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International Trade and Finance

Notes close to –1 and 1 represent higher marginal inter-industry trade : if ∆X > ∆M , M I I T”’ > 0, and if
∆X < ∆M , M I I T’” < 0. So, values of M I I T’” > 0 indicate that exports are expanding at the expense
of imports (strong domestic industry performance), conversely for M I I T’” < 0 (weak domestic
industry performance). Unlike previous Grubel-Lloyd type indices, this index cannot have a (un)
weighted average taken to assess marginal intra-industry trade at the country level; an average of –
1 and 1 is zero, which grossly misrepresents the type of trade.
One final issue with the measurement of marginal intra-industry trade comes from Thom and
McDowell (1999). They claim that the Brulhart Index cannot distinguish between inter-industry trade
&&
and vertical intra-industry trade, and therefore, overestimates the costs of adjustment due to changes
in trade composition—though the costs of adjustment for vertical intra-industry trade (quality
differentiated goods) may be higher than horizontal intra-industry trade (variety differentiated goods),
both will have lower adjustment costs than inter-industry trade. As we shall see in the next section,
this is not entirely true. The Brulhart Index captures all intra-industry trade for which there is a
&&
simultaneous export and import of the same commodity classification; this includes horizontal intra-
industry trade and vertical intra-industry trade that is defined by quality differentiation, but does
not include vertical intra-industry trade along the lines of vertical integration within an industry—
two, or more, distinct commodities traded between two countries, which are usually deemed as
being within the same industry. The latter of the definitions of vertical intra-industry trade is usually
not considered in empirical studies, and for good reason; grouping distinct commodity classifications
together, although intuitively appealing at times since different sizes of automobiles have distinct
commodity classifications, returns us to the difficulties of categorical aggregation discussed above.
Commodity categories have become sufficiently disaggregated to avoid categorical aggregation issues
and meaningfully disentangle vertical and horizontal product differentiation, but we must be careful
not to take two steps backward from this one step forward.
7.6 Disentangling Horizontal and Vertical Intra-Industry Trade

Although the measurement of intra-industry trade as a whole has come a long way since Balassa
(1966) first proposed a measure, we have seen above, for reasons of measuring adjustment costs, that
there are reasons to disentangle horizontal and vertical intra-industry trade from each other. Also, as
we will see below, vertical and horizontal intra-industry trade have different expectations with respect
to parameter values of the determinants of intra-industry trade. We will now discuss how these two
trade types have been disentangled in the literature.
Unfortunately, the Grubel-Lloyd Index, and its variants, gives us no explicit way to differentiate
between one-way an two-way trade; the index tells us the degree of trade overlap, but doesn’t tell us
when we are dealing with two-way trade. If we are to take the definition of two-way trade literally,
the simultaneous import and export of the same commodity classification, any commodity that has a
Grubel-Lloyd Index greater than zero will be deemed two-way trade. More generally, we can consider
trade within a commodity classification two-way trade when the value of the minority value flow of
trade represented at leastγ percent of the majority value flow of trade, which is the following condition
:

Min ( X p,t ,M p,t )
Two-way trade if : Max ( X p,t ,M p,t ) > γ% ... (14)

where p ≡ product and t ≡ year. Below this level, the minority value flow would not be considered
significant since it does not represent a structural feature of trade. This criterion can then be used to
calculate an index of two-way trade :

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