Intra-Industry Trade: The Pakistan Experience

Muhammad Shahbaza, and Nuno Carlos Leitob

Presented by: Shemiah Parshad Ameer Kayani

Overview
Analysis of Pakistan's intra-industry (IIT) during the period 1980-2006. Intra-industry trade refers to the exchange of similar products belonging to the same industry. IIT is an inverse function of the difference in GDP per capita between Pakistan and their trade partners. It is influenced by similar demand. Importance of scales economies and the variety of differentiated products. Trade increases if the transportation costs decrease.

Introduction
Trade between developed versus developing countries is usually explained based on the Heckscher Ohlin theorem. products are differentiated imperfect competition scale economies industrial concentration

Pakistan followed import-substitution policy for industrialization that was supported by high tariff rates, import quotas and overvaluation of exchange rate.

Pakistan has joined two regional-trading blocs i.e. South Asian Association for Regional Cooperation (SAARC) and the Economic Cooperation Organization (ECO).

 This paper tests the determinants of intra-industry trade (IIT) between Pakistan and the main ten trade partners (United States, United Kingdom, Japan, Germany, Saudi-Arabia, Canada, France, Italy, Netherlands, and Norway) using an unbalance panel for the period (1980-2006). The study demonstrates that IIT occurs more frequently among countries with similar levels of demand.

Literature Review
Heckscher-Ohlin (HO) model; predicts that a particular country exports the products
that use its relatively abundant factor intensively and imports the products that use its relatively less abundant factor intensively.

3 types of trade:
1) 2) 3) Trade in Homogeneous Goods. Trade in Horizontally Differentiated Goods. Trade in Vertically Differentiated Goods.

Horizontal IIT vs. Vertical IIT; intra-industry trade in horizontally differentiated products (products differentiated by attributes) VIIT: intra-industry trade in vertically differentiated products (products differentiated by quality). The model of Krugman (1979) demonstrates that IIT occurs between identical economies (geographical proximity). The model of Lancaster (1980), called Neo-Hotelling model shows that consumers have a preference map, i.e. ideal variety. Brander and Krugman (1983) demonstrated that is possible to explain IIT with Cournot style.

 Shaked and Sutton (1984) explained the VIIT with the natural oligopoly. Demand for each quality of the product depends on the distribution of income. Wakasugi (2007) constructed an index of vertical intraindustry trade to measure the fragmentation of production, concluded that fragmentation increased with intra-industry trade. The study of Leito and Faustino (2009) examines the determinants of intra-industry trade in the automobile component sector in Portugal. This study concludes that IIT occurs more frequently among countries that have similar endowments. Leito and Faustino (2009) also show that trade increases if the transportation costs decrease.

Measurement of Intra-Industry Trade

The level of IIT is generally measured by the Grubel and Lloyd (1975) index. It defines IIT as the difference between the trade balance of industry i and the total trade of this same industry. The index is presented as a ratio in which the denominator is total trade.

 The index is equal to 1 if all trade is of the intra-industry trade type. If IIT is equal to 0, all trade is inter-industry trade.

Econometric model:
The study applies a gravity equation with panel data. dependent variable: intra-industry trade (IIT) Explanatory variables: World Bank, World Development Indicators (2008). Dependent variables: Federal Bureau of Statistics (FBS).

 Response Variable: Intra Industry Trade (IIT) as measured by Grubel and Lloyd Index
Explanatory Variables:
1) Economic difference between countries (DGDP) Difference in GDP between Pakistan and its trading country. Countries with similar demands will trade similar products. (-) 2) MinGDP lowest value of GDP per capita between Pakistan and the partner country. - This variable controls the size effects. (Homoskedasticity) (+) 3) MaxGDP We speculate a negative (-) sign because similar countries are in economic dimension, the greater the IIT between them.

4) DIM the average of GDP per capita between Pakistan and trading partner. - many studies use this measure as a proxy for potential economics of scale and variety of differentiated goods. (+)

5) DIST geographical distance between countries. Negative (-) because proximity enhances IIT due to lower transportation and transaction costs.

6) FDI Foreign Direct Investment inflows. The relationship is ideally ambiguous because - Greenaway et al. (1994) estimated a positive (+) sign for this coefficient.

7) Trade Imbalance (TIMB) Following Lee and Lee (1993), this variable is included as a control variable.

According to theory, a negative (-) correlation between TIMB and IIT exists
TIMB = 0 if there is no TRADE IMBALANCE

TIMB= 1

if

either IMPORTS or EXPORTS are zero

MODEL SPECIFICATION

All variables are in logarithms. All proxies (DIM, Dist, FDI and TIMB) controls relative size effects.

PANEL DATA: Fixed Effect modelling

All values are statistically significant at 99% confidence interval except for FDI. Why? - efficiency-seeking and export-oriented foreign direct investments (FDI) - Cost of FDI on local trade patterns and industrial production.

CONCLUSION
- Econometrics estimations support the hypothesis formulated. - Scale of economies & product differentiation VERY CRUCIAL for IIT (PROVED) using LogDGDP
Weakness of the Study USE Dynamic analysis using Brulhart Marginal IIT index - Need to disentangle IIT into Vertical IIT & Horizontal IIT POLICY RECCOMENDATIONS

- Pakistan needs to invest more towards product differentiation (vertically and horizontally) positive relationship between DIST & IIT - South Asian Free Trade Agreement (SAFTA) because proximity matters! - Pakistan cutting tariff lines to 100 under SAFTA AGREEMENT [Tribune, Oct/10/2012]