Today, we look at an important fact about international trade:
the great prevalence and increasing importance of intra-industry trade.
Here's a classic or paradigmatic example of what we typically think about, --
when we think about trade based upon comparative advantage:
wheat and cane sugar.
So, in this example, --
one country which has the comparative advantage in wheat;
it exports wheat and it imports cane sugar.
The other country produces and exports cane sugar and it imports wheat.
Here's another paradigmatic or classic example,
this one from Heckscher-Ohlin theory:
jet aircraft and shoes --
or a high-skill, high-capital intensive good,
and a low-skill, low-capital intensive good.
Again, the key here is that one country exports --
the jets and imports the shoes.
The other country exports the low-capital, low-skill good,
the shoes,
and it imports the high-skill, high-capital good, --
the jets.
Now, when we actually look at the trade data, however,
what do we see?
Well, the paradigmatic example in the data,
might actually be motorcycles.
That is, one country exports these motorcycles,
and imports these motorcycles, --
and the other country imports these and exports these.
Now, that's a little peculiar, --
because, at first glance, these motorcycles look awfully similar.
Why should one country be exporting one and importing the other
and vice versa for the other country?
And, yet, this intra-industry trade; --
trade based upon similar goods,
where one country is both exporting and importing
the same good or a similar good; turns out to be very common.
This intra-industry trade is what this lecture is all about.
So, intra-industry trade is the share of trade
that is within or intra the industry --
rather than across sectors.
It's typically measured by the Grubel-Loyd index or other indexes,
but this one is the one which is most common.
Let's show how this Grubel-Loyd index works.
Let's first, here,
the top is the absolute value of exports minus imports
divided by the sum of exports and imports.
So, for example, suppose there's a good which a country exports,
but does not import.
Well, then imports are going to be 0; --
this number is going to be 1.
1 minus 1 is 0.
So, in that case, intra-industry trade would be 0.
That is, if we have a good which we export
but don't import, --
intra-industry trade, as measured by the Grubel-Loyd index, will be 0.
Same thing if there's a good for which we import, --
but we don't export it.
On the other hand, suppose that exports equal imports.
So, we have a good for which --
the number of exports is about the same as the number of imports,
then this is 0 and this is 1.
So, the Grubel-Loyd index
for a good which we both export and import would be equal to 1.
So, let's give some examples.
So, in 2010,
the U.S. exported 170 million dollars worth of raw sugarcane
and it imported 1.9 billion dollars of raw sugarcane.
So, this is the case where we import a lot of the good
and export hardly any at all,
so we should have a number which is close to 0, --
and, in fact, when you do the calculation,
you find that for cane sugar the Grubel-Loyd index is --
.164.
In other words, there's not very much intra-industry trade.
On the other hand, what about motorcycles?
Well, in 2010, --
the U.S. exported about a billion dollars worth of motorcycles --
and we also imported about a billion,
actually 1.2 billion worth of motorcycles.
So, if you calculate the Grubel-Loyd index,
what you find is that it should be close to 1 and, in fact, it is.
It's .909.
So, that's how you calculate intra-industry trade.
Let's look at what it is across some different countries.
To measure the amount of intra-industry trade by country,
we're going to take those indexes which we just calculated by product
or by industry in the last slide.
We're going to sum them all up rating each by the share of total trade.
And if you do that,
you can get an intra-industry trade statistic for the country as a whole,
and a bunch of these are shown over here.
These are measured in really just the same way.
Instead of .9,
it's multiplied by a 100 to get us 90.
But what this indicates is that countries near the top; --
most of their trade is intra-industry trade.
So, Belgium, France, United Kingdom, Spain; --
they are importing and exporting very many similar goods.
Even the United States has a intra-industry trade statistic of 72.
So, that means the paradigmatic example for the United States
is not the cane sugar example,
which had a intra-industry statistic of about .1, --
but instead is the motorcycle example, closer to the motorcycle.
So, the United States is often importing and exporting similar goods.
Down here, towards the bottom, we get countries which --
have lower levels of intra-industry trade.
Australia and Chile, for example; --
these countries export a lot of minerals --
which they don't so much import.
So, their values are lower.
For most of other countries in the world, however,
the intra-industry trade statistic is very high indeed.
Intra-industry trade also varies by the industry that we're talking about.
So for medical and pharmaceutical products,
the United States both exports a lot of these products,
but it imports a lot of them as well.
So, intra-industry trade is very high.
On the other hand, for footwear,
the United States mostly imports footwear;
it doesn't export footwear.
And for other countries as well,
the other countries may export a lot of footwear
and not import a lot of footwear.
So, around the world, in fact,
footwear tends to have low intra-industry trade.
You're either exporting it or you're importing it, not both.
Same thing with medical and pharmaceutical products;
you're probably doing both, exporting and importing those products.
There's some hint here, by the way, that the countries or, excuse me,
that the industries with high intra-industry trade
show a little bit more monopoly power,
a little bit more suitable perhaps for monopolistic competition.
That's the theory that we're working towards and there's some evidence for that,
though just a little bit, in this kind of description here.
What this graph shows is that intra-industry trade
has become more important as a total share of world trade.
So, if we go back to that paradigmatic example of --
comparative advantage of trading wheat for cane sugar.
In Ricardo's time, that example was indeed representative.
That wheat for cane sugar idea intra-industry trade was quite low.
So, that example at that time was representative.
But we're moving from a world, in which wheat for cane sugar is representative,
towards one in which trading motorcycle for motorcycle, is representative.
Okay, these are important facts to know.
But what does it all mean?
I've already hinted at sort of a traditional story which is not quite correct.
But let's give it a traditional story.
It's that comparative advantage and --
Heckscher-Ohlin theory explains trade across different goods or countries --
and thus has difficulty explaining intra-industry trade.
So, the fact of intra-industry trade was used to motivate --
many of the new trade models based upon increasing returns,
based upon a product differentiation and monopolistic competition.
So, Helpman and Krugman, who were key pioneers in this area,
said that trade patterns seemed to include substantial two-way trade
in goods of similar factor intensity.
This intra-industry trade seems both pointless and hard to explain, --
from the point of view of conventional trade analysis.
So, they argued that, in order to explain intra-industry trade,
you needed a new theory, and the theory which they and others;
Krugman in particular was a pioneer, Helpman too; --
was one based upon product differentiation,
internal economies of scale, and monopolistic competition.
And that's the theory which we're moving towards,
but we have to provide one footnote to that before we get there.
Once it became clear that the intra-industry fact was important, --
theorists began to ask,
'Is it really the case that the only theory capable of explaining inter-industry trade
is the increase in returns, monopolistic competition theory?'
And they raised two objections.
The first objection, perhaps a more minor objection,
but an interesting conceptual one,
is, what is the right level to define an industry?
So, we took the industry definition as motorcycles,
but that's arbitrary, that was just chosen by a government statistician
for entirely different purposes.
Why choose that level of definition?
If we aggregate even further, --
we can make almost all trade intra-industry.
So, for example, if we said that the industry is not motorcycles,
but vehicles, --
then much more of trade is going to be intra-industry.
On the other, hand if we said, 'No, no, no. The right level of aggregation
is not motorcycles, but --
big engine motorcycles and small engine motorcycles,
then almost no trade would be intra-industry.
If we define the industry to be --
a coincident with the product itself,
then no trade would be intra-industry.
So, it's somewhat arbitrary at what level of aggregation that we choose.
Second objection, and a more important one,
is that small changes to comparative advantage and Heckscher- Ohnlin theory
can in fact explain intra-industry trade.
And the basic idea is this: --
In trade theory an industry means activities with similar factor shares.
But, if producing, let's say,
Harley motorcycles and Kawasaki motorcycles,
use similar factor shares, --
and if their factor price equalization, --
then, precisely because these industries are similar,
these products are similar,
small differences in productivity can generate lots of specialization.
Small differences in productivity in a factor price equalization world
can generate lots of specialization.
So, what do we make of this?
Well, my view is that micro-economic evidence suggests that
product differentiation, internal increase in returns,
and monopolistic competition are important.
So, even if we look outside the trade theory,
there is evidence for these assumptions of the theory.
Moreover, this new trade theory,
does in fact offer a compelling explanation
of intra-industry trade and other trade facts.
It's also not entirely clear to me
whether other theories can explain all of the facts
including, for example, the intra-industry trade statistics by industry,
which industries have the most intra-industry trade.
Monopolistic competition theory offers an answer to that
based upon monopoly power;
it's not clear that Heckscher-Ohlin theory does.
But, maybe the theorists will come up with something; I don't know.
In any case, we're going to be looking closely at a new trade theory, --
even if it cannot be judged to be the only theory capable of explaining the facts,
it's certainly an important theory and we're going to spend some time on it.
Here's some further reading: Marius Brülhart has a good account
of the statistics across nations.
Helpman and Krugman who were key players in the new trade theory.
They summed up a lot of their work from the early 1980's in their book,
"Market Structure and Foreign Trade".
A more recent textbook, Krugman, Obstfeld, and Melitz,
has some good material on this subject.
And the key paper in the counter attack --
showing that Heckscher-Ohlin and comparative advantage
could explain intra-industry trade is this important paper by Donald Davis.
Thanks.