Trade, Theory and Econometrics

James R. Melvin, James C. Moore, Raymond G Riezman

• Publisher: Routledge
• Year: 2012
• ISBN:
  9781134752812
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book brings together cutting edge contributions in the fields of international economics, micro theory, welfare economics and econometrics, with contributions from Donald R. Davis, Avinash K. Dixit, Tadashi Inoue, Ronald W. Jones, Dale W. Jorgenson, K. Rao Kadiyala, Murray C. Kemp, Kenneth M. Kletzer, Anne O. Krueger, Mukul Majumdar, Daniel McFadden, Lionel McKenzie, James R. Melvin, James C. Moore, Takashi Negishi, Yoshihiko Otani, Raymond Riezman, Paul A. Samuelson, Joaquim Silvestre and Marie Thursby.

1

INTRAINDUSTRY TRADE:
ISSUES AND THEORY

Jagdish Bhagwati and Donald R. Davis

Introduction

In a recent issue of the Journal of Economic Perspectives, two Stanford graduate students, Joshua Gans and George Shepherd (1993), wrote about the difficulties that eminent economists had in getting their ideas published in the mainstream professional journals. They focused on papers containing unfamiliar ideas that have yet no resonance for the profession trapped in “conventional wisdom.” But they ignore the difficulty that sometimes attends publishing papers that challenge an orthodoxy that is newly established, no matter how penetrating and persuasive the critique is, simply because the challenge is seen as emanating from the “old and obsolete school.”

This latter has been the fate of John Chipman’s important work on intraindustry trade which refuted the new orthodoxy among the younger trade theorists working with models of imperfect competition; that perfectly competitive models could not generate intraindustry trade. Rejected by referees on grounds that Chipman’s results were “uninteresting” or “wrong” or “obvious” or attacking “straw men,” and published in consequence in volumes and exotic journals, this work remains a major contribution. This festschrift provides an appropriate place and occasion to resurrect that work, put it into context, and to reshape and extend it analytically.¹

The issues

Two different concepts of intraindustry trade

The phenomenon of intraindustry trade, which was propelled into center stage by the seminal empirical work of Grubel and Lloyd (1975), has been taken in the analytical literature to raise two wholly different questions.

1. Close substitutes in consumption One set of theorists has taken the phenomenon to mean that there is two-way trade in “similar products” across countries, obviously thinking of intraindustry trade therefore as trade in products which are close substitutes in consumption, much the way industrial-organization theorists implicitly and typically define an industry prior to undertaking the analysis of oligopolistic or large-group market structure in partial-equilibrium.²

When Staffan Linder (1961) initiated the analysis of intraindustry trade, noting that countries at similar stages of development had a high degree of trade, evidently he had in mind trade in similar products, so defined. So did Bhagwati’s (1964) survey of the theory of international trade where Linder’s theory of trade was set alongside Ricardo’s and the Heckscher–Ohlin theory as an alternative approach of significance.

In fact, while some of the writers on intraindustry trade have dismissed this trade in similar products by asserting that it simply reflects “categorical aggregation” (where the word “categorical” is used, not in the sense of the Kantian Imperative but simply as defined by categories of the SITC variety) and that therefore there is nothing more to be said about the matter, this is surely wrong. Linder himself attempted to explain why such two-way trade would arise (as with countries trading different varieties of cars, small and large), arguing basically from the demand side, allowing demand differences to obtain across countries and for there to be greater overlap between countries with closer per capita incomes than across poor and rich countries, and hence greater trade in similar products and in trade per se. Of course, this demand-side explanation is complete only when paired with a theory of location that accounts for the need for trade.

In a similar vein, Bhagwati (1982) also produced the outlines of a theory, based on differences in tastes and demands across countries which reflect essential differences in country “environment,” which then lead to similar product developments, with characteristics differentiated so as to reflect the different country “tastes,” in countries endowed with similar resources and broad know-how.³ With tastes diffusing quickly, and translating into demand for most such similar products, trade in similar products will break out. This was described as a “biological” theory of trade in similar products and its “dynamic” essentials detailed as follows (Bhagwati, 1982: 175–176):

just as in biological theorizing the “environment” interacts with “genetic factors” to produce a phenotype, we can think of an economic process whereby a specific choice of a product type emerges within a nation-society. Thus, think of the income level and the level of R&D in manufacturing as defining the capacity of the society to come up technologically with a given set of characteristic product combinations, e.g. small, medium, and large cars. The United States and Japan share this “genetic” set of traits … But which phenotype is selected in the market depends on the interaction of this common set of “genetic” traits with the specific “environment” of Japan and the United States. Thus the land–man ratios, the size and structure of the family, etc. may lead to the evolution of “gas guzzlers” in the United States and of smaller, fuel-economy cars in Japan, as, in fact, has been the case. At the next stage … the successful development of small cars in Japan and of gas guzzlers in the United States gets reinforced by localized technical change in precisely these types of cars with the result that one is now dealing with a situation of ex ante differentials in the know-how of producing and selling different types of cars. Next, since “cars” represent a generic product, representing a certain manner of transportation, the taste for cars diffuses to the United States and for gas guzzlers to Japan as part of the Schumpeterian process of dynamic capitalism, aided by advertising in search of new markets. Thus, trade in similar products arises.

Subsequently, Feenstra (1982) and Dinopoulos (1988) have formalized the essential elements of this “biological” theory.

2. Similar factor-intensity in production In contrast to this way of thinking about intraindustry trade as trade in similar products, however, trade theorists in the 1980s defined intraindustry trade from the production side, as two-way trade in commodities whose production was similar in factor-intensity.

From an empirical, as against a theoretical, point of view, the latter definition does not seem to correspond to the way that the bureaucrats and experts who devised the SITC categories down to five digits at the United Nations were grouping commodities. There is no evidence of ex ante intention to do so, and research by Michael Finger (1975) shows in fact that capital to labor ratios varied less between 3-digit industries than within them.⁴

Why did this factor-intensity-based definition arise and come to dominate the analysis and arguments which Chipman and others have addressed? The principal reason is the dominance in this period of the Heckscher–Ohlin–Samuelson model, whose analytic framework emphasized factor proportions. Equally, it was believed that trade in goods of similar (or especially identical) factor intensity posed a genuine puzzle that could not be accounted for in this model (Helpman and Krugman, 1985: 2).⁵

Any other way of getting to two-way trade in commodities of identical factor intensities, such that (say) homothetic symmetry of tastes or production functions across countries was abandoned while perfect competition was maintained, was not considered. In fact, many claims that imperfect competition was necessary to generate intraindustry trade may be found in the literature of the 1980s; and this gave a significant boost to the imperfectly-competitive theory of international trade (which, of course, is a major scientific achievement whose credentials do not depend on invalid arguments).⁶

The aggregation issue

Before we turn to a fuller analysis of the theoretical issues, it is necessary to note an altogether different, aggregation-based, critique of intraindustry trade that Chipman has done most to advance, which is orthogonal to the analytical issues as posed above.

Chipman (1992) has argued that the SITC-data-generated estimates of intraindustry trade reflect aggregation of different goods, and statistically demonstrates that disaggregation, carried down to multiple digits as far as is necessary, virtually eliminates such intraindustry trade. Note that this exercise simply fits an equation to the existing SITC categories, which have no clear correspondence to either of the two criteria which we discussed earlier, and which go down to five digits. Chipman shows that carrying the disaggregation down to 18 digits would reduce the share of intraindustry trade to negligible levels.

How should we look on this demonstration? Given the doubts that we have noted above about the correspondence between the SITC division into industries and the theoretical categories, which require aggregation by factor intensities, we find these results more interesting than compelling. Extrapolating by fitting an equation to SITC-groupings-generated data, where there is no identifiable principle by which these data are generated, seems to lack the necessary theoretical rationale on which to base any theoretically interesting conclusions.

Moreover, the theoretical work of Chipman and others, reviewed below, which shows that properly-defined intraindustry trade (i.e. aggregated by factor intensities, in contrast to the SITC data) is compatible with the conventional competitive Heckscher–Ohlin–Samuelson (H–O–S) theory, also suggests that empirical questions about the share of intraindustry trade are less pertinent.

Key theoretical questions

In any event, the key theoretical questions are the following:

• How do we account for trade in goods of similar factor proportions; and

• Why is there such a large volume of trade between countries with similar endowments?

The primary presumption of the new trade theorists that these phenomena – correctly observed or not – require that the constant returns to scale and perfectly competitive HOS model must be abandoned, and the secondary presumption that this requires a turn to increasing returns to scale and imperfect competition (rather than alternative formulations) need to be reexamined. This is the task to which we now turn, in the spirit of Chipman’s major theoretical contributions.⁷

The theory

Introduction

In the remainder of this chapter, we will review theoretical models of intraindustry trade in a competitive setting.⁸

1 First we focus on Chipman’s (1988, 1991) demonstration that intraindustry trade can be generated in a competitive HOS model. We proceed, however, to re-prove his principal theorem in a simpler and more transparent way by resort to a generalized version of the celebrated Lerner diagram of trade theory.

2 Next we extend this argument to show, as did Chipman (1992) and Rodgers (1988), that a large share of trade in this model being intraindustry is not anomalous.

3 Then we review the contributions of Bhagwati (1964) and Davis (1992, 1995) which account for intraindustry trade instead by departing from the conventional HOS model, not by allowing imperfect competition, but by allowing for international differences in production functions.

4 Finally we address a different, but related, issue which was considered by Chipman (1992) and has been addressed more fully by Davis (1997): in a multilateral world, with the competitive HOS model in place, would one be able to account for the presumed fact that there is more trade between countries that are similar rather than dissimilar in factor proportions? The answer again is in the affirmative.

In combination, therefore, these contributions present a powerful argument that the competitive trade theory in general, and the HOS factor proportions theory in particular, cannot be rejected based on evidence of the large share of intraindustry trade in world trade, or the large share of the major developed countries in world trade.

Intraindustry trade and the theory of aggregation: proving the compatibility of the HOS model with intraindustry trade

Chipman (1988, 1991) argues that the oft-cited statistics on the large share of intraindustry trade in total trade provide no basis for rejecting the HOS factor proportions model of trade, and develops a theorem that it is always possible to find endowments for which 100 percent of trade is intraindustry trade. In this section, we will provide an intuitive development of his theorem, and discuss its importance for the broader problem of intraindustry trade.

It proves convenient to think about the Chipman argument in a framework that focuses on trade as the implicit exchange of factors. Accordingly, we develop two points of analysis. The first reviews the conception of trade in the Samuelson–Dixit–Norman–Helpman–Krugman “integrated equilibrium” framework. The second develops what we call the Lerner technology matrix, which generalizes the familiar Lerner diagram to a many-dimensional setting.

The integrated equilibrium is defined to be th...

Table of contents

• Front Cover
• Trade, Theory and Econometrics
• Routledge Studies in the Modern World Economy
• Title
• Copyright
• Dedication
• Toast
• Salute
• Remarks
• Contents
• Tables
• Synopses of chapters
• 1 Intraindustry trade: issues and theory
• 2 Trade policy and US economic growth
• 3 On the mutual imposition of tariffs with free capital mobility
• 4 The importance of price normalization for models ofinternational trade under imperfect competition
• 5 Flexibility: a partial ordering
• 6 Free trade agreements as protectionist devices: rules of origin
• 7 Demand conditions in international trade theory
• 8 Factor shares and the Chipman condition
• 9 Oligopoly and customs unions
• 10 Competitive industry equilibrium with firm–specific uncertainty
• 11 Estimation and inference in simultaneous equations
• 12 On lumpsum compensation
• 13 A result on large anonymous games: an elementary andself–contained exposition
• 14 Complicated behavior in models with two commodities: a review
• 15 Computing willingness–to–pay in random utility models
• 16 The core and competitive equilibria in finite economies
• 17 Quasi–equivalent variation analysis in the Gorman Polar case
• 18 Marshallian demonstration of a tax–subsidy scheme under variable returns to scale
• 19 The envelope theory in a smooth constrained optimizationproblem with applications in economics
• 20 A classical theorem for John Chipman: maximal and minimalMalthusian population; a sweeping non–substitution theorem at the core of the canonical classical model
• 21 External diseconomies in the commons
• Index