Intra-Industry Global Trade and Imperfect Market

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Table of Contents

Economies of Scale
Monopolistic Competition and the Gravity Model of Trade
Global Oligopoly (Strategic Trade Policy)
Agglomeration Economies (External Economies of Scale)
Case Study
Conclusion
References

Intra-Industry international trade refers to the process of importing and exporting similar goods and services belonging to one industry between different countries (Brülhart, 2009). The essence and causes of intra-industry trade are the subject of much discussion as this process contradicts the traditional frameworks of trade as well as the principle of comparative advantage. This deviation from the classical patterns can be explained by exchange rates and differentiation of products and services. In addition, imperfect market structure also rates among the major factors in the shift of patterns (Cabral & Silva, 2006).

Thus, the paper at hand offers to provide an analysis of intra-industry international trade in connection to imperfect market structure. It will define and investigate economies of scale, monopolistic competitions, the gravity model of trade, global oligopolies (strategic trade policy), and agglomeration economies (external economies of scale) using examples. The analysis will end with a case study with the aim of giving a closer look at theoretical materials that could help draw a precise and accurate conclusion.

Economies of Scale

Economies of scale are supposed to be achieved if the manufacturer manages to produce more units of goods or/and services at a greater scale with lower input costs. Thus, the result can be identified as a cost advantage that appears with the higher output of a product (Clark, 2010). This implies that when a company grows and increases production, it receives more opportunities to reduce its input costs as they are distributed between larger amounts of products. Variable costs per unit are also likely to be reduced due to operational efficiency. Such economies are divided into two major types: 1) internal economies of scale (that appear within the organization); 2) external economies of scale (emerging as a result of some extrinsic factors such as the size of the industry). When economies of scale are realized in a lot of different industries, economic growth is said to be achieved (Cabral & Silva, 2006).

Industries featuring a low level of scale economies generally have quite high intra-industry trade shares. This happens for several reasons (Clark, 2010):

Economies of scale are restricted to organizations that are monopolistically competitive and manufacture differentiated goods. To ensure that several companies coexist within one industry, economies of scale will become exhausted at low output levels. When this happens, the average costs may remain unchanged—changes in output will not affect per unit costs. Therefore, low-scale economies result in more companies within one industry, the outputs of which go into trade.
There is also evidence that scale economies are captured within branches of industry that have huge organizations characterized by reduction of costs with the increase of size. Such companies usually produce standardized goods (metals, chemicals, etc.) that are involved in inter-industry trade rather than in intra-industry trade. Thus, scale economies are captured due to a low variety of products, which allows concluding that a negative association exists between the economies of scale and intra-industry trade.
Industries with low-scale economies are expected to have rather high levels of intra-industry trade also due to their vertical specialization. The point is that vertically integrated processing chains can be fragmented into stages. Each stage is performed in the country that can complete it with the lowest possible expenses. This means that components are produced in one plant whereas the assembly takes place in another. With this approach, plants tend to get smaller rather than larger in size as one operation does not require additional space. Plants export outputs from their stages of manufacturing. These outputs are later returned embodied in other, more advanced stages of goods. This process contributes to the development of intra-industry trade as the product flows usually refer to the same industry.

Along with the economies of scale, there exist diseconomies of scale. This term describes the situation in which production is lower than input. This happens when there is a certain inefficiency within the organization that leads to an increase in average costs (Clark, 2010).

Monopolistic Competition and the Gravity Model of Trade

Intra-industry trade mechanisms and patterns can be better explained by describing the essence of monopolistic competition under the Gravity Model of Trade in connection with intra-industry international trade (Melitz & Ottaviano, 2008).

Monopolistic competition is a kind of market structure that occupies an intermediate position between perfect competition and a monopoly. It possesses the characteristic features of both systems. In a monopolistic competition market structure, competition exists among organizations proposing similar goods or services (that still cannot be called identical substitutes). It keeps prices close to average costs and at the same time fosters preferences for differentiation of goods and services (Melitz & Ottaviano, 2008). This approach makes it possible for manufacturers to have a marginal quantity of market power. Thus, it can be stated that such differentiation results in intra-industry trade due to its ability to ensure both perfect competition and market power (Brülhart, 2009).

The Gravity Model of Trade is a highly significant model for understanding the function of international economics. The model of new trade theory is considered to be an alternative approach to provide the required theoretical basis for the gravity model. It incorporates various factors including the colonial history of the counties involved, the variables needed to perform accounting at the income level (GDP), tariffs, pricing, and language communication (Brülhart, 2009).

Monopolistic competition is represented under this model by particular assumptions: Manufacturers view marginal utility of income as an unchanging cost. Another assumption is that price terms are created externally. The differentiation of goods and services happens not by the country of origin. Instead, products become differentiated among manufacturing firms. The actual success of the model supports the explanation of intra-industry trade provided within the framework of monopolistic competition. In summary, the foundation for intra-industry trade in a market dominated by monopolistic competition is differentiations of products manufactured and services provided (Cabral & Silva, 2006).

Global Oligopoly (Strategic Trade Policy)

Global oligopolies play a significantly influential role, being the key actors in intra-industry trade. This structure is established when a limited number of organizations take total control over a particular industry or at least have a dominating market share in that industry. Leading international airline companies can serve as a good example of a global oligopoly. There are only five airlines that control the prevailing majority of all the world’s travels by air (approximately 85%). These are Delta Airlines, American Airlines, China Southern Airlines, Southwest Airlines, and United Airlines. All other companies share the remaining percentage. One more example of global oligopolies is the market of mobile operating systems: At present, almost 90% of it is occupied by iOS (Apple) and Android (Google) (Melitz & Ottaviano, 2008).

Strategic trade policies are alliances that allow creating global oligopolies. Trades can be investigated with the help of the model of reciprocal markets. This model assists in understanding the functioning of the intra-industry trade system within the given framework. The reciprocal-markets model is quite a simple structure that allows analyzing trade in the conditions of oligopoly (Melitz & Ottaviano, 2008). The most convenient of its properties is the possibility to explore the market of each separate country in isolation from others due to the assumption that all national markets are divided into segments. This implies that the presence of the side party is impossible, which allows the output to command equilibrium prices.

However, it also means that organizations can make price decisions for each market. Oligopolies foster intra-industry trade, which happens because of the variation of equilibrium prices in different countries. Oligopolies receive a greater profit in the global market rather than in the isolated one. Since the global market, with its enormous level of competitiveness, is capable of restricting the earning potential of oligopolies, they have to use strategic trade policies to guarantee the stability of high outputs (Brülhart, 2009).

Thus, the varying levels of equilibrium prices in different countries, as well as segmented markets influencing price considerations, form the foundation of intra-industry international trade (Brülhart, 2009).

Agglomeration Economies (External Economies of Scale)

Agglomeration economies result from external economies of scale. It can be exemplified by Walmart’s distribution center being situated close to most of its suppliers. This helps reduce transportation and transactional expenses. Agglomeration economies can exist as long as the external economies of scale are able to reduce the cost of production. The most important thing for the economy is to understand how agglomeration economies can contribute to intra-industry international trade. In fact, they usually cause a variation in employment levels and wages. This often results in the outsourcing of services and can also cause the import of products, which has the purpose of reducing total cost. Therefore, external economies of scale are more integrated into the world’s economy and trade markets rather than connected with the country in which they are situated (Cabral & Silva, 2006).

Case Study

Intra-industry trade dominates the world trade of food and drinks. The major trading nations in this industry include the United Kingdom. In its case, the international exchange of similar food products accounts for more than 60% of total trade whereas the percentage is even higher in drinks (approximately 70%). This popularity of intra-industry trade is caused by the changing patterns of taste for food and drinks in the world in general and in the United Kingdom in particular (MacFie & Meiselman, 2012).

Another reason is growing international investment, which provided British consumers with products that were never available before. The huge amount of food and drink products (as well as their perishable nature) makes international investment the best way to enter the market. The United Kingdom hosts many international food companies and invests in the food and drinks sector of foreign economies. As a result of this particular type of intra-industry trade and investment, British companies manufacture products abroad while foreign firms produce similar goods on the territory of the United Kingdom (opting for varieties that are not typical of the British market). For instance, Cadbury chocolates are produced and sold abroad while Mars and Nestle are sold in Britain and produced there at the same time (MacFie & Meiselman, 2012).

Conclusion

No matter which trade model is applied, supply and demand are still key factors that determine trade. There is much debate on the essence and causes of intra-industry international trade. However, there is common agreement that specialization (coupled with comparative advantages created under the conditions of the economy of scale) is one of the most influential powers affecting the fluctuation of supply and demand within the scope of intra-industry international trade. Even so, agglomeration economies also make their contribution, though it is often hard to identify the nature of this contribution. Intra-industry international trade should not be approached from a narrow perspective as it can be realized by investment in foreign markets producing similar goods as well as by hosting international companies that produce alternative products. Since the economies of the world are becoming more and more integrated, this issue requires further investigation.

References

Brülhart, M. (2009). An account of global intra-industry trade, 1962–2006. The World Economy, 32(3), 401-459.

Cabral, M., & Silva, J. (2006). Intra-industry trade expansion and employment reallocation between sectors and occupations. Review of World Economics, 142(3), 496-520.

Clark, D. P. (2010). Scale economies and intra-industry trade. Economics Letters, 108(2), 190-192.

MacFie, H., & Meiselman, H. L. (2012). Food choice, acceptance and consumption. Berlin, Germany: Springer Science & Business Media.

Melitz, M. J., & Ottaviano, G. I. (2008). Market size, trade, and productivity. The Review of Economic Studies, 75(1), 295-316.

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