Introduction: More Reasons to Trade

The idea of comparative advantage is the fondation of our understanding of

the gains from trade and its potential i1come distribution effects. Unfortu
nately, trade models built exclusively on the idea of comparative advantage
have a mixed record when it comes to predicting a countrys trade patterns.
This is an important failure since we tend to think that if we accurately mea
sure a countrys comparative advantage, we should be able to predict import
and export patterns. In addition, if we know in advance what specific prod
ucts an economy could produce at the Lowest relative cost, it would give po1icymakers and entrepreneurs a definite advantage in deciding what to
produce. The prob1em,however, is that it is exceedingly difficult to measure
a countrys comparative advantage. This problem is compounded by the fact
that there are many potential products an economy might export that use the
same comparative advantage, and there is no way to determine which specific
products will dominate. Furthermore, and perhaps most seriously, a large
share of international trade is not based on comparative advantage. This
chapter takes up two important exceptions to the models of the previous
chapters, and examines how and why many Countries try to select and plan
the development of their export indtrstries.
The first section tries to make sense of the fact that an important share of
world trade consists of countries exporting the same thing they import.
Canada and the United States, for example, have the largest trade relation
ship in the world, and a large share of it is based on both countries exporting
cars and car parts to each other.This pattern is clearl at odds with the bread
for-steeL examples shown in Chapters 3 and 4. In the second section of the
chapter, we examine industrial clustering. Many traded goods and services
that are essential parts of a countrys exports are produced in regional clus
ters. For example, the U.S. advantage in entertainment products (music, tele
vision programming, and movies) largely reflects the output of a handful of
regions such as Hollywood and Nashville. Software reflectsclusters in Silicon

Valley, Seattle, and a-few other spots, and biotechnology is in San Francisco,

Intraindustry Trade
The models of compartive advantage developed in Chapters 3 and 4 are built
on the foundation of country differences. In those models, differences in pro
ductivity (Chapter 3) or factor endowments (Chapter 4) make it possible for
countries to raise their living standards by specializing their production and trad
ing.The point of these models is not to paint a detailed portrait of economic life,
but rather to create a simplified abstract model of the economy that is focused
on key economic relations in the area of trade. To that end, unnecessary details
are omitted, and rare or exceptional cases are ignored.
Sometimes it happens that rare or exceptional cases become more important
over time. Such is the case with the increasing importance of intraindusiry trade
(the prefix intra means within). Intraindustry trade s the international trade of
products made within the same industry, for example steel-for-steel, or breadfor-bread. The opposite of intraindustry trade is interindustry trade .(the prefix
inter means between). Interindustry trade is international trade of products
between two different industries (for example, bread-for-steel). The growing
importance of intraindustry trade has forced economists to develop a new set of
models in order to explain the reasons why countries often export the same
goods theyimport, and to explain the benefits from this type of trade.

Measures of Intraindustry Trade

Intraindustry trade between industrial countries is common. Empirical measures
01 the importance of intraindustry trade vary, however, because of the funda
mental problem of defining an industry. For example, ifeomputers are defined as
office machinery, then computers and pencil sharpeners are in the same industry
and a country that exports computers and imports pencil sharpeners would
engage in intraindustry trade, In general, the broader the definition of an indus
try, the more trade appears tobe intraindustry. Conversely,the more detailed the

definition, the less trade is defined as intraindustry. Inraindustry trade is mea

sured for each industry with ihe followingstat.i&tic called the Grubel-Lloyd (GL)
index:

The equation says that the index for any industry (industry j) is calculated by
taking the absolute value of the trade balance for the industiy jX1 M1, dividing
it by exports plus imports from the same industry, X+ M1, and subtracting the
ratio from 1. If exports of a domestic industry are equal to the value of imports
from the same industry (X1 = M1), then the numerator n the ratio is equal to O
and the index equals 1. In that case, all of the industrys trade is intraindustry.
Conversely, if a country only exports or only imports, then either X1 or M1 will be
O. In that case, the numerator equals the denominator, the index is O, and none
of the industrys trade is intraindustry. in order to calculate the index for
the whole economy and not just for one industry, both the numerator and the
denominator of the ratio are summed over all industries before calculating the
ratio, and the result is subtracted from 1.
Estimates of the share of total U.S. merchandise trade that is intraindustry
range between one-third and twothirds, depending on the narrowness of the
definitions of industry. When narrow definitions are used, so that goods are clas
sified together only when they are very similar, U.S. intraindustry trade is more
than 50 percent of total merchandisc trade (excluding services and food). This
pattern is repeated for most industrial countries, and probably more than 40 per
cent of total world trade is intraindustrY. Evidence suggests that intraindustry
trade is greater inhigh technology industries where the rapid generation of new
products leads togreater product differentiation, and is greater in countries with
few barriers to trade. IntraindustrY trade also grows in importance as a nations
income rises.