EU-India intra-industry trade (2000-2008).

Eshleman, Tommy ; Kotcherlakota, Vani

Abstract

Intra-industry trade resulting from product differentiation and economies of scale has several benefits, including the minimization of the dislocation of workers and resource owners from contracting (importing) industries to expanding (exporting) industries, as workers and resource owners are more likely to remain within the same industry. Inter-industry trade resulting from comparative advantage often suffers from this problem, resulting in protectionist sentiment in the affected domestic industries. This study analyzes the degree of intra-industry trade between India and its largest trading partner, the European Union, over a 9-year period from 2000 to 2008. Utilizing the Grubel-Lloyd method to calculate intra-industry trade index numbers, this analysis found a relatively high degree of intra-industry trade between India and the EU, especially in more capital intensive industries, but no significant trend toward increased or decreased intra-industry trade overall was found over the study period.

I. INTRODUCTION

The main objective of this paper is to determine the degree of intra-industry trade between the European Union (EU) and India. Traditional trade theory following the Heckscher-Ohlin (1950) model suggests that in a free trade environment, a country will export goods for which it has a comparative advantage as determined by its relative factor endowments, technology, and climate, and import goods for which it has a comparative disadvantage. This results in inter-industry trade since comparative advantage usually favors one industry over another, so countries will export predominantly in some industries and import predominantly in others.

In contrast, many countries export and import similar products within the same industry, such as that discussed by Ruffin (1999) for heavy industry trade between the USA-Mexico for 1998. This intra-industry trade is most often the result of gains through economies of scale from product differentiation (Grubel and Lloyd, 1975), allowing countries to specialize in the production of a version of some general product. This specialization often stimulates innovation (Smith, 1937) and thus economic growth. This theory gained significant relevance from the Nobel Prize winning work of Paul Krugman beginning in the late 1970's.

Intra-industry trade may avoid the negative impacts of inter-industry trade, such as the redistribution of income from scare resources to abundant resources and the resulting dislocation of workers and resource owners from contracting (importing) industries to expanding (exporting) industries, as described by the Heckscher-Ohlin (1950) model and the Stolper-Samuelson Theorem (1941). With intra-industry trade, the impact on income redistribution is minimized since workers and resource owners are more likely to remain within the same industry (Balassa, 1966). This in turn reduces the demands for government protection of domestic industries since in any industry there are both exports and imports (Marvel and Ray, 1987). Huffbauer and Chilas (1974) stated "GATT negotiations very much favor intra-industry trade over inter-industry specialization. It is easier to secure one industry's consent for lower trade barriers if that same industry stands to gain from reciprocal concessions. Thus GATT concessions typically favor intra-industry specialization."

In this study we attempt to assess the importance of EU-India intra-industry trade. Increasingly, intra-industry trade is occurring between developed countries and less developed countries, especially those in close proximity to each other. The EU is one of the largest industrial trading blocks in the world, functioning as one independent unit with regard to trade with non-EU countries. India is a developing country with one of the highest trade growth rates in the world. The paper gives a review of literature outlining the history and progression of studies on intra-industry trade. Economic profiles and trade policies for India and the EU are given, followed by a description of the data and methodology used to analyze the degree of intra-industry trade between the EU and India from 2000 to 2008. Finally, results and conclusions of the EU-India intra-industry trade analysis for the 9 year study period are reported.

II. LITERATURE REVIEW

Verdoon (1960) first reported on intra-block transactions in the Benelux region of Europe. Balassa (1966) defined intra-industry trade as the inter-country exchange of commodities belonging to the same industry, observing a less disruptive effect in factor income distribution in adjustment to changes in intra-industry trade vs. adjustment to inter-industry trade.

After waning for nearly a decade, interest in the topic was renewed by Grubel and Lloyd (1975), who identified product differentiation as the underlying factor resulting in intra-industry trade, and proposing that economies of scale, location theory, and monopolistic competition were the most important concepts in developing a model of intra-industry trade. They developed a formulation for an intra-industry trade index (IIT), also known as the Grubel-Lloyd index, to measure the degree of intra-industry trade of a country or between two countries.

Krugman (1979) developed a Chamberlinian monopolistic competition market model showing how increasing returns to scale results in intra-industry trade of differentiated products between countries with identical characteristics. His work in this area earned him the 2008 Nobel Prize in economics.

Caves (1981) showed the importance of increases in the share of new intra-industry trade to properly measure the effect of changes in trade policy on adjustment costs. Hamilton and Kniest (1991) expanded research in this area, developing the marginal intra-industry trade (MIIT) index to capture the effect of changes in net trade compared to changes in total trade. Brulhart (1994) introduced a measure for MIIT applied to adjustment costs, and Menon and Dixon (1996) proposed a measure for MIIT applied to changes in total trade. Lovely and Nelson (2000) applied the MIIT to a general equilibrium model.

Brulhart and Thorpe (2001) analyzed the trade flows of NAFTA members using static (IIT) and dynamic (MIIT) measures, concluding that U.S.-Mexico and U.S.-Canada (predominantly intra-industry) trade flows have resulted in less market adjustment pressures, while Canada-Mexico (predominantly inter-industry) trade flows have caused relatively more adjustment pressure.

Caetano and Galego (2006) used a panel data approach to identify the determinants of vertical and horizontal intra-industry trade between the EU and Central and Eastern European countries (CEEC). Though most trade between the EU and CEEC is inter-industry trade based on comparative advantage, they found a significant decline in inter-industry trade and an increasing specialization in vertical intra-industry trade.

Dinopoulos, Syropoulous and Xu (2009) incorporated the Chamberlinian mechanism of income distribution to determine the effects of intra-industry trade on factor prices and skill upgrading. The model suggests that each country engaged in intra-industry trade will benefit in terms of firm output, factor productivity, and the share and income of high skilled workers in the affected industries.

The above review is not totally comprehensive, but highlights the progression of studies on intra-industry trade over time. Studies on intra-industry trade vary in their emphasis of subjects such as measurement, development of theoretical models, and empirical estimation of models for a given country or group of countries. Most empirical studies involve developed countries, but intra-industry trade is becoming more prevalent between developed and developing countries, which is the focus of the analysis below.

III. INDIA ECONOMIC PROFILE AND TRADE POLICIES

India is a relatively large country in Southern Asia covering 1,269,346 square miles (3,287,590 sq km), over one-third the size of the United States. With just over 1.1 billion people, one-quarter of which live under the poverty line, it is the second most populous country in the world. India has a high population density of 954 people per square mile. 31% are under the age of 15, 64% are between 15 and 64 years of age, and 5% are over 65. There are 28 states and 7 union territories (all information in this section from CIA World Factbook 2008, unless otherwise noted).

India has a diverse economy of traditional village farming, moderate commercial agriculture, handicrafts, and several modern manufacturing and service industries. Nearly one-fourth of the labor force is employed in the services sector, which accounts for 54% of India's total domestic output. The manufacturing sector employs 17% of the work force, accounting for 28% of domestic output. Agriculture employs the largest share of the work force at 60%, but produces only 18% of total domestic output. The main agricultural products are rice, wheat, oilseed, cotton, jute, tea, sugar cane, potatoes, cattle, water buffalo, sheep, goats, poultry and fish. Manufacturing industries consist of textiles, chemicals, food processing, steel, transportation equipment, cement, mining, petroleum, machinery and software.

Inflation and unemployment were high in 2008 at 8.3% and 9.1% respectively. GDP in 2008 was $3.3 trillion, making India the 5th largest economy in the world, with an impressive real GDP growth rate of 7.4%.

While government controls on foreign trade and investment have been reduced, high tariffs and restrictions on foreign direct investment still exist in some areas. India's main exports are textile goods, gems, jewelry, engineering goods, chemicals, and leather goods. India primarily imports crude oil, machinery, gems, fertilizers, and chemicals.

The EU is the largest export market for India as well as its largest source of imports. Although the European Union had only 15 members in 2003 and 25 members from 2004 to 2006, the data in all of the tables and analysis that follows are adjusted to include all 27 countries which currently comprise the EU. Table 1 shows India's imports and exports with its major trading partners from 2003-2007.

India Trade Policy

In June 1991, India initiated economic policy changes to address its structural imbalance problems regarding the government budget and the country's balance of payments, seeking assistance from international financial institutions. As a founding member of the World Trade Organization (WTO) in 1995, the government has adopted a more open and transparent trade regime emphasizing export promotion and import liberalization, especially for capital goods. Special efforts were made to attract foreign direct investment for export oriented establishments in India. In addition, India has facilitated the convertibility of the rupee, and has limited the number of items on its negative list of imports which are allowed protection under the rules of the WTO for reasons of security, health, and environmental protection (Rajan, 2002).

IV. EUROPEAN UNION ECONOMIC PROFILE AND TRADE POLICIES

The EU consists of 27 member countries spanning 1,535,279 square miles (3,976,372 square kilometers), nearly half the size of the United States, covering most of western Europe and parts of eastern Europe. Notable European countries which are not members include Switzerland, Norway, Iceland, and Russia. The area functions as one independent unit for trade purposes, with free trade, labor and capital mobility among its members, and common external tariffs for non-EU members. The area also functions as a Monetary Union with a common currency (euro), the major exceptions being the U.K., Sweden, and Denmark. Per capita GDP is very high by world standards at $33,700 in 2008, but there is considerable variation among the member States ranging from $12,900 in Bulgaria to $81,200 in Luxembourg. Of the nearly half a billion population, 16% are under the age of 15, 67% are between 15 and 64 years of age, and 17% are over 65 (all information in this section from CIA World Factbook 2008, unless otherwise noted).

The EU has some of the world's largest and most technologically advanced manufacturing and service industries. Over one-fourth of the labor force is employed in the manufacturing sector, two-thirds are employed in the services sector, and only 4% in production agriculture. The percentage of domestic output by these three sectors is roughly the same as their labor force percentages. The main manufacturing-export industries are machinery, motor vehicles, aircraft, plastics, pharmaceuticals, iron and steel, wood pulp and paper, textiles, dairy products, fish and alcoholic beverages. The bulk of EU imports are in machinery, vehicles, aircraft, plastics, crude oil, chemicals, textiles, metals, foodstuffs, and clothing. The agricultural sector is heavily subsidized, which has led to much friction with trade partners.

As a group, the EU is the largest economy and the largest trader in the world. Inflation in 2008 was 3.5%, while unemployment was moderately high at 7.2%. GDP in 2008 was over $14.9 trillion, slightly higher than the U.S., with a real growth rate of .9%. The EU contains one-fourth of all global wealth.

India is the 8th largest export market for the EU and its 10th largest source of imports. Table 2 shows the EU's imports and exports with its major trading partners from 2003-2007.

European Union Trade Policy

The EU is a proponent of World Trade Organization (WTO) multilateral negotiations for a wider inclusion of countries. The EU's new generation of regional trade agreements emphasizes greater reciprocity of market-access commitments than in the past, and includes a broader range of trading partners. Their development policy is focused on a Generalized System of Preferences (GSP) designed to promote growth in 176 designated developing countries by providing preferential entry of goods with no reciprocity requirements. The EU emphasizes the reduction of non-tariff barriers to trade with major trading partners resulting from product regulations and standards, and strengthening their trade relations to more effectively manage their trade conflicts (WTO, 2000).

V. DATA AND METHODOLOGY FOR INTRA-INDUSTRY TRADE ANALYSIS

To determine the impact of intra-industry trade between the EU and India, import and export data between these two economic entities was collected for the years 2000-2008 (Table 3) for the following Standard International Trade Classification (SITC) categories:

* SITC 0--Food & Live Animals

* SITC 1--Beverages & Tobacco

* SITC 2--Crude Materials Except Fuel

* SITC 3--Mineral Fuels, Lubricants, & Related Materials

* SITC 4--Animal & Vegetable Oils, Fats, & Waxes

* SITC 5--Chemicals & Related Products

* SITC 6--Manufactured Goods

* SITC 7--Machinery & Transport Equipment

* SITC 8--Miscellaneous Manufactured Articles

* SITC 9--Commodities & Transactions Not Classified Elsewhere

Using this data, a Grubel-Lloyd intra-industry trade index (Grubel and Lloyd, 1975) was calculated for EU-India trade in each SITC category for each of the years of the study period. The Grubel-Lloyd index will take a value between 1 and 0, with 1 indicating all trade is intra-industry, and 0 indicating no intra-industry trade. The formula for the calculation is:

G[L.sub.i]=1- [|[X.sub.i] - [M.sub.i]|/(Xi + Mi)] (1)

where

[GL.sub.i] = Grubel-Lloyd intra-industry trade index for industrial category i.

[X.sub.i] = EU exports of industrial category i to India.

[M.sub.i] = EU imports of industrial category i from India.

In addition, an aggregate Grubel-Lloyd intra-industry trade index was calculated for all EU-India trade utilizing a formula for unbalanced trade where total exports and total imports between the two trading partners is not equal (Appleyard and Field, 1992). The formula for the calculation is:

GLa = 1-[sigma]|[X.sub.i]/X-[M.sub.i]/M|/ [sigma] ([X.sub.i]/X + [M.sub.i]/M) (2)

where

[GL.sub.a] = Grubel-Lloyd intra-industry trade index for all EU-India trade.

[X.sub.i] = EU exports of industrial category i to India.

X = Total EU exports to India.

[M.sub.i] = EU imports of industrial category i from India.

M = Total EU imports from India.

VI. RESULTS OF EU-INDIA INTRA-INDUSTRY TRADE ANALYSIS

A Grubel-Lloyd index number over .5 indicates that more trade was intra-industry than inter-industry. The closer the index number is to 1, the greater the degree of intraindustry trade. The results of the analysis are given in Table 4.

The degree of intra-industry trade between the EU and India was greatest for SITC category 5, Chemicals and Related Products, with a Grubel-Lloyd index averaging .96 over the 9 year study period. The second highest degree of intra-industry trade was in SITC category 6, Manufactured Goods, with a Grubel-Lloyd index averaging .89 over the study period. This was the largest category for EU imports from India. There was no discernable trend toward an increasing or decreasing level of intra-industry trade in either of these two categories over the 9 year study period.

SITC category 2, Crude Materials Except Fuel, had the third highest degree of intra-industry trade, with a Grubel-Lloyd index averaging .88 over the study period. This category experienced a significant decreasing trend in the level of intra-industry trade over the last 4 years of the study period compared to the first 5 years.

The fourth highest category of intra-industry trade was SITC 1, Beverages and Tobacco, with a Grubel-Lloyd index averaging .72 over the study period. This category showed a very significant increasing trend in the degree of intra-industry trade over the 9 year study period, with the index numbers rising from a low of .45 in 2000 to a high of .96 in 2007.

These 4 are the only SITC categories that consistently exhibited a greater degree of intra-industry trade than inter-industry trade over the 9 year study period. These 4 categories accounted for an average of 51% of the total trade between the EU and India over the study period, which contributed to an aggregate Grubel-Lloyd trade index for all EU-India trade averaging .66 for the study period. There was no discernable trend toward an increasing or decreasing level of intra-industry trade in total over the 9 year study period.

The largest category for EU exports to India was SITC 7, Machinery and Transport Equipment, where the degree of intra-industry trade averaged .48, giving roughly an even split between intra-industry and inter-industry trade. There was no discernable trend toward an increasing or decreasing level of intra-industry trade in this category over the 9 year study period.

VII. CONCLUSIONS

The EU is the largest trading partner for India, and India is a top ten trading partner for the EU, so an understanding of the factors driving trade between the two is useful for policy makers. The level of intra-industry trade between the two economic entities is moderately high in comparison to world trade in general. About two-thirds of all trade between the EU and India was intra-industry trade over the 9 year study period from 2000 to 2008, compared to about one-fourth of total world trade (Krugman and Obstfeld, 2000). There does not appear to be any trend in the level of intra-industry trade in the aggregate between the EU and India over the study period, though trade in several SITC categories exhibited an increasing trend and one category exhibited a decreasing trend. The degree of EU-India intra-industry trade was highest in capital intensive industries such as chemicals and manufactured products, and was lowest in more labor intensive industries such as fuels and lubricants, and food and animal products. The analysis indicates that production gains due to specialization and economies of scale are more important than production gains due to comparative advantage in the determination of trade between the EU and India.

References

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Brulhart, Marius (1994), "Marginal Intra-Industry Trade: Measurement and Relevance for the Pattern of Industrial Adjustment," Weltwirtschaftliches Archiv, V. 13-#3, pp. 600-613.

Brulhart, Marius and Michael Thorpe (2001), "Export Growth of NAFTA Members--Intra-Industry Trade and Adjustment," Global Business and Economics Review, Vol. 3, No.l, pp. 94-110.

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TOMMY ESHLEMAN AND VANI KOTCHERLAKOTA

University of Nebraska-Kearney

Table 1
India's Top 10 Trading Partners

                              India Imports (Million US $)

                   2003       2004       2005       2006       2007

European Union   16497.6    21333.5    26479.0    30654.0    40410.9
China             4004.5     6711.7    10911.2    17427.9    24575.8
Saudi Arabia       728.9     1253.5     1638.8    13358.8    16570.2
United States     4974.8     6780.3     9500.0    11721.0    14206.4
UAE               2035.1     4528.4     4371.4     8641.3    11702.8
Switzerland       3270.3     5768.3     6574.9     9090.4    10638.1
Australia         2617.4     3552.4     4967.5     6994.9     7680.9
Singapore         2060.3     2562.8     3367.1     5479.3     6901.6
Japan             2635.6     3115.4     4077.2     4587.0     5832.8
South Korea       2795.2     3400.3     4582.0     4797.0     5437.7
Total World      77200.9   108248.0   149750.0   185384.9   218645.3

                              India Exports (Million US $)

                   2003       2004       2005       2006       2007

European Union   15905.1    20357.6    23705.7    28394.0    36000.8
United States    11375.8    13176.8    17439.7    18862.1    20133.3
UAE               5039.1     7038.1     8544.0    12003.4    14447.0
China             2918.8     5300.8     6785.1     8279.0     9492.0
Singapore         2098.7     3793.4     5444.6     6058.0     6390.1
Hong Kong         3221.7     3630.1     4488.5     4672.1     5845.0
Japan             1688.3     2002.6     2490.8     2857.5     3263.4
Saudi Arabia      1109.5     1367.8     1816.7     2583.5     3221.4
Sri Lanka         1303.0     1344.1     2032.4     2251.5     2594.2
Bangladesh        1719.4     1593.3     1670.8     1624.9     2063.8
Total World      63034.6    79834.1   103404.2   126125.5   145898.1

Source: UN Comtrade Statistical Yearbook, 2008

Table 2
European Union's Top 10 Trading Partners

                              EU Imports (Million US $)

                    2003        2004        2005        2006

China              120121.2    160044.7    199181.8    244745.0
United States      178833.4    198201.5    203518.1    220151.1
Russia              79910.3    104406.3    139872.4    176928.3
Switzerland         67930.2     78354.8     84006.6     91318.9
Japan               81865.0     92910.6     91991.6     97079.9
Norway              57691.4     68764.9     83442.9     99426.2
Turkey              30824.5     40712.1     44811.0     52380.5
South Korea         29405.9     38155.3     42774.6     51208.6
Brazil              21613.6     27009.8     29935.3     34140.0
India               15905.1     20357.6     23705.7     28394.0
Total World       1057625.6   1278653.1   1465519.5   1697724.9

                    EU Imports
                  (Million US $)

                      2007

China              317298.9
United States      248267.8
Russia             196917.8
Switzerland        107284.9
Japan              106865.5
Norway             105185.7
Turkey              64332.3
South Korea         54025.5
Brazil              44747.1
India               36000.8
Total World       1953968.8

                               EU Exports (Million US $)

                    2003        2004        2005        2006

United States      257415.5    292882.8    313970.1    338119.5
Switzerland         81653.9     94770.8    103814.7    111652.0
Russia              42122.4     57244.3     70635.3     90858.6
China               46953.7     60164.2     64413.2     80170.3
Turkey              34929.1     49907.7     55425.7     62836.8
Japan               46345.2     53921.6     54253.2     56217.8
Norway              31312.9     38275.7     42112.7     48342.0
India               16497.6     21333.5     26479.0     30654.0
UAE                 18733.4     23465.4     31744.4     31754.0
Canada              24432.1     27490.2     29668.8     33542.6
Total World        983918.5   1187479.5   1310102.2   1459460.0

                     EU Exports
                   (Million US $)

                    2007

United States      358762.3
Switzerland        128906.2
Russia             122222.6
China               98463.3
Turkey              72163.5
Japan               60037.0
Norway              59494.2
India               40410.9
UAE                 36791.6
Canada              35533.1
Total World        702983.7

Source: UN Comtrade Statistical Yearbook, 2008

Table 3
EU-India Trade By SITC Category

                        EU Exports to India (Million Euros)

          2000    2001     2002    2003     2004     2005    2006

SITC 0       34      58      104      68       57       59     203
SITC 1       23      23       23      28       31       54      60
SITC 2      426     502      444     508      604     1066     915
SITC 3      424      65       68      52       83       97     167
SITC 4       37      11        6       9       11       11      12
SITC 5     1276    1310     1375    1372     1695     1923    2196
SITC 6     5681    5077     5281    6447     7007     8806    8252
SITC 7     4067    4097     4560    4630     6045     7209   10233
SITC 8      772     839     1000     954     1116     1440    1703
SITC 9      743     578      365     232      166      400     302
Total     13678   12950    14330   14572    17153    21322   24385

          EU Exports to India
          (Million Euros)

           2007    2008

SITC 0      110     110
SITC 1       76      67
SITC 2     1224    1354
SITC 3      127     199
SITC 4       13      13
SITC 5     2476    3049
SITC 6     9610    9782
SITC 7    13050   13941
SITC 8     1850    2031
SITC 9      503     750
Total     29467   31604

                     EU Imports from India (Million Euros)

           2000    2001     2002    2003     2004     2005    2006

SITC 0     1129    1085    1.057    1115     1013     1144    1397
SITC 1       79      73       59      54       57       60      75
SITC 2      533     469      463     470      581      595     710
SITC 3       40     147      106     168      382      886    1017
SITC 4      147     129      106     118      169      142     107
SITC 5     1141    1190     1339    1449     1631     1990    2377
SITC 6     4514    4606     4531    4502     5436     5879    7111
SITC 7     1206    1301     1385    1632     2150     2386    2822
SITC 8     3988    4369     4531    4592     4877     5853    6827
SITC 9       49      61       51      44       56      125     144
Total     12846   13462    13682   14064    16364    19086   22612

          EU Imports from India
          (Million Euros)

           2007    2008

SITC 0     1555    1739
SITC 1       82     101
SITC 2      817     821
SITC 3     1512    2326
SITC 4      122     223
SITC 5     2969    3318
SITC 6     8499    8468
SITC 7     3764    5017
SITC 8     7130    7232
SITC 9      111     172
Total     26603   29471

Source: Eurostat Statistical Yearbook

Table 4
Grubel-Lloyd Intra-Industry Trade Index for EU-India by SITC
Category and Total Aggregate

          2000   2001   2002   2003   2004   2005   2006   2007

SITC 0    0.06   0.10   0.18   0.11   0.11   0.10   0.25   0.13
SITC 1    0.45   0.48   0.56   0.68   0.70   0.95   0.89   0.96
SITC 2    0.89   0.97   0.98   0.96   0.98   0.72   0.87   0.80
SITC 3    0.17   0.61   0.78   0.47   0.36   0.20   0.28   0.15
SITC 4    0.40   0.16   0.11   0.14   0.12   0.14   0.20   0.19
SITC 5    0.94   0.95   0.99   0.97   0.98   0.98   0.96   0.91
SITC 6    0.89   0.95   0.92   0.82   0.87   0.80   0.93   0.94
SITC 7    0.46   0.48   0.47   0.52   0.52   0.50   0.43   0.45
SITC 8    0.32   0.32   0.36   0.34   0.37   0.39   0.40   0.41
SITC 9    0.12   0.19   0.25   0.32   0.50   0.48   0.65   0.36
Total     0.64   0.65   0.67   0.65   0.68   0.64   0.66   0.66

          2008

SITC 0    0.12
SITC 1    0.80
SITC 2    0.75
SITC 3    0.16
SITC 4    0.11
SITC 5    0.96
SITC 6    0.93
SITC 7    0.53
SITC 8    0.44
SITC 9    0.37
Total     0.67