Inter Industry and Intra Industry Trade - Essay Example

? Inter Industry and Intra Industry trade Introduction Currently there are increasing instances of international trade taking place between industrialised nations, especially in the field of product manufacture. International trade is a major factor for macroeconomic stability for a nation. With increasing globalisation in the 21st century, international trade has turned complex with large-scale transactions worth billion dollars taking place annually. Within the realms of international trade, inter-industry trade is referred to trade in products belonging to divergent industries. As for example, trading of agriculture related products of a country with technology related machineries manufactured in another country would be categorised as inter-industry trade. This form of trade is primarily based on competitive advantages derived by the concerned countries. In contrast, intra-industry trade is based on a trade of products belonging to the same type of industry. In this context, experts have noted that, “intra-industry trade, that is trade of similar products has been a key factor in trade growth in recent decades…owing to fragmentation of production (outsourcing and offshoring) as a result of globalisation” (Handjiski, Lucas, Martin and Guerin, 2010, p.15). This article will examine the concept of inter and intra industry trade and review the importance of intra industry trade within the realms of international trade. Discussion The term ‘inter industry trade’ is often explained using Ricardian model or the Heckscher-Ohlin model, where countries are said to intensify their production values, and trade takes place amongst the industries. As for example, a Heckscher-Ohlin model hypothesises that if a country’s economy that is capital rich specializes in producing capital concentrated cloth that is exported to a foreign country. The foreign country, with a labour-based economy, focuses in the production of labour intensive food, which is then imported by the capital rich country. Thus, inter industry trade occurs between nations where imports and exports comprise of different products and services, and is based on variations within factor endowment. Countries export products where factors can be intensively used for goods production, and import goods to countries they lack their own production, or where products can be manufactured with poor cost-effectiveness, owing to factor scarcity, intensively used for goods production. Under such circumstances, a country does not generally export and import the same product type. Inter-industry trade is in direct contrast to intra-industry trade that is a result of ‘imperfect’ competition between nations having identical factor endowments (Falvey and Kierkowski, 1987, 143-161). Examples of intra-industry trade include technology, beverages, minerals and automobiles. As per the definitions provided by OECD, intra-industry trade can be viewed through intra-industry trade measurements: a) “Trade in similar products (“horizontal trade”) with differentiated varieties (e.g. cars of a similar class and price range); b) Trade in “vertically differentiated” products distinguished by quality and price (e.g. exports of high-quality clothing and imports of lower-quality clothing)” (OECD, Glossary of Statistical terms, 2007). There are two different forms of intra-industry trade: Horizontal intra-industry trade: this comprises of simultaneous imports and exports of products categorised within an identical industry, and at an identical processing stage, therefore, based primarily on product differentiation, as for example, Korea’s export and import of cellular phones at the same time, at a same processing stage (Grubel, and Lloyd, 1975). Vertical intra-industry trade: This comprises of imports and exports of products at the same time within the same industry sector, but at a different processing phase. It is based on a growing ability to arrange for production fragmentation into various stages, each occurring at different places, and taking advantage of conditions in the locality of production. As for example, China, imports computer parts from the western countries and uses its cheap labour power to assemble the imported parts in a labour- intensive final phase of production, before the finished product (computers) is again exported to the US and Europe (Marvel and Ray, 1987). In the context of trying to place the concept of intra-industry trade within a frame of economic theories, a question arises, as why countries concurrently export and import the same products, or products belonging to the same industry type? In an answer to this question, Nigel Grimwade claimed, “an explanation cannot be found within the framework of classical or neo-classical trade theory. The latter predicts only inter-industry specialisation and trade” (Grimwade, 2000, p. 71). However, this is not justified and inter-trade industry can be explained largely by economic theories. The traditional trade pattern was based on models proposed by Ricardo and the Heckscher–Ohlin model that attempted at construing activities that take place within the realms of international trade. In both the models, there is the notion of comparative advantage with an analysis of why nations choose to conduct trade. Many experts have however claimed that the two models fail to present an adequate analysis as regards intra-industry trade, since as per the hypothesis projected by the models, the nations that show identical factor endowments would refrain from manufacturing/producing goods and trading at domestic levels (Krugman and Obstfeld, 1991). Finger (1975) also tried analysing inter-industry trade using economic dimensions and derived that existence of it was ‘unremarkable’ in nature, as current classifications categorised products of composite factor endowments into one industrial unit. However, observations reveal that when industries are broken down into very small components, even then inter-industry trade still takes place, thus nullifying this argument. Flavey and Kierzkowski (1987) proposed another theory, where a model was designed that attempted to remove the notion that all products are manufactured under the same technical situation. Flavey and Kierzkowski’s model proposed that the perceived feature of high and good quality products that are manufactured under high capital intensity allows for product differentiation on the demand side. However, this analysis has also been rejected on the basis that it fails to apply on all cases of inter industry trade and does not directly take into consideration the trade between products of identical factor endowments. Eli Heckscher and Bertil Ohlin in their researches on inter-industry trade developed the Heckscher-Ohlin Model, which followed an approach of general balance, as regards international trade (Blaug, 1992). The basic notions behind this model is that nations will focus on export of goods for manufacturing of which abundant resources are required, while concurrently countries would also try to import goods for production of which scarce resources are required in respective countries (Kemp, 2008). The three main feature of the Heckscher –Ohlin model as delineated by Ruffin (1999) are: Each nation exports goods as per its comparative advantage. As for example, China having cost effective resources manufactures and exports technological products, which gives it a comparative advantage, while Turkey exports clothes as cotton is cheap and there are modern textile industries to manufacture clothes in the country; Global trade based on comparative advantage provides advantages to some industries, while having a negative effect on others. As for example, when the US exports technological products, various technology firms are benefitted; however, when cotton clothes are imported into the US, unskilled labourers within cloth manufacturing industry are negatively affected; Global trade between nations would lead to equalisation of product prices. In other words, the Heckscher –Ohlin model suggested, “Economies export the services of their abundant factors and import the services of their scarce factors” (Ruffin, 1999, p.4) Amongst all the economic theories, New Trade Theory by Paul Krugman is the widely accepted one on inter-industry trade (Krugman, 1980). Here Krugman contended that world economies concentrate on taking benefits from rising returns, without following variations existing within regional factor endowments, especially allowing countries to concentrate in producing limited goods and derive gains of rising returns (economies of scale), without decreasing product variety available for the consumers (Krugman, 1980).  Donald Davis in his analysis made further developments on the Heckscher-Ohlin-Ricardo model, where it was presented that despite having persistent returns, intra-industry trade still occurs under traditional conditions (Davis, 1995). This model explained that trade would still exists between nations with same factor endowments owing to technological variations, as this promotes specialisation and hence trade (as was seen in the Ricardian model) From an initial glance, even though it may appear strange that nations take part in international trading activities that involve exporting and importing the same product types, there are many advantages offered by the intra-industry trade to the countries that engage in it (Brander, 1981). The chief advantages of intra-industry trade can be categorised into three main points that show its importance in the context of global trade (Johnson and Taylor, 2009): 1. Intra-industry trade raises the product variety within a single industry that in turn benefits both consumers and the overall business scenario. This advantage is possible since currently the product range within an industry are highly distinct, and intra-industry trade provides a larger scope for having a variety of differentiated goods amongst trade companions; 2. Intra-industry trade provides scopes for business to benefit from economies of scale and use the available comparative advantage. Therefore, nations will derive greater economic advantages if they specialise on producing particular product types of specific range based on their comparative advantages, instead of manufacturing variety of ranges of particular product types; 3. Inter-industry trade encourages industry innovation and helps the economy to remain stable during short-term economic crises. Conclusion Currently under increased instances of globalisation, intra-industry trade has turned into an essential part of global macro-economic activities, which is beneficial as regards bringing in stability at a macro-economic level, increasing the number of products of the same type within the market giving a consumer more choices and advocating innovation (Falvey, 1981). This trade is primarily based on the advantage where it allows consumers to have at their disposal a larger range of products at cheaper rates, while allowing producers to acquire economies of scale in goods manufacture by giving them an access to a wider global market.  With an overall rise in output, fixed costs are disseminated over a wide range of units, thus decreasing the corporation’s average production cost. Therefore, despite various debates on its rightful place within the realms of economic theories, intra-industry trade occupies an important position within the realms of modern international trade. 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Retrieved from http://stats.oecd.org/glossary/detail.asp?ID=7263 [accessed 25th October 2012] Ruffin, R., 1999. The Nature and Significance of Intra-industry Trade. Federal Reserve Bank of Dallas. Retrieved from http://www.dallasfed.org/assets/documents/research/efr/1999/efr9904a.pdf [accessed 25th October 2012]   Read More