Intra-Industry International Trade Case Study Case Study

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intra-industry international trade within the standard international trade classification SITC6, which represents manufactured foods classified chiefly by material. The scope of this paper is limited to processed foods, and includes analytical frameworks from the gravity model, and classic approaches to product differentiation, product commoditization, pricing, and market structure.

References to market structures in the literature typically oversimplify the dynamics influencing the development of market types -- perfect competition, monopolistic competition, oligopoly, and monopoly -- and this tendency is exacerbated when the focus is on intra-industry trade. Further, the distinctions become considerably more obfuscated when companies that are in the same trade do business in both domestic and international markets. A global manufacturing strategy is the goal of most multinational companies, and rationalizing manufacturing strategies is an objective for nations, as well (Lee, 1984). For instance, assume that a country has the industrial infrastructure to produce canned beverages, but there are few natural resources to support the industry, productivity is low and is only growing slowly. These are the countries to which a company should locate new production. The reason for this is that global strategic advantage in manufacturing is generated predominantly by "logistical economies of scale, purchasing economies of scale, global experience, and production economies of scale" (Lee, 1986). The new competitiveness goes beyond one country producing all commodities cheaper than other countries -- outperforming international competitors is insufficient for the contemporary market (Lee, 1984). The metrics to watch today indicate whether a company is performing better relative to its own economy than a competitor performs relative to its own economy.

Economies of Scale

The literature points to a positive link between economies of scale and intra-industry trade (Brander and Krugman, 1983; Sharma, 2002). According to Harrigan (1984), examining the volume of trade directly is preferable to examining the proportion of intra-industry trade. In his words, "there is some evidence in favor of the proposition that the volume of trade is higher in sectors with large scale economies, but that inference is somewhat sensitive to the choice of proxy" (Harrigan, 1984). Consider the matter of transport costs: The welfare effects of intra-industry trade can increase if transport costs are low and remain low. However, if transport costs are high, the intra-industry opening up of trade can bring about a decline in welfare -- essentially, "the precompetitive effect is dominated by the increased waste due to transport costs" (Brander and Krugman, 1983). Where economies of scale produce benefit in an industry, countries are restrained from themselves producing a full range of products in that industry. This dynamic can shape a platform and scope for the exchange of similar products between countries (Sharma, 2002).

Monopolistic Competition and the Gravity Model of Trade

In monopolistic competition, many sellers exist in an industry and/or a number of good substitutes for the produced goods exist, but companies still retain a degree of market power. Monopolies are characterized by an absence or lack of substantive economic competition in the production of a good or service. A lack of viable substitutes for an industry's goods or services conditions the establishment of a monopoly. An example of a processed food item for which there is both limited supply and no viable substitute is the elderflower. Limited supplies of the blossom of the elderberry trees are available each spring, and several products, including a sugary syrup that is used for beverages and cooking, are made from the elderflower. The popularity of a liquor produced by San Germaine and a version of Aquavit called Hallands Flader have contributed to demand for the elderflower -- the price for the flower, the syrup and the cordial remain high. There are no viable substitutes. Monopolies have market power and are able to avoid being price takers, as they would be in perfect competition. Without regulatory intervention, monopolies typically structure a market that enables them to maximize profit by limiting production of their goods and selling the goods at prices that are higher than would occur under conditions of perfect competition. For example, if a company believes that there is higher demand elasticity in foreign markets, the company will charge a higher price at home and a lower price in the foreign market. Brander and Krugman (1983) argued that this type of reciprocal dumping is an indicator of oligopolistic behavior and not standard monopolistic price discrimination. When the markets for homogeneous goods are segmented and competition is imperfect, intra-industry trade may occur as a result of "reciprocal dumping" (Brander and Krugman, 1983). Without the specialization that accompanies differentiated goods, firms may expand trade into other markets and undifferentiated goods -- which means they do not forgo competitive advantage (Baier and Bergstrand, 2009). The fundamental driver of reciprocal dumping appears to be that companies perceive each national market as a separate (segmented) market for which distinct decisions can be made with regard to trade quantity (Brander and Krugman, 1983). In effect, each country assumes a Cournot perception in which a pre-determined profit-maximizing quantity is identified and fixed.

Trans-industry trade can involve several to many interacting markets in which a particular set of prices can bring about overall equilibrium or general equilibrium. The set of equilibrium prices is considered to be long-term prices, while actual prices are viewed as deviations from the equilibrium prices.



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The gravity model of trade is a "parsimonious and tractable representation" of global economic interaction. The gravity model has found favor with researchers as a method to examine bilateral trade flow patterns and to analyze the effects of regional trade cooperation (Anderson, 2011). The tractability of the gravity model is largely attributable to its modularity, such that, comparisons can be made across several countries. The model articulates the distribution of goods and variables across country spaces that are influenced by gravity forces -- which are conditioned in turn by the size of location-based economic activity (often represented by GDP) and the distances involved in the transactions (Anderson, 2011). The utility of the model's modularity extends capacity to disaggregate data independently from models of market structure or models of production in full general equilibrium (Anderson, 2011). Disaggregation is also independent of scale and can apply to any goods or any regions, allowing inferences to be made about trade costs (Anderson, 2011).

The conventional model of gravity is derived from an analogy with Newton's Law of Gravitation (Anderson, 2011). To whit: A corpus of labor, good, or other variables of production occurs at an origin (i) and (Yi) experiences attraction to a corresponding mass of demand at destination (j) (Ej), with the potential flow between the two locations is reduced by the distance between the origin-destination pairs (dij) (Anderson, 2007). The analogy is represented in a strict form as: Xij = YiEjdeij (Anderson, 2007).

The unit of analysis of intra-trade transactions is an origin-destination pair. Relative levels of attractiveness occur between the origin-destination pairs; the theory of bilateral flows is applied to the strength of the attraction between the elements of the pairs. Theoretically, any purchase can occur at multiple possible origins and any sale can have multiple possible destinations, such that, "any bilateral sale interacts with all others and involves all other bilateral frictions" (Anderson, 2011). The structural gravity model elegantly solves this problem of general equilibrium (Anderson, 2011).

Global oligopoly (Strategic Trade Policy)

Companies interact strategically in an oligopoly. The conventional theories regarding the economy of trade present models that differ for industries depending upon whether they are compete in business through importation, in which case they are likely to prefer protectionism, or whether they compete through exportation, which can result in a preference for industry protectionism (Milner & Yoffie, 1989). Given these positions, a large number of multinational industries look to the strategic trade policies that are currently undergoing scrutiny (Milner & Yoffie, 1989). The trade policies are considered strategic because they tend to support domestic free trade only if foreign markets open or the governments of foreign countries reduce the subsidies that they charge to firms (Milner & Yoffie, 1989).

Agglomeration Economies (External Economies of Scale)

Economies of agglomeration are described as the benefits that become available when firms locate in close proximity to one another -- in other words, they agglomerate (Arribas, et al., 2009). These firms -- through the economies of scale achieved, often realize savings and network effects -- since suppliers and customers may cluster near the plants, too (Arribas, et al., 2009). In the case of processed foods, consider that various companies that lack the infrastructure for bottling and canning processed foods may all employ the services of a common bottler or canner (Arribas, et al., 2009). Locating the various companies close to the bottling or canning operation can help to keep transport costs down (Arribas, et al., 2009).

Case Study

Food habits are becoming internationalized and developing economies are experiencing rapid urbanization (Sharma, 2002). Intra-industry trade of processed foods, particularly, is subject to influence by…

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