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

(ii) Vertical differentiation: It is broadly consistent with quality differences i.e. availability of Notes
alternative quality grades unlike the earlier case of availability of alternative specifications of a
product in a given quality grade.
Oligopolistic Markets and IIT
Because a variety of assumptions can be made regarding conjectural variations, equilibrium outcomes
can be generated in a wide range of contexts. Scale economies have also been associated with IIT
models in their role as a source of barriers to entry. Strategic interaction among oligopolists whose
market share is related to internal economies may result in two way trade as in Brander (1981).
Further, with regard to 'Rome market effects" of Helpman and Krugman which leads the monopolies
to specialise geographically, Rauch (1989) suggests that a monopolist could internalize Ethier's
international external effects by organising as a multinational and engaging in intrafirm IIT. This
possibility means that unless the externalities are tied to non-tradable inputs, IIT would not necessary
be reduced in the presence of increasing returns. Furthermore, Rauch points out those internal
economies linked to a specific location by non-traded inputs or transport costs effects must be strong
enough to offset the diseconomies of metropolitan agglomeration before they have the effect of reducing
IIT. Because these diseconomies rise steeply with city size he argues that it is difficult to envision
large countries as having a comparative advantage capable of affecting the international location of
manufacturing simply because they are large. Everything depends on assumption regarding basic
structural features of the market concerned and the conjectural variation.
Some important insights into international trade have been gained by adopting the Cournot (1838)
assumption that imperfectly competitive firms take each others output as given. Papers by Brander
(1981), Brander and Krugman (1983), Neven and Phlips (1984) and Krugman (1984) have made this
assumption. The Cournot approach has led to the possibility of trade arising purely because imperfectly
competitive firms have an incentive to try to gain incremental sales by "reciprocal dumping" in each
others home markets.
The model of Brander (1981) envisages an industry consisting of two firms, each in a different country
and each acting as a monopolist in autarky. They take the other firm's deliveries to each market as
given. There would be an incentive for each firm to sell a little bit in the others home market as long
as the price there exceeds marginal cost and it will continue until, with symmetric firms, each firm
has a 50% share of each market. This theory of "reciprocal dumping" is related in important ways to
the traditional Industrial Organization literature on basing point pricing and cross hauling. What the
new models make clear, however, is that despite the waste involved in transporting the same good in
two directions, trade can still be beneficial. The major importance of the Cournot approach, however,
lies in its versatility and flexibility of discussion of trade policy. As opposed to this model, different
models have been developed where products are vertically differentiated and entry considerations
are important. Unlike the Falvey Kurzkowski model, product quality is exogenously given. These
models are based fundamentally on the work of Gabszewicz, Shaked, Sulton and Thisse (GSST) in a
natural oligopoly framework.
The mathematical complexity of the model is beyond the scope of this review. The above theoretical
models have empirical basis and much of the intra-industry trade literature is based upon empirical
studies relating to the degree of intra industry trade and the associated country and industry features
explaining it. The empirical analyses of IIT requires some discussion regarding problems of
measurement and the methodological issues to which we turn in the next section. Assessing the
importance of these theories in explaining the pattern of trade is essentially an empirical matter.
7.2 Intra-Industry Trade: Recent Empirical Evidences Using A Global
Database

We measure the extent of IIT in manufactures for a set of countries and study the country characteristics
and interrelationships between the degree of IIT and some country features. The analysis to be carried
out will help explaining the source of generation of IIT in developing countries and the relevance of
analysis of IIT, both theoretical and empirically, in the context of developing countries. We use Global

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