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International trade is traditionally thought to consist of each country exporting the goods most suited to its factor endowment, technology, and climate while importing the goods least suited for its national characteristics. Such trade is called inter-industry trade because countries export and import the products of different industries. But the top exports and imports of most industrial countries are actually similar items, such as passenger cars, electrical generators, or valves and transistors. Indeed,passenger cars are the number one export and import of Great Britain, Germany, and France.In the real world, international trade is largely trade within broad industrial classifications.Intra-industry trade occurs when a country exports and imports goods in the same industry. Intra-industry trade has been a hot topic among trade economists for several decades, but it has received scant attention among economists in general. 1 This article gives an overview of intra-industry trade for the generalist. In the debate over NAFTA, for example, commentators focused much attention on America’s interindustry trade with Mexico but none on the far more important intra-industry trade. This article begins with a brief summary of
Ricardian and factor endowment approaches to trade theory to highlight the contribution of intraindustry trade theory. Next, the article discusse the foundations of intra-industry trade theory and the significance of intra-industry trade for an economy. Finally, the U.S.– Mexico trade relationship is addressed as a pertinent example.STANDARD TRADE THEORY
To understand why trade economists have turned their attention to intra-industry trade, it is
necessary to understand the implications of inter-industry trade. Standard trade theory involves trade in homogeneous products; hence,with perfect competition there is only interindustry trade. David Ricardo (1817) introduced standard trade theory when he formulated what we now call the theory of comparative advantage. Ricardo highlighted the key ingredient of the theory: goods are more mobile across international boundaries than are resources (land,labor, and capital). This assumption still characterizes the theory of intra-industry trade. The theory of comparative advantage deals with all those causes of international trade that are generated by the differences among countries.Ricardo’s contribution was not simply that he
noted countries are different but that he showed how those differences resulted in all countries
The Nature and Significance of Intra-industry Trade Roy J. Ruffin Intra-industry trade represents international trade within industries rather than between industries. Such trade is more beneficial than inter-industry trade because it stimulates innovation and exploits
economies of scale. Roy J. Ruffin is a research associate of the Federal Reserve Bank of Dallas and M. D. Anderson Professor of Economics, University of Houston. 3 ECONOMIC AND FINANCIAL REVIEW FOURTH QUARTER 1999 being internationally competitive even though
they might have higher wages (for advanced countries) or lower productivity (for developing
countries) than their neighbors. Ricardo’s own subtle explanation is couched in terms of the barter of exports for imports. In the practical world, trade is conducted in terms of prices: people buy homogeneous goods where they are the cheapest. Consider a world of two countries, called home and foreign. The two homogeneous goods are apples and bananas. Suppose in the home
country apples cost $1 each and bananas cost $2 each, and in the foreign country bananas cost $1 and apples cost $2. For simplicity, the two countries are mirror images. Keeping with
the simple theme, but without any sacrifice of insight, imagine everyone in the world spends
exactly one-half his or her income on each good.Suppose each country has income of $100.
Thus, before trade, the home (foreign) country consumes fifty apples (bananas) and twenty-five
bananas (apples). If trade is opened between the countries and there are zero transport costs
and tariffs, people will buy the homogeneous products in the country where they are the
cheapest. Thus, with free trade between the two countries, the home country will buy bananas
from the foreign country, and the foreign country will buy apples from the home country. The
price of each product in a competitive world will be the price in the lowest cost country.
Thus, without tariffs or transport costs, the prices of apples and bananas will both be $1 in
a world of perfect competition
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