product today is a potential export product
today and may be an actual export product tomorrow." This means that there would be a similarity
between a country's export vector of manufactures and its import vector of manufactures--irrespective
of its level of development. This export-import similarity is measured by either, Finger and Kreinin
(1979) Export-Import Similarity (EIS) index or, by Allen's Cosine measure (COS).

In Linder's version, exports of manufactures are an outgrowth of a home production
satisfying the home consumption demand

A study by Linnemann and Beers (1988) on the commodity composition of exports of a country and
of imports of another country shows that Linder thesis of a potentially relatively stronger trade in
manufactures between countries of similar level of per capita income is rejected. On the other hand,
the potential intensity of trade would generally seem to increase with increasing per capita income of
the trading partners. Gray notes the applicability of Linder's proposition to the explanation of IIT and
relates it to the theory of differentiated markets in international trade. Gray calls these goods as 'Linder
Goods' and these goods are the primary component of the large volume of trade between countries.
Overlapping demands also arise in the context of product variety i.e., the number of goods in a
country's basket of imports/exports. Overlapping demands among rich countries can cover both
income elastic and income inelastic goods.
Increasing Returns and Scale Economies
Increasing returns to scale provide an additional factor motivating trade where both countries benefit
from trade even when they are identical with respect to tastes and technology. This is supply side
explanation of models. Such trade cannot be carried on in conditions of perfect competition and
equilibrium will require that the firms involved have some degree of market power. The role of scale
economies is of particular interest because of their importance to theoretical models. Most genuine
IIT consists of two way trade in differentiated products, since with the exception of strategic trade in
oligopoly market situations, homogenous goods IIT is believed to represent border or seasonal trade.
The first departure from the standard competitive model is the Marshallian approach in which
increasing returns are assumed to be external to the firm and internal to the industry, allowing perfect
competition to remain. According to Krugman, the literature did not seem to offer the interaction of
increasing returns and comparative advantage as explanations of trade. Ethier cast his approach to
the problem in terms of the two-way trade in intermediate goods, providing a formal basis for relating
IIT to external economies linked to the world market size. Subsequently in Ethier, he produced a
model in which external and internal economies of scale interact to generate IIT starting from the
allocation of resources to production and trade. According to a simplistic version of the scale economy
thesis, the large nation because of an assured home market will specialize in goods produced with

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