When you are driving a Toyota on the road in Boston, have you ever wondered why the U.S. imports vehicles from Japan and other countries when it can, and does, produce its own high-performing cars, and even exports a large volume of cars? Another similar case is China’s rice trade. China, as one of the main rice exporters, has been experiencing an unexpected spike in rice imports since 1995.[i] So, why would a country import and export similar products at the same time?
Limited by underlying assumptions, traditional trade theories, such as the Ricardo and Heckscher-Ohlin models, do not furnish comprehensive explanations. After decades of research by economists, the Intra-Industry Trade Theory (IIT) was established.
The IIT theory suggests why a nation exports and imports similar products simultaneously, within the same industry. The extent of intra-industry trade is measured by Grubel-Lloyd (GL) index:
In this formula, Xi and Mi denote the export and import of section i. If a country only exports or imports goods within the same sector, the GL index will be zero, indicating that there is no intra-industry trade. If the export and import are the same amount, then the index will be 1.
To illustrate, let’s look at the natural rubber import-export situation in Vietnam. In 2012, Vietnam exported 2.85 billion USD and imported nearly 803 million USD of natural rubber.[ii] According to the formula above, we can calculate the level of IIT:
The value falls between one and zero. This indicates that intra-industry trade exists in Vietnam’s rubber sector. Considering that rubber is one of the major agricultural export products in Vietnam, accounting for nearly 25% of the total value of its agricultural exports, the level of intra-industry trade is relatively high. So what is the reasoning behind this?
Firstly, product differentiation is attributed to the high import volume. Vietnam imports different rubbers that are needed for domestic production but are in shortage or not produced in Vietnam, including CSR10 and RSS.[iii] In addition, re-export activity accounts for 60% of the import usage, and causes a high import portion.[iv] Vietnam has low geographical advantage and lacks in the external economies of scale, relative to Cambodia, its largest rubber supplier. Therefore, importing high quality rubber at an appealing price from Cambodia and re-exporting the rubber enhances Vietnam’s exporting advantage. As a result, the import volume of natural rubber has remained at a high level for years.
Now let’s go back to the stories at the beginning where our discussion started. By calculating the Grubel-Lloyd index, we find that China’s rice sector has an average index of 0.68, and the U.S. car sector has an average of 0.47. In addition to product differentiation and external economies of scale, there are other reasons that also contribute to the intra-industry trade, for example, the need for variety and the internal economies of scale. China has a high production of rice, but as Chinese consumers diversify their food consumption, Chinese traders import different types of rice that domestic consumers favor, including long-grain rice from Pakistan and Jasmine rice from Thailand, thus boosting the rice import volume. The same reasoning applies in the trade within the car sector. American and Japanese cars are both high-quality but exhibit different features, which lead to product differentiation that meets the public need for variety. Meanwhile, the global spread of operations helps the car producers achieve higher internal economies of scale, thus more international intra-industry trade is promoted.
Based on the above analysis, we find that the phenomenon of intra-industry trade can be explained from the perspective of microeconomics, including product differentiation and economies of scale. However, does it imply that traditional trade theory fails in the framework of intra-industry trade? Not exactly.
In fact, the idea of comparative advantage set forth by traditional trade models provides a relevant explanation. Within the same sector, product differentiation allows each country to specialize in the types of products in which it has a comparative advantage. At first glance, we may be confused by the simultaneous import and export of rubber in Vietnam, but on closer inspection we see that Vietnam mainly exports natural rubber that has low levels of processing due to cost and technology limitation, and imports other types of rubber that are costly or infeasible to produce domestically.
As globalization develops and international trade becomes more open, the phenomenon of intra-industry trade will be more pervasive, allowing every country to derive more benefits from trade by providing differentiated and specialized products in a fully segmented global market.
Ngo Kinh Luan, Natural Rubber Industry Report 2013, Fpt Securities, May 2013, p13-p15