International Trade: Concept, Inter-Industry Trade, And Theoretical Explanations

The Concept of International Trade

Discuss about the International Trade for Goods and Services.

International trade can be defined as the process of exchange of goods and services in between the countries. This kind of trade yields to the betterment of the world economy as a whole, in the entire process supply and demand as well as the prices play a vital role and are also affected by the events taking place all around the globe (BernatonytÄ— and NormantienÄ— 2015). For instance if there is a change in the political framework of Asia it may give rise to the cost of hiring labor force and thereby increase the manufacturing cost of American sneaker company which is based in Malaysia (Degryse et al. 2012). This will certainly increase the price of the product available all over the world. On the other hand, a decrease in the cost associated with labor will certainly result in a fall of the price of the product (Cabral et al. 2013).

The opportunity of global trading is that the countries get exposure towards the goods and services which are not readily available to them; in the international market almost all types of goods are available like, cloths, foods, jewelry, stocks, wine and etc.  In the context of international trade a good that is sold in the global market is termed as an export on the contrary, whenever a good is bought from the global market it is called an import (Cabral et al. 2013). These imports and exports are accounted in the balance sheet and the balance of payments of the concerned trading country.

Presently it has become a myth that the world is highly integrated and become g more integrated with the passage of time. it is a matter of fact that since the second world war international trade has grown faster than that of the income. According to Jambor (2014), an intra-industry trade is defined as the trade between similar goods that requires the same proportions of the input factors. While on the other hand inter-industry trade is defined as the trade process which is driven by the differences present in the factor proportions or may be the differences across the preferences across the countries (Ramondo et al. 2016). It has been argued that there is a decline in the proportion of inter-industry trade mainly because of two reasons: a) It has been observed that the there is a similar growth in the factor proportion across various countries. The reason behind this is the increase in the level of physical as well as human capital is greater than or that of the factors like labor and land. b) The structure of preference is non-homothetic and this gives rise to the growing similarity of preferences across various countries with the rise in the level of per capita income (Ramondo et al. 2016). Both of these mechanisms will lead to a decrease in the trade ratio until and unless these mechanisms are mitigated by an intra-industry trade (Balassa and Bauwens 2014).

Opportunities in Global Trading

In association with the activity of solving the mysterious behavior of the long term trade ratio, it is also believed that an appraisal of the characteristics of the international trade during the time period of 19^th century is quite important and evident in learning and understanding the intellectual development of the inter-industry trade theory developed by Heckscher and Ohlin (Balassa and Bauwens 2014). It has also been argued that the Heckscher Ohlin theory of trade is unable to explain the key features of the international trade effectively and efficiently. For example it fails to explain the trade between the large and fast growing trade between two analogous countries in similar products. Although it is worth to argue that the Heckscher Ohlin theory of trade was more relevant in the past when trade was motivated mostly by the differences in the preferences or factor proportions (Vona 2013).

The inter-industry trade is mainly driven by the existence of the dissimilarities in the factors of production or the preferences across the countries while intra industry trade is mainly driven by the changes in the economies of scale involved in the process of production of the production of various differentiated products (Hine and Greenaway 2016). There are evidences that intra industry trade was less important while compared to that of the inter industry trade during the pre-World War II period. Since the occurrence of World War II a number of researchers have presented studies that depicted the fact there was a persistent fall in the level of inter industry trade. In this section of the study two consecutive theories will be demonstrated which will be able to determine the underlying reasons behind these phenomenon (Botrić 2013).

There is a tendency that inter industry trade will shrink if and only if the concerned countries grow similarly with their factor proportions with the passage of time. It has also been suggested by Botrić (2013), that there are a number of factors that gives rise to this growth in the similarity of factor proportions. Moreover, if the natural resources acted as the source of differences in the factor proportions, technology used to conserve those resources will eminently reduce the amount of trade based on differences of resources (Balassa and Bauwens 2014). In a more general way it can be stated that in a world where there are some factors that are exogenously given such as labor and land and also there are some factors that can be augmented endogenously such as the physical capital as well as human capital (Ferto and Jambor 2015). Now, the growth of these endogenous factors compared to the exogenous factors is quite likely to give rise to similarities in the proportions of input factors across the countries. This mean that investing equal amounts in both the capital rich and capital poor countries which is obviously greater than the rate of growth of labor will be amalgamated in the growth of similarity in the proportion of input factors across these countries (Ferto and Jambor 2015).

Inter Industry Trade

It is quite easy to depict that in a world where there are two countries, two goods and two factors of proportion, if there is an increase in the growth of similarity between the proportions of input factors it will lead to a shrink in the inter-industry trade. The proof of this statement can be depicted with the help of a figure,

Figure 1: Autarky Equilibrium

(Source: Ahern and Harford 2014)

In the figure above the production possibility curve of country 1 is given by the curve aa and it is also quite evident from the curve that the country is well endowed with the factor that is more intensively used in the production of X. I₀ and I₁ represents the indifference curves respectively. When there is no trade the economy will be in equilibrium at point A where the indifference curve I₀ is tangent to the production possibility frontier (Ahern and Harford 2014). The price ratio at this equilibrium level can be obtained by determining the slope of the tangent to the indifference curve at the point A.

Now, if country is 1 is opened for trade, it is not necessary that production and consumption will occur at the same point. In any given international price ratio the country will be in equilibrium when the production possibility curve will have the same slope as the price ratio curve (Ahern and Harford 2014). If a tangent is drawn at this point this will represent the budget line. Hence the optimal point of consumption will be the point where the budget line is tangent to the indifference curve.

Figure 2: Initial Trade Equilibrium

(Source: Ahern and Harford 2014)

Now in the figure above the production possibility frontier of both the countries are represented. In the case of the production possibility frontier of country 2 it is observed that, the country is endowed with more of the factors that is most intensively used in the production of Y (Ahern and Harford 2014). For the sake of simplicity is assumed that both of the countries possess homothetic preferences. It is quite evident that in equilibrium both the countries will be faced with the same price ration and the value of exports sold by them will be exactly equal to the value of imports bought by them (Ahern and Harford 2014). The trade ration for country 1 in this case will be double the ratio of cd and Og. On the contrary the trade ratio for country 2 will be the same (Ahern and Harford 2014).

Heckscher-Ohlin Theory of Trade

Now, if the factor endowments are relocated between country 1 and country 2 so as to make them more identical but maintain their sizes equal to each other as depicted in the figure below.

Figure 3: Convergence of factors

(Source: Casson 2012)

The countries are subject to the same budget line gg and the consumption of these countries will also be retained ta the point C. the production point of country 2 will now be nearer to point E^’ because of the reduction in the slope of the new production possibility frontier and similar will be the case for country 1, production point will be represented by D. in this case total trade as well as the trade ratio will reduce (Casson 2012).

There is another theoretical framework that is dedicated in explaining the decline in the level of inter industry trade is focused on the existence of homothetic preferences. Author pointed out a static framework that depicts non-homothetic preferences play an important role in determining the North South trade (Ito and Okubo 2012). If the comparatively poor countries have faster rate of per capita growth compared to the rich countries preference will soon become similar as the gap between the per capita incomes gradually mitigates. It is also pointed out by Peterson and Thies (2012) that if the poor countries are not growing at a significantly faster rate compared to that of the rich countries the net effect of growth process will make the indifference curve of both the countries more or less similar.

Now to stress on the non-homotheticity two countries are considered each of which possesses identical production possibility frontier. However, the country 1 is endowed with a larger population compared to that of country 2and therefore; the per capita income of country 2 is lower. It is also assumed that the individuals in both the countries possess identical preferences (Gabrisch 2012). Such that, when the income level is low, preference is skewed towards the staple good X and when the level of income is high the preference of the individuals will definitely be inclined towards the luxury good Y. now, because of the difference in the per capita income the indifference curve of both the countries are not identical (Ahern and Harford 2014). In the figure below the budget line is tangent to the indifference curves of both the countries and it is also consistent with the balanced level of trade. In this case both the countries will produce at C; consumption will remain at A in both the countries (Gabrisch 2012). It is also to be noted that both the countries have equal level of production and as a result trade will be balanced and the trade ratio will also be equal across the countries.

Theoretical Explanation of Inter-Industry Trade

Figure 4: Non-homothetic Preferences

(Source: Gabrisch 2012)

The study above have successfully addressed the concept of inter industry trade in the context of two countries and the underlying reason behind the fall in the inter industry trade. In the next section intra industry trade will be discussed briefly (Gabrisch 2012).

The term intra industry trade refers to that genre of international trade where similar products which belong to the same industry are exchanged between the countries involved in trade process (MacCharles 2012). The reason behind the inter industry trade can easily be explained with the help of an example. Consider there are two countries they mainly produce watches and radios. It is also assumed that the products are homogeneous and the countries are analogous (Ahern and Harford 2014). Again it is assumed that there are economies of scale, this means that when greater output is generated production costs will fall consecutively (Melitz and Trefler 2012). Therefore, it is quite evident that it will definitely be beneficial for the countries if one of them produces only watch and the other produces only radio. However, this is still not the case of intra industry trade; intra industry trade will take place in when transport costs are incorporated (Crescenzi et al. 2015). For example two countries share a border but some of the states are served best by the nearer plants because of the transportation cost involved. Now if the products are differentiated then also one country will definitely specialize in producing a particular variety of watches. Then one country will produce more sports watches and the other will produce luxurious watches (Kimura and Obashi 2016).

As per the statistics of 1996, 57 percent of the trade in US took place within, rather than between the four digit Standard International Trade Classification industries. It is also to be noted that the intra industry trade contributes to more than 60 percent of the total European trade and near about 20 percent in the total Japanese trade (Degryse et al. 2012). As per the theory of trade Japan will definitely have a lower amount of intra industry trade because its factor endowments are completely different from the other developed countries, on an added note it can also be stated that Japan does not possesses much of the border trade. Moreover, in Japan the ratio of population to the land is 365 which is significantly higher (Markusen 2013). Therefore, it is quite evident that the country will import a significantly large amount of raw materials compared to most of the other developed countries. With this high amount of imported raw materials the scope of producing highly differentiated products is less and thereby the amount of intra industry trade is also lower (Ahern and Harford 2014).

The basic significance of intra industry trade arises from the fact that this type of trade is not based on comparative advantage (Degryse et al. 2012). In order to determine the main characteristics it is found that the intra industry trade mainly takes place because of the highly differentiated products and it is also a fact that producing a particular product will also involve a specific fixed cost (Markusen 2013). Therefore, Ford makes more of the sports utility vehicles and thereby reduces the unit cost, the more convertibles produced by Mercedes Benz the lower will be the unit cost. It is also argued that some elements of comparative advantage may also be involves in this context such as Germany may possess a competitive advantage in producing cars of higher quality. However, according to Aobdia et al. (2014), the pattern of trade cannot be determined to the extent the comparative advantage is involved, but when the economies of scale are involved who exports what becomes determinate.

Intra industry trade is beneficial for the economy of the country as well as the industry (Degryse et al. 2012). However, the first and foremost benefit of intra industry trade that can be pointed out is that international trade is not needed to incorporate in itself the dislocations yielded by the intra industry trade (Ban 2015). According to the Stolper Samuelson theorem due to international trade there may be a relocation of income distribution between the scarce factors to the abundant factors. However, it should also be noted that if the lion’s share of the international trade is intra industry the effect of internal distribution of income will be reduced (Rana et al. 2012). Moreover, if the trade process is not based on the abundant and scarce factors it will definitely not result in an increase in the demand for abundant factors and a reduction in the demand for scarce factors. Therefore, the expansion of trade may not result in a major changed in the income distribution (Degryse et al. 2012).

On the other hand, intra industry trade also boosts the gains from trade by exploiting the economies of scale in a proper manner except from competitive advantage (Kim 2013). This is because trade compels the countries to focus on some particular products of a particular industry. This also contributes in increasing the world output by reducing the fixed costs (Ramondo et al. 2016).

Now, in order to summarize it can be stated that the study has effectively evaluated the concepts of both, the intra industry and inter industry trade in an efficient manner. In the context of the inter industry trade the concept has first been introduced and then the recent trends in the inter industry trade have been discussed followed by a brief description of the caused behind this trend. Two approaches have been used in deciphering the underlying reasons behind this trend. The first theory explained this trend by using the concept of diminishing differences between the factor proportions while the second one focused more on the non-homothetic preferences.  In the context of intra industry as well, at first the conceptual framework of intra industry trade has been described. In the next section the underlying causes of intra industry trade and the significance have been stated. In the modern day it is quite evident that most of the trade is intra industry. It should also be noted that there is a lack of study conducted in the context of inter industry trade, therefore, this study may contribute in the literature regarding this topic and may help the researchers who will further show interest in this context. Moreover, while conducting the study a brief survey of relevant literature has been conducted and this has helped to gain a broader insight of the concepts of international trade. In the light of this knowledge it have been tried to address all the contexts of the concerned study. 

Reference List:

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