Inter-industry and intra-instry trade.

Heckscher-
Ohlin Model
Posted on June 23, 2012 by John Dudovskiy

Differences between inter-industry and intra-industry trade.

International trade is one of the key factors of macroeconomic prosperity for
any country. Today with the increasing force of globalisation international
trade has become very complex with multi-billion transactions taking place
every year. Yet, some of the aspects of international trade are still not fully
researched and even existing theories related to the international trade need to
be submitted to critical analysis taking into account ever-changing global
economic environment.

Difference between Inter-industry and Intra-industry trade

Although their wording is very similar the terms ‘inter-industry’ and intra-
industry’ trade have a very different meanings.

Inter-industry trade is a trade of products that belong to different industries. For

instance, the trade of agricultural products produced in one country with
technological equipment produced in another country can be classified to be an
inter-industry trade. Countries usually engage in inter-industry trade according
to their competitive advantages.

Intra-industry trade, on the other hand, is a trade of products that belong to the
same industry. As it has been noted, “intra-industry trade (IIT), that is trade of
similar products, has been a key factor in trade growth in recent decades. These
trends have mostly been attributed to the fragmentation of production
(outsourcing and offshoring) as a result of globalisation and new technologies”
(Handjiski et al, 2010, p.15).

Explanation of Intra-Industry Trade by Economic Theory

It first sight it may seem strange that countries do engage in importing and
exporting same type of products with their international partners. However,
there are a range of benefits intra-industry trade offers businesses and countries
engaging in it in general.
The benefits of intra-industry trade have been explained by various business
researchers, and all of these benefits can be summarised into three points that
which is illustrated by Johnson and Taylor (2009) in the following way:

Firstly, intra-industry trade increases the variety of products the same industry,
which is beneficial to both, businesses, as well as consumers. This benefit of
intra-industry trade is possible because today product range from the same
industry can be highly differentiated, and intra-industry trade will provide the
opportunity of having a vast range of differentiated products within the markets
of trading partners.

Secondly, intra-industry trade gives opportunity for businesses to benefit from

the economies of scale, as well as use their comparative advantages. In other
words countries will get more economic benefits if they concentrate on
producing specific types of products within specific range, according to their
comparative advantages rather than producing all ranges of specific products.

Thirdly, inter-industry trade stimulates innovation in industry, and can assist

the economy in cases of short-term economic fluctuations.

The main benefit of intra-industry trade can be explained in simple terms by

using an example of car trade between Japan and Germany. Let’s suppose
Toyota, a Japanese car company mainly produces family cars, and German car
manufacturer Audi concentrates on producing sport cars. Accordingly, when
Toyota produces more family cars, the lower will be the unit cost, and
similarly, more sports cars are produced by Audi, the lower unit price of the car
will be.

Heckscher-Ohlin Model and Intra-Industry Trade

Heckscher-Ohlin Model was developed by Eli Heckscher and Bertil Ohlin and
offers a general equilibrium approach to the issues of international trade. The
essence of the model can be summarised to the idea that countries will
concentrate on exporting products for the production of which their abundant
resources are required, at the same countries try to import those products for
production of which resources required that are scare in respective country
(Kemp, 2008).
Ruffin (1999) mentions three fundamental characteristics of Heckscher –Ohlin
model of intra-industry trade as following:

Firstly, each county exports products according to its comparative advantage.

For instance, China produces and exports technology products because the low
prices of relevant resources in China provide comparative advantage in
producing and exporting this type of products, while Turkey mainly exports
clothing products due to the cheaper prices of cotton and advanced textile
industry present in Turkey.
Secondly, international trade that is based on the comparative advantage will
benefit some industries, at the same time hurting other industries. For example,
when UK exports technology abroad, technology companies will benefit;
however, when clothing items are imported into UK, unskilled workers within
clothing industry in UK will be hurt.
Thirdly, international trade between countries will result in price equalisation.
To put it simply Heckscher –Ohlin model of intra-industry states that
“economies export the services of their abundant factors and import the
services of their scarce factors” (Ruffin, 1999, p.4)

However this theory has attracted criticism due to a set of assumptions it

makes. Specifically Heckscher-Ohlin Model assumes that there is a constant
supply of productive factors in the in a country, the points of differences
between of countries are only on factor endowment, and also the theory does
not take into account technological progresses.

Nevertheless, apart from the serious shortcomings of Heckscher-Ohlin theory,

it still fails to explain intra-industry trade between countries, because the theory
contradicts to the notion of intra-industry trade in fundamental level.

Specifically, Heckscher-Ohlin theory states that countries will engage in

exporting those products for the production of which their abundant resources
are going to be used. However, intra-industry trade involves products from the
same industry being traded between countries, compromising the validity of
Heckscher-Ohlin theory in today’s economic environment.

Conclusion
Intra-industry trade has evolved to be one of the important macro-economic
practices that is beneficial in terms of maintaining macro-economic stability,
promoting innovation and increasing the number of differentiated versions of
the same type products in markets of the trading partner countries.

The above and other benefits of intra-industry trade have been explained in
economic theory by various authors. However, Heckscher-Ohlin theory fails to
explain intra-industry trade because the theory states that only product
produced with abundant resources are going to be exported, scarce resource
products will be imported to a country, whereas countries engaged in intra-
industry trade use the same resources.

The pattern of inter-and intra industry trade within the EU

While trade between countries is can be imports and exports, depending on if
the goods are coming into country, or leaving the country; movement of goods
within European Union is referred to as arrivals and dispatches.

The exact definitions of arrivals and dispatches are given in the following way:

“Arrivals are goods in free circulation within the EU which enter the statistical
territory of a given Member State.

Dispatches are goods in free circulation within the EU which leave the
statistical territory of a given Member State to enter another Member State”
(Eurostat, 2011, online)

The trade within EU from dispatches was calculated to be EUR 2 194 341
million in 2009 (Eurostat, 2011). This amount is more than double the amount
of trade engaged in with non-EU countries. The share of dispatches within EU
compared to exports to countries outside of EU for each country is presented
on the following table:
The importance of the internal market was highlighted by the fact that for each
of the Member States, intra-EU trade of goods was higher exports. The highest
shares of intra-EU trade were recorded for the Czech Republic, Slovakia and
Luxembourg, in cases of United Kingdom, Italy, and Malta this number was
considerably lower.
We can see that intra-EU trade decreased in 2009 even more significantly
compared to the exports. There are many reasons for this change, and of the
main reasons can be pinpointed to be the global economic crisis that started in
US in 2007, and within a short period of time extended to all EU member
countries as well. Taking into account arrivals and dispatches together, the
biggest decrease in intra-EU trade were observed in cases of Latvia, Lithuania,
Estonia and Finland, where intra-trade has decreased about 30%. This was the
reasons why latter countries suffered the most from the global economic crises
of 2007-2010.

In order to analyze performance of any given member of EU, looking at intra-

industry trade would not suffice; rather the trade surplus (extra and intra-EU
combined) should be looked at.

Germany was leading in terms of the trade surplus for goods for the year of
2009, at EUR 134 780 million. The next highest trade surplus in 2009 (EUR
39 244 million) was observed in case of Netherlands, followed by Ireland
(EUR 37 753 million).

However, for the same period some EU members have experienced trade
deficit as well. For instance, the highest trade deficit of EUR 93 189 million
was recorded by the United Kingdom, although this was an improvement
compared to even worse performance in 2008.

Implications for Trade Diversion and Trade Creation within EU

Trade creation, as Czinkota et al (2008) inform, is a benefit of economic
integration. Specifically, it is a benefit a particular country obtains as a result of
number of countries trading freely among themselves, and creating barriers to
non-members.

Trade diversion, according to Czinkota et al (2008) is a cost of economic

integration to a particular country of being a part of group of countries that
trade freely among themselves, but maintain barriers to non-members.

In order to analyse implications of above figures for trade diversion and trade
creation within EU, it would be more efficient approach first to analyse EU
from the point of view of Free Trade Area (FTA) or a Union.
Outside a union, and operating independently, countries will attempt to use its
comparative advantage In a free trade area, on the other hand, countries will
trade with other countries they choose, attempting to exploit their comparative
cost advantage by the means of specialisation They will export goods they
produce most efficiently, and import goods from low-cost countries that have
exploited their own comparative cost advantage to produce cheap exports. In a
situation where countries form FTA’s such as EU, trade will be vague and the
pattern of trade will change. Inefficient producers may be may be protected and
encouraged, at the expense of more efficient imports.

The creation of a customs union, with common external tariffs, will further
change the existing pattern of trade flows. The assumption is that before the
union, members imposed differential tariffs on different countries to protect
their own industries.

Once a union is created, members agree to eliminate tariffs between

themselves. The effect of this is that, facing lower priced, zero-tariff, imports
from members, consumers increase their demand for these goods, and new
trade will be created.

For example, if Denmark and the UK form a customs union, tariffs on Danish
butter must now be reduced, and once they are completely removed, the free
market price of 120p will be highly attractive to UK consumers. UK consumers
will now consume more butter in total because average butter prices will have
fallen with the removal of tariffs on Danish butter, and total demand for butter
rises. For example, total output and consumption might increase to 32m kgs
(up by 2m), with UK farmers down from 20m to 15m, New Zealand exports
collapsing to just 2m, and Denmark increasing its output and sales of butter to
the UK to 10m (from 5m to 10m).

Furthermore, this will enable a dynamic reaction within Denmark and the UK.
Over time, as countries (Denmark and the UK) become more integrated,
increased trade will generate further efficiency gains, such as through the
application of economies of scale. Prices may fall even further, relative to those
of non-member countries, and the process of trade creation continues. For
example, with increased sales, Denmark can specialise further in butter
production, and produce on large scale, bringing prices down even further
(perhaps nearer to the New Zealand level). Also, the UK can now free up its
resources, and move them out of butter production and into goods and services
for which the UK has a comparative advantages over Denmark. Hence, over
time, trade creation will continue as a positive long-term effect of a customs
union.

The major loser in this is the previous trading partner left outside the bloc –
less trade now exists between new members and their old trading partners.

For example, after Denmark and the UK form a customs union, New Zealand,
which was the most efficient butter producer, suffers a loss of sales to the UK,
from 5m to 2m, with trade diverted from New Zealand to Denmark. However,
there is some debate about the use of the term trade diversion. In its simplest
form it means any trade diverted away from efficient global producers as a
result of the creation of a customs union. Other economists regard trade
diversion as relating to the long-term loss of trade resulting from inefficient
producers (such as Denmark, in our hypothetical example) becoming more
efficient following membership of the union. For example, if the price of
Danish butter falls from 120p to 95p as a result of trade expansion within the
union, it is now 5p cheaper than New Zealand in the open market, and more
trade may now be diverted away from the formerly highly efficient New
Zealand. Whichever definition is accepted, it is clear that in this case the union
has distorted trade.

Within a free trade area many markets and multiple countries are affected by
any economic or otherwise changes within that area. Therefore, to analyze the
total effects of a FTA, we need to aggregate the impacts across markets and
countries.

Accordingly, each member state of EU has experienced economic

disadvantages in the form of trade diversion. A good example of trade
diversion in case of UK would be the import of lamb into the UK. Before UK
joined the EU lamb was imported into the country from New Zealand at a
suitable price. However, as a result of UK joining EU France became the main
importer of lamb into UK with much higher price than it was imported from
New Zealand. In this was we can see the economic disadvantage UK had to
experience as a result of joining EU.

The recent enlargement of the European Union (EU) be attributed and the
need for the expansion intra-industry trade within the EU. Explain.
The secondary data research has revealed that recent enlargement EU was
undertaken for a variety of reasons, and one of the main reasons was the need
for the expansion of intra-industry trade within EU.

According to analysis by The Centre for Economic Policy Research (2011) one
of the main reasons of recent EU enlargement was to improve the level of
intra-industry trade within EU, by trading low-skill and high skill products
within one sector. Moreover, the analysis states that the amount of total intra-
industry trade among Singapore, South Korea, and Taiwan was bigger than the
EU before the expansion, and the recent EU enlargement put the Union ahead
of above named countries in terms of the amount of inter-industry trade.

The above statement can be explained in a more simple terms. For instance, if
Latvia exports low priced clothes to UK, the clothes will be the result of work
of low-skilled workers working for minimum wages according to EU standard.
Accordingly, when at the same time UK exports clothes to Latvia, these clothes
will be highly priced, apparently with good quality because they would be
produced by high-skilled workers in UK.

In the above situation the benefit for UK labour market will be in a way that
the demand for skilled workers in UK will increase, because more clothes need
to be produced to export to Latvia and other new members of EU, and at the
same time the demand for low-skilled workers in UK will decrease, due to the
fact that cheaper clothes made by low-skilled workers are already being
imported by Latvia and other new members of EU.

Conclusion
This paper has looked at the issues of inter-industry trade within countries from
the EU perspective. It has been identified that partner countries gain significant
benefits through engaging intra-industry trade in many levels. Moreover, it has
 been also established that EU countries engage intensively in intra-industry
trade, however in some occasions trade diversion may put some countries in
disadvantaged positions. Also, the paper has established that one of the main
reasons for EU enlargement was to promote intra-industry trade between
member-countries.

References
 Handjiski, B, Lucas, R, Martin, P & Guerin, SS, 2010, Enhancing Regional
Trade Integration in Southest Europe, World Bank Publications
 EU Enlargement: Implications for East-West Trade, Centre for Economic
Policy Research, Available at:
http://www.cepr.org/pubs/bulletin/meets/719.htm
 External and intra-EU Trade-Statistical Yearbook, Data 1958-2009, Eurostat
Statistical Books
 Johnson, D & Turner, C, 2009, International Business: Themes and Issues in
the Modern Global Economy, Taylor & Francis
 International Trade in Goods, 2001, Eurostat, Available at:
http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/International_tr
ade_in_goods#Further_Eurostat_information
 Kemp, MC, 2008, International Trade Theory: A Critical Review, Routledge
 Ruffin, RJ, 1999, The Nature and Significance of Intra-industry Trade,
Federal Reserve Bank of Dallas