international trade 2011

8/2/2019 International Trade 2011

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Table of contents:

..........................................................................................................2Tables and Figures ...................................................................2Q1: Di stingui sh between extern al and internale co no mi es of sc al e a nd us e t he se co nc ep ts t oexplain the phenomenon of intra- industry trade. Canthe Hec kscher -Oh lin model o f t ra de exp la in int ra -industry trade?............................................................................2

1.1 The Distinguish between external and internal economies of scale :...........................2

Fi gur e 1.1 in th e cas e of ext er nal econ omi es of scale . As shown in the f igure point A represents themarket equi l ibrium, in the equi l ibrium point the f i rmsare competing in order to sel l 40 mil l ion units at $19

a un it . Al so t he u pw ar d- sl op in g s up pl y cu rv e S 1witch represents the tota l of smal l indiv idual f i rms'views of the market with the downward-sloping long-run a vera ge c os t c urve .To bring out points a boutinternat ional t rade, le t us imagine that opening up anew export market shifts demand outward. Each f i rmw ould respond to the s tronger demand by raisingoutput . I f eac h f i rm a cted a lone a nd a ffec ted onlyi tse l f , the ex tra demand would push the market upthe supp ly c urve S1 to a po in t l i k e C . Ye t the new

export business raises the whole industry's outputand empl oyment, bringing addi ti onal externaleconomies. This means, in ef fect , a susta ined r ight-h an d m ov em en t of t he i nd us tr y s up pl y c ur ve . T oshow c os t-c ut ting c onvenien tl y, the a vera ge c os tcurve including external economies is used. Demanda nd supply expansion c atch up w ith eac h o ther a tthe new equilibrium Point......................................................4

1.2 Economies of scale and the phenomenon of intra-industry trade: ...............................4

1.3 The Heckscher-Ohlin model of trade (Inter-Industry Trade). Can it explain intra-industry trade?......................................................................................................................6

Q 2: Exami ne th e ext en t an d pat ter n of i nt ra-indus try t ra de w ithin the Euro zone t ra ding a rea.What are the impl icat ions of your analysis for t radecreation within this trading zone? Explain with direct

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reference to your analysis of re levant ev idence anddata. .................................................................................................8

2.1 Euro zone and trade creation: .......................................................................................8

2.2 Intra-Industry Trade and Euro zone:..............................................................................9

2.3 The Grubel-Lloyd Index (IIT Index) ..........................................................................11

Q3: Exp la in w ha t you understand by an opt imumc urrenc y a rea . I s Euro-zone a n opt ima l c ur renc yarea? Discuss wi th reference to the key theoret ica land empir ical indicators inc luding your analysis of the extent and pattern of intra- industry trade wi thinthe Euro-zone trading area in (b) , and an analysis of the extent of labour mobi l i ty in Euro-zone area. Whatare the impl ica t ions of the theoret ica l predict ionsand empir ica l ev idence concerning the future of the

Euro as a si ng le curr ency ? Disc us s. ..............................203.1 What is an Optimum Currency Area ..........................................................................203.2 Advantages and Disadvantages of an Optimum Currency Area ................................213.3 Labor Mobility and Optimum Currency Area ............................................................22

4 References:.............................................................................23Tables and Figures

Figure 1.1: External Economies Magnify an Expansion in a competitiveIndustry......................................................................... 2Figure 2.1: the intra and extra EU-27 trade for 2009) ........................................... 9

Table 2.2: Intra-Industry Trade and GDP per capita in 2007 for EU27........................ 12-18

Q1: Distinguish between external and internaleconomies of scale and use these concepts toexplain the phenomenon of intra- industry trade.

Can the Heckscher-Ohl in model of trade explainintra-industry trade?

1.1 The Dist inguish between external and internaleconomies of scale :

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P au l R .K ru gm a n ( 20 0 3) e st at es t ha t E xt er na l e co no m ie s o f sca l e happens when t he un i t cos t o f p roduc ti on depends on t hes i ze o f i ndus t r y i n gene ra l and no t necessa r i l y t he s i ze o f anyone f i rm , on t he o t he r hand The i n t e rna l econom ies o f sca l e i st he c om pl et e o pp os it e w hi ch m ea ns t ha t i n o rd er f or i t t o

happen t he cos t o f un i t o f p roduc t i on mus t depends on t he s i zeo f a n i nd iv id ua l f ir m b ut n ot n ec es sa ri ly t he i nd us tr y s iz e(Krugman & obs t fe ld , 2003) .

F igure 1 .1 be low demonst ra tes Ex te rna l economies o f sca le

External Economies Magnify an Expansion in a competitive Industry 1.1

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Figure 1 .1 in the case o f ex te rna l economies o f sca le . As shownin t he f i gu re po i n t A rep resen t s t he marke t equ i l i b r i um , i n t hee q u i l i b r i u m p o i n t t h e f i r m s a r e c o m p e t i n g i n o r d e r t o s e l l 4 0m il l i on u ni ts a t $ 1 9 a u ni t. A ls o t h e u p wa rd - sl op in g s up pl yc u r v e S 1 w i t c h r e p r e s e n t s t h e t o t a l o f s m a l l i n d i v i d u a l f i r m s '

v iew s o f t he m ar ke t wi th th e d ow nw ar d- sl op in g l on g- ru na v er a ge c o st c ur v e . To b ri ng o ut p oi nt s a bo ut i n te rn a ti o na lt r ad e, l et u s i ma g in e t ha t o p en i ng u p a n ew e xp o rt m ar k etsh i f t s demand ou tward . Each f i rm wou ld respond to the s t ronger demand by ra i s ing ou tpu t . I f each f i rm ac ted a lone and a f fec tedo n ly i ts e lf , t h e e x t ra d em an d w ou ld p u sh t h e m a r ke t u p t hesupp l y cu rve S1 t o a po i n t l i ke C . Ye t t he new expo r t bus i nessr a i se s t h e w h ol e i n du s tr y ' s o u tp u t a n d e m pl o ym e nt , b r in g in ga dd it i on al ex ter na l e co nom ies . Th is m ea ns , i n e ff ec t, asus ta ined r igh t -hand m ovement o f the indus t ry supp ly curve . Tos ho w c os t- cu tt i ng c on ven ie nt ly, th e av er ag e c os t c ur ve

i n cl u di ng e x te r na l e co no mi es i s u se d. D em an d a nd s up p lye x pa ns io n c at ch u p w it h e a ch o th er a t t he n ew e qu i li br i umPoin t .

I nt er n al a nd E xt er na l E co no mi es o f s ca le i mp l i ca ti on s a r ed if f er en t depend ing on th e Indus t ry typ e, An ex te rn ale c o n o m i e s o f s c a l e i n d u s t r y w i l l b e c o n s i s t i n g o f m a n y s m a l land per fec t l y compet i t i ve f i rms, However i n the case o f In te rna le co n om ie s o f S ca le , F ir ms w it h l ar g e s iz e w i l l h av e a c os tad vantage ov er o ther smal le r f i rms wh ich wi l l l ead toimper fec t l y compe ti t i ve f i rms (K rugman & obs t fe l d , 2003 ) . F irmsare aware tha t i n the case o f imper fec t compet i t i on the p r i ce o f

t he p r od uc ts c an b e i nf lu en c ed b y t he f ir m i ts el f a nd m or ese l l i ng can be ach ieved on l y by reduc i ng t he p r i ces . I mperf ec tcompe t i t i on happens when t he re a re f ew p roduce rs o f a c re t i np r o du c t o r f o r i n d u s tr i es i n w h ic h t h e p r o d u ct o f c r e t i n f i r m i sseen by consumer as s t rong l y d i f f e ren t i a t ed f rom t hose o f r i va lf i rms , so each f i rm i s cons i de red t o be a p r i ce se t t e r (K rugman& obs t fe ld , 2003) .

1.2 Economies of scale and the phenomenon of intra-industry t rade:

T he In tr a- In du st r y T rad e t he or y i s b as ed on th re e m aj or f ac t o rs , t he f i r s t one i s econom ies o f sca l e , t he second one i sassumpti on o f i nc reas i ng re t u rns t o sca l e , and t he t h i rd one i sproduc t d i f f e ren t ia t i on (Krugman, 1983) .

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T h e c h a r a c t e r i z a t i o n o f I n t r a - I n d u s t r y T r a d e i s t h a t c o u n t r i e simpor t and expo r t s im i l a r goods and p roduc t s . A l mos t mos t o f t h e i n t r a - i n d u s t r y t r a d e h a p p e n s i n t h e d e v e l o p e d P a r t o f t h ew or l d, b et we en c ou n tr ie s t ha t h av e v er y s im il ar s oc i al a ndeconomica l s t ruc tu re . (He lpman e t a l .1999) .

M an y f ac to rs c an c au se t he I mp or ts a nd e xp or t o f s im il ar p roduc t s, Howeve r i t i s t he assumpti on o f t he consumer s l ovef or d if fe re nt ia ti on a nd v ar ie ty t ha t m ak es t he d em an d f or another var ie ty o f s im i la r p roduc ts (He lpman e t a l .1999) .I nt ra -In du st r y T ra de h as m an y b en ef i ts . F ir st o f a l l t hei n c r e a s e d c o m p e t i t i o n i n t r a d e w i l l m a k e t h e P r i c e s o f g o o d sfa l l down, Second ga ins f rom increas ing re tu rns to sca le can bea c h ie v ed a s t h e m a rk e t e x pa n de d , w h ic h i n r e t ur n w i l l l o w e r t he ave rage p roduc t i on cos t . Th i rd i n t he p rocess o f economyi n te g r at i on I n tr a - In d u st r y T r ad e c r ea t es l e ss d i st o rt i on t h anI n t e r - I ndus t r y T rade . The exp l ana t i on f o r t h i s i s t ha t a pe rson

e xp ec ts m or e f l ex ib il it y w ith in i nd us tr ie s t ha n b et we eni n d us t ri e s, t h er e fo r e s m a ll e r a d ju s tm e n t c o s ts a r e s h ow n i nindus t r i es where In t ra - Indus t ry T rade happens.

The bas i c Theory o f I n t ra - I ndust r y T rade re f e rs t o f ac t o rs sucha s t h e p r o d u c t i o n o f d i f f e r e n t i a t e d p r o d u c t s a n d e x i s t e n c e o f e c on o m ie s o f S c al e . T h e a s su m p ti o n o f m o no p ol i st i c m a rk e ts t ruc tu re compet i t i on makes the p roducers o f d i f f e ren t p roduc tsse t the i r own pr i ce to max im ize p ro f i t s wh ich leads to p roduce ad if f er en t v ar ie t y o f g ood s, w he re as s imi la r p ro du cts a reassumed t o be p roduced i n marke t s where pe r f ec t compe t i t i onaccu rse and S ince consumers have a d i f f e ren t p re f e rences anda l l d i f f e r e n t p r o d u c t s a r e c o n s u m e d , I n t r a - I n d u s t r y T r a d e w i l lh ap pe n i n t he c as e of n o t r ad e r es tr ic ti on s. ( Kr ug ma n &obst fe ld , 2003)

S om e o f t he h y po th e se s o f I nt ra - In du st ry T ra de t he or y a ndeconomies o f sca le a re p resented be low.

1) In tr a- in du st ry t r ad e is ex pe ct ed t o b e h ig he r i nindus t r i es w i th h igher degree o f economies o f sca le andp roduc t d i f f eren t i a t i on (He lpman e t a l .1999,P .1 6 8) .T he p ro d uc er s r e ly o n e co n om i es o f s c al e i np roduc ti on and t hey a re ab l e t o spec i al i ze i n a spec i fi cvar ie ty o f goods to meet the consumer s demand. Theseg ood s a re t r ad ed f or o th er d if f er en ti ate d g oo ds .t he re fo re , t he l ev el o f I nt ra -I nd us tr y T ra de w il l b ei nc reased by hav i ng more spec i al i zed goods t ha t a reproduced w i th economies o f sca le

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2) T h e d e g r e e o f I n t r a - I n d u s t r y T r a d e i s e x p e c t e d t o b eh ighe r i n t rade be t ween econom ies w i t h h i gh pe r cap i t aincome and be tween economies w i th g rea te r s im i la r i t i esin per cap i ta i ncome (Rober t C .e t a l .1999,P.83)D i f fe r en t ia ted p r oduc ts a re most l y cap i ta l

i n t ensi ve p roduct s , t hus an i nc rease i n t he income per c ap i ta w il l i n cr ea se t he p r od u ct io n o f D if fe re n ti at edproduc ts i n add i t i on s im i la r economies w i l l have s im i la r f a ct o rs e n d ow m en t s, w h ic h w i ll l e ad t o a n i n cr e as e i nthe Hor i zon ta l I n t ra - Indus t ry T rade.

3) The deg ree o f i n t ra - I n t ra - I ndus t r y T rade i s expec t edto be h igher i n t rade be tween la rger economies and them o r e s i m i l a r t h e e c o n o m i e s a r e i n s i z e ( H e l p m a n e ta l . 19 9 9, P .2 0 5) .I n l ar g er e co no m ie s p r od u ce r s h av el a r ge r m a rk e ts f o r t h ei r p r o du c ts t h at a r e p r o du c e d

w i t h i nc reas ing re t u rns t o sca l e wh i ch means t ha t mored i ff e re n ti a t ed p r o du c ts w i ll b e e x po r te d a n d t h is w i l ll ead t o i nc rease i n t he I n t ra- I ndus tr y T rade . I n add i ti oncoun t r ies w i t h t he same s i ze po t en t i al l y can expo r t andimpor ts goods produced w i th economies o f sca le . I n thecase o f d i f f e ren t economy s i ze t he coun t ry w i t h l a rge r e co no my w il l b e e xp or ti ng m or e p ro du cts a nd th esma l l e r econom ica l coun t ry w i l l be f o rced t o impor t a l lt he p ro du cts s in ce th ey c an n ot b en ef i t f r om t heeconomies o f sca le in the i r p roduc t ions .

1.3 The Heckscher-Ohl in model of t rade ( Inter - IndustryTrade) . Can i t expla in intra- industry t rade?

T he s im pl es t w ay t o e xp la in t he I nt er -I nd us tr y t ra de i s t ou nd er st an d t ha t i t r ep re se nt t he e xc ha ng e o f o ne k in d o f p roduc t s p roduced i n one i ndus t r y f o r ano t he r t ype o f d i f f e ren tp roduc t p roduced in another i ndus t ry .

The bas i c R i ca rd i an mode l i s cons i de red t o be t he base f o r t hem or e s op hi st ic at ed H ec ks ch er -O hl in m od el ( Ka em pf er ,eta l . 1995) . Thes e t wo Theor i e s concen t r a t e on t he s up p l y S i de o f t he

Trade and they based on the compara t i ve advantage Theor ies .C om p ar at iv e a dv an ta ge s h ap pe n s b ec au s e c ou n tr i es h av ed i f fe ren t benefac t ion fac tor s for p roduct ion , which means tha t somec o un t ri es a r e c ap i ta l abundant a nd o th er c ou nt ri es a re l abour abundant , accord ing to R icard ian mode l count r ies w i l l p roducegoods w i t h t he l owes t oppo r t un i t y cos t , and t h i s i s caused by

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t he d i f f e rences in l abour p roduc t i v i t y and produc t ions methods ,i n more s imp le words t h i s means t ha t t he p roduc t i on o f a goodwi l l t ake p lace in a count ry where i t i s cheap to p roduce and i t sno t necessa r i l y t ha t t h i s coun t ry has t he cheapes t p roduc t i onmethods .

The Hecksche r -Oh l i n mode l use t h i s t heo ry as a base and t hene xp l ai n s h ow t ra de h ap p en s b e tw e en c ou n tr ie s w he n f ac to r p roduc t iv i t y a re equa l , wh i ch means t ha t a l abou r- r i ch coun t ryw i l l b e p r od u ci ng l ab ou r -i n te ns iv e g oo ds a n d c ap it al - R ic hc ou nt r ies w i l l be p r od uc ing cap i ta l - i n tens ive g ood s ,c om pa ra ti ve a dv an ta ge b as ed T he or ie s i nd ic at es t ha t t hed i f f erences between two coun t r ies when i t comes toendowment s f ac t o rs d i f f e rs and t he g rea t e r t hese endowment sfac to rs the grea ter i s the t rade be tween these count r ies .

I n a d d i t i o n t h e H e c k s c h e r - O h l i n m o d e l i s u s e d t o e x p l a i n t h et ra de b et we en i nd us tr ia l iz ed c ou nt r ies a nd d ev el op in gc o u nt r ie s . t h e D e ve l op i n g c o u n t ri e s u s u al l y d o n o t h a ve t h eneeded techno logy and descr ibed as labour abundant count r iess o t he y w il l e xp or t l ab ou r i nt en s iv e g oo ds , t he F re ed o m o f t ra de w it ho ut b ar r ie rs w i l l i nc r ea se t he d em an d f or l ab ou r -i n t e n s i v e g o o d s w h i c h i n r e t u r n w i l l i n c r e a s e t h e w a g e s a n dr ed uc e t he u ne mp lo ym en t r at e a nd w it h t im e t he c ou nt rycompara t i ve advantage w i l l s ta r t t o a l te rs , desp i te tha t fac t s t i l lt he count ry i s cons idered as labour - in tens ive compared to o ther i ndus t r i a l i zed count r ies , the compara t i ve advantage w i l l s ta r t t osh i f t t o o ther more cap i ta l - i n tens ive p rodu c ts and in the end thes a m e d e ve l op i n g c o un t ry w i ll s t ar t t o p r o du c e m o r e c o m p l exp roduc ts a va l i d example fo r th i s case i s Sou thKorea(Markusen. e t a l . 1995) .

Fo r a l l t he above reasons t he Hecksche r -Oh l i n mode l can no te xp la in t he I nt ra -I nd us tr y t ra de a nd t he re fo re n ew T ra detheor ies have spec ia l i zed in the In t ra - Indus t ry T rade.

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used to t rade w i th another count ry ou t o f the un ion because thecos ts were lower wh i le t rad ing w i th tha t count ry (V iner ,1950) .

T h e c r ea ti on o f a c us to m u n io n w it h n o t ar i ff s b et we en t hemember count r ies and un i f i ed ta r i f f s aga ins t o ther count r ies ou t

o f t he un i on make i t more p ro f i t ab l e t o s imp l y t rade w i t h i n t heun ion (Krugman & Obst fe ld , 2003) .

Bu t i n o rde r f o r t he Un ion t o be a f f ec t i ve t he member coun t r i ess ho ul d b e s im il ar i n m an y a sp ec ts , t he m em be r c ou nt ri esshou l d have s im i l a r it y i n t he i r cu l t u re , i n t he i r G ross Domes t icP r od uc t , i n t he ir i nf ra st ru ct ur e e tc . t he e xp la na ti o n i s t ha ts im i l ar coun t r i es t ends t o t rade more be t ween each o t he rs andt h i s e x p l a i n s w h y m o s t o f t h e t r a d i n g i s b e t w e e n n e i g h b o r i n gc ou n tr ie s , al so t ra de b et we en s im il ar c lo se r c ou n tr i es w il ld ec re as e th e t ra ns po rta ti on a nd o th er t r an sa ct io n c os ts

(Car l ton & Per lo f f ,2005 ) .

2.2 Intra- Industry Trade and Euro zone:

T h e c l os er t he c ou n tr ie s t o e ac h o th er s i nc r ea s e t he I nt ra -I ndus t r y T rade be t ween t hese coun t r i es and on t he con t ra ry al ar g e d is ta nc e b et we en t wo c ou n tr ie s d ec r ea s es t he I nt ra -Indus t ry T rade (Hansson 1994)T h e n e ga t iv e r e la t io n sh i p b e tw e en I n tr a - In d us t r y T r ad e a n d

g e o g r a p h i c a l d i s t a n c e c a n b e r e f l e c t e d b y t h e c o s t o f m o v i n gp r od u ct s f ro m o ne c ou n tr y t o a no th e r i n a dd it io n B al as sa &Bauwens(1988 ) f ound t ha t when coun t ri es a re pa r t o f a cus t omu n i o n s u c h a s t h e E u r o p e a n u n i o n t h e s h a r e o f I n t r a - I n d u s t r yT r ad e w il l i n c re as e b e t we en t he se c ou n tr i es a ls o h a v in g ag e og r a ph i c al b o r de r s w i ll i n c re a se t h e I n tr a - In d u st r y T r ad e ,fu r ther more In Euro zone coun t r ies w i th s im i la r g ross domest i cp roduc t pe r cap i t a , s im i l a r cu l t u re and s im i l a r l i ngu i s t i c a reat en ds t o h av e m or e I nt ra -I nd us tr y T ra de b et we en t he m i nad di t i on a lmost m os t o f the c ou nt r ies in euro zone arecons ide red as deve l oped coun t r i es wh i ch means t ha t t hey w i l l

have more In t ra - Indus t ry T rade be tween them (Hansson 1989) .

I n the case o f Euro zone In t ra - Indus t ry T rade can happen und er d i ff er en t m a rk et s tr u ct ur es ; m on op ol is t i c c om p et it io n a ndp e r fe c t c o m pe t it i on , I n t h e c a se o f I n tr a - In d u st r y T r ad e w i thmonopo l i s t i c compe t i t i on marke t s t ruc t u re t he goods p roduceda r e m o re i n du s tr y s p ec i f i c t h an c o un t r y s p e c i fi c . t hi s m e an st ha t t he p roduc t s a re pe r f ec tl y subs t i t u t ed w i t h each o t he r and

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d i f f e ren t i a t ed w i t h i nc reas i ng re t u rns t o sca l e t he re f o re I n t ra -Ind us t ry Tr ade w i l l tak e p lac e in the sec tor o f i n ter na leconom ies o f sca l e w i t h more p roduc t d i f f eren t i at i on (Hansson1989) . Howeve r I n a marke t w i t h pe r f ec t compe t i t i on i nc reasi ngre t u rns a re assumed t o be ex t e rna l t o t he f i rms and i n t e rna l t o

t he i ndus t r y , I n t ra - I ndus t r y T rade w i l l a r i se be t ween coun t r i esw i th s im i la r i t i es , s ince they p roduce s im i la r p roduc ts . Thus , thet w o t r ad i ng p a r tn e r s h a v e s i mi l ar f a ct o r p r ic e s w h ic h m e an stha t p roduc ts can be d i f f e ren t ia ted (Hansson 1989)

F igure 2 .1 taken f rom Euros ta t webs i te fo l l owed by the tab lebe low demonst ra te the in t ra and ex t ra EU-27 t rade , 2009( impor ts p lus expor ts , % share o f to ta l t rade)

CountryExtraEU-27

Intra EU-27 Country

ExtraEU-27

IntraEU-27

EU-27 2,294 4,321 Denmark 40 86United Kingdom 277 323 Slovenia 11 26Italy 250 336 Cyprus 2 5Malta 2 2 Latvia 4 9Finland 35 53 Belgium 137 381Lithuania 10 15 Romania 18 50

Bulgaria 11 18 Hungary 30 86Ireland 47 80 Austria 50 151Sweden 66 114 Estonia 3 10Greece 21 37 Poland 49 152Germany 534 946 Portugal 19 62Netherlands 243 432 Luxembourg 7 26Spain 128 234 Slovakia 16 64France 255 494 Czech Republi 29 127

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2.1(the intra and extra EU-27 trade for 2009)


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cSource: Eurostat(ext_lt_intratrd)F rom t he above f i gu re and t ab l e (2 . 1 ) , i t i s no t i ced t ha t f o r a l lo f t he t wen t y seven coun t r i es To t a l t rade w i t h i n t he Eu ropeanun ion i s more than the to ta l t rade w i th in o ther count r ies ou ts ide

o f t h e u n i o n w h i c h i s a n i n d i c a t o r a n d p r o o f o f t he ex i s t encea nd t he d eg re e o f In tr a- In du st r y T ra de b et we en th es ecount r ies

2.3 The Grubel -Lloyd Index ( I IT Index)

T h e s ta nd a rd m ea su r e o f t he I nt ra - In d us tr y T ra de I IT i s t heGrube l -Ll oyd i ndex , G rube l and L l oyd (1975 ) de f i n i t ion o f I I T i s

w h en th e v al u e o f e xp or ts o f a n i nd u st ry w hi ch i s e xa c tl ymatched by the impor ts o f the same indus t ry (Grube l and L loyd1975, p .20) .The Grube l -L l oyd i ndex was deve l oped f rom equa t i ons o f i n t ra -and in te r i ndus t ryTrade as per be low

In ter - indust ry t rade= | X i -Mi |

Int ra - indust ry t rade= (X i+Mi ) - | X i -Mi |

X r ep re se nt s t he c ou nt ry e xp or ts o f th e i nd us tr y i a nd Mrepresents the count ry impor ts o f i ndus t ry i based on these twoe q u a t i o n s t h e G r u b e l - L l o y d i n d e x w a s e s t a b l i s h e d , t h i s i n d e xm ea su re s t o w ha t e xt en t t he s ha re o f t ot al t ra de i s I nt ra -Indus t ry T rade ( I IT )

So t = ( (X i + Mi ) | X i -Mi | ) / (X i+Mi )Which means tha t t = 1 - | X i -Mi | / (X i+Mi )

I f t he v al ue o f t he i nd ex i s z er o t he n t he re i s a c om pl et espec ia l i za t ion wh ich means tha t a l l t rade i s In te r - Indus t ry T radea n d i f t he v al ue o f t h e i nd ex i s o ne t he n t h e re i s o nl y I nt ra -Indus t ry T rade (Krugman,2000) .

I n 1989 Par j anne d i d some s t ud i es on t h i s i ndex and f ound ou tt w o m a in o b je c ti o ns w h ic h s h ou l d b e c o n si d er e d w h en u s in gt h i s i ndex , f i r s t ob j ec t i on i s t ha t t he i ndex i s no t l i nea r wh i chm e an s t ha t f or a c on s ta nt i nc r ea se i n e xp or t ( im po r t) f or ag iv en l ev el o f i mp or t ( ex po rt ) t he v al ue o f t he i nd ex , t , i s

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d im in is hi n g. T he s ec on d o bj ec ti on i s th at t he i nd ex i s n o tdependent on the abso lu te va lues o f impor t and expor t s ince I ITi s wr i t ten as a f rac t i on o f the indus t r y s to ta l t rade(Par janne,1989) .

Th e main i ssue wh en m eas ur ing I IT is th e ca teg or i ca laggregat ion p rob lem (Grube l &L loyd , 1975) . The s ta t i s t i ca l da tac a n b e c l a s s i f i e d a n d a g g r e g a t e d i n d i f f e r e n t l e v e l s , w h i c h i so n e p a rt o f t h e p r o b l em ( H an s s on , 1 98 9 ) a n o t h er p a r t i s t h atD i f fe ren t ia ted p roduc ts may be aggregated to the same produc tg roups (Bowen e t a l , 1 9 9 8 ) . T h e r e a r e t w o m a i n r e a s o n s w h yc a t eg o r ic a l a g g re g at i on h a p pe n s ( P ar j an n e , 1 9 8 9) . F i rs t t h eposs i b i l i t y o f sub -g roups w i t h oppos i t e s i gns de f i c i t o r su rp l usa n d t h i s w i l l l e a d t o a t ra de i mb al an c e a nd I IT i nd ex w il l b eove rva l ued . Second depend ing on how impor t an t t he we igh t edsub -g roups a re we igh ted e f f ec t s may cause t he I I T i ndex t o be

d i s to r te d ( P ar j a nn e 1 9 89 ) . S o i f t h e c a te g o ri c al a g g re g at i onp ro bl em i s i gn or ed t he I IT i nd ex w il l b e i rr el ev an t w he n i tc o m es t o u n d er s ta n di n g a c tu a l t r ad e p a tt e r ns ( B o we n e t a l ,1998) . Three to four d ig i t l eve ls a re su i tab le when do ing the I ITc al c ul at io ns a nd i n m os t c as es m an y e co n om ic s s ta te d t ha tt h e s e w i l l l e a d t o a p p r o x i m a t i o n s w i t c h a r e a c c u r a t e f o r t h i sr ea so n t he se l ev el s m os tl y u se d i n t he e co no mi c s tu di es(Par janne1989) .

Tab le 2 .2 be low was made based on in fo rmat ion d i s t rac ted f romt he e xt er na l an d in tr a- Eu ro pe an u ni on t r ad e 2 002 -2 00 7Euros t a t pocke t book wh i ch ca l cu l a t es t he I n t ra - I ndus t r y T radeindex f o r t he t wen t y seven coun t r i es o f t he Eu ropean Un ion f o r t h e y e a r o f 2 0 0 7 i n d i f f e r e n t i n d u s t r i e s b a s e d o n t h e e x p o r t sa nd i mp or ts a mo un ts i n b il l i on s f or a c er ta in i nd us tr y , i na d di t i on t he b el ow t ab le s ho ws t he G ro ss d om es ti c p r od u ct(GDP) pe r cap i ta i n Pu rchas ing Power S t andards (PPS) whi chis expressed in re la t i on to the European Un ion (EU-27) averages et t o e qu al 1 00 w hi ch m ea ns t ha t i f t he c ou nt ry G DP p er C a p it a i s h i gh e r t h a n 1 0 0 t h en t h is c o un t r y G D P p e r c a p it a i sh i g h e r t h a n t h e E U a v e r a g e a n d v i c e v e r s a , t h e c l o s e r t h eI nt ra - In d us tr y t ra d e i nd ex t o o ne t he m or e i t r ep r es en t t hed e g re e o f I n t ra - I nd u s tr y T r a de i n a c e rt a in i n du s tr y , o n t h eother hand the c loser the In t ra - Indus t ry T rade index to Zero themore i t represent the degree o f In te r - Indus t ry T r ade in a cer ta inindus t ry .

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(Table 2.2 Intra-Industry Trade and GDP per capita in 2007 for EU 27)

Country Industry Exports ImportsIIT

IndexBelgium:

GDP per capita in

2007 Primary products 55.6 71.2 0.87697 116 Food and beverages 24.6 21.1 0.92341

Crude materials 9 15 0.75000 Energy 22 35 0.77193 Manufactured goods 259.2 230.3 0.94096 Chemicals 91.6 73.6 0.89104 Machinery and vehicles 75.1 76.5 0.99077 Other manufacturedproducts 92.5 80.2 0.92878

Bulgaria: GDP per capita in

2007 Primary products 3.9 7.2 0.70270 40 Food and beverages 1 1.2 0.90909

Crude materials 0.9 1.7 0.69231 Energy 2 4.4 0.62500 Manufactured goods 9.4 14.5 0.78661 Chemicals 1 1.9 0.68966 Machinery and vehicles 2 6.5 0.47059 Other manufacturedproducts 6.4 6.1 0.97600

Czech Republic GDP per capita in


Crude materials 2.4 2.2 0.95652 Energy 2.4 6.9 0.51613 Manufactured goods 81.1 72.6 0.94470 Chemicals 5 8.9 0.71942 Machinery and vehicles 48.4 37.1 0.86784

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Other manufacturedproducts 27.7 26.7 0.98162

Denmark: GDP per capita in

2007 Primary products 23.6 14.3 0.75462

123 Food and beverages 13 8.1 0.76777 Crude materials 2.9 2.5 0.92593 Energy 7.6 3.6 0.64286 Manufactured goods 49.4 56.7 0.93120 Chemicals 9.8 8 0.89888 Machinery and vehicles 20 25.2 0.88496 Other manufacturedproducts 19.6 23.5 0.90951

Germany: GDP per capita in


116 Food and beverages 43.4 50.6 0.92340 Crude materials 20.4 33.3 0.75978 Energy 23.1 83.2 0.43462 Manufactured goods 855.7 591.1 0.81711 Chemicals 134.8 98.7 0.84540 Machinery and vehicles 481.2 285.1 0.74410 Other manufacturedproducts 239.8 207.3 0.92731

Estonia: GDP per capita in

2007 Primary products 2.5 3 0.90909

70 Food and beverages 0.7 1 0.82353 Crude materials 0.8 0.5 0.76923 Energy 1 1.6 0.76923 Manufactured goods 5.6 8.4 0.80000 Chemicals 0.5 1.1 0.62500 Machinery and vehicles 2.4 4.1 0.73846 Other manufacturedproducts 2.7 3.2 0.91525

Ireland: GDP per capita in

2007 Primary products 11.1 12.1 0.95690 148 Food and beverages 8.7 5.5 0.77465 Crude materials 1.7 1.3 0.86667 Energy 0.7 5.3 0.23333 Manufactured goods 74.9 45.4 0.75478 Chemicals 43.2 8.1 0.31579 Machinery and vehicles 21.4 23.6 0.95111 Other manufactured 10.3 13.7 0.85833

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productsGreece:

GDP per capita in2007 Primary products 6.3 15.9 0.56757

90 Food and beverages 3 5.7 0.68966

Crude materials 1.1 1.8 0.75862 Energy 2.1 8.4 0.40000 Manufactured goods 10.3 39.3 0.41532 Chemicals 2.4 7.8 0.47059 Machinery and vehicles 2.3 16.5 0.24468 Other manufacturedproducts 5.7 15 0.55072

Spain: GDP per capita in


Crude materials 6.3 12.4 0.67380 Energy 10.2 42.4 0.38783 Manufactured goods 143.3 204.8 0.82333 Chemicals 23.1 31.7 0.84307 Machinery and vehicles 71.4 103.9 0.81460 Other manufacturedproducts 48.8 69.3 0.82642

France: GDP per capita in

2007 Primary products 68 105.6 0.78341 108 Food and beverages 42.4 32.7 0.87084

Crude materials 10.5 12.4 0.91703 Energy 15.2 60.4 0.40212 Manufactured goods 325.8 342.8 0.97457 Chemicals 69.7 59.6 0.92189 Machinery and vehicles 157 156.1 0.99713 Other manufacturedproducts 99 127.1 0.87572

Italy: GDP per capita in


104 Food and beverages 21.5 27.6 0.87576 Crude materials 5.5 18.4 0.46025 Energy 14.2 60.5 0.38019 Manufactured goods 313.2 257.2 0.90182 Chemicals 36.8 47.2 0.87619 Machinery and vehicles 137.2 105.8 0.87078 Other manufacturedproducts 139.2 104.2 0.85620

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Cyprus: GDP per capita in

2007 Primary products 0.4 2 0.33333 92 Food and beverages 0.2 0.8 0.40000

Crude materials 0.1 0.1 1.00000

Energy 0.2 1.1 0.30769 Manufactured goods 0.6 4.3 0.24490 Chemicals 0.2 0.6 0.50000 Machinery and vehicles 0.3 1.8 0.28571 Other manufacturedproducts 0.2 1.9 0.19048

Latvia: GDP per capita in


Crude materials 1.1 0.5 0.62500

Energy 0.2 1.2 0.28571 Manufactured goods 3.9 8.3 0.63934 Chemicals 0.5 1.1 0.62500 Machinery and vehicles 1.2 3.9 0.47059 Other manufacturedproducts 2.2 3.3 0.80000

Lithuania: GDP per capita in



Luxembourg: GDP per capita in



Hungary:

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GDP per capita in2007 Primary products 7.4 10.7 0.81768 62 Food and beverages 4.2 2.8 0.80000

Crude materials 1.3 1.2 0.96000 Energy 2 6.6 0.46512

Manufactured goods 60.9 58.4 0.97904 Chemicals 5.6 6.4 0.93333 Machinery and vehicles 43.1 36.6 0.91844 Other manufacturedproducts 12.2 15.4 0.88406

Malta: GDP per capita in


Crude materials 0 0Energy 0 0.3 0.00000

Manufactured goods 2 2.4 0.90909 Chemicals 0.2 0.3 0.80000 Machinery and vehicles 1.4 1.3 0.96296 Other manufacturedproducts 0.5 0.7 0.83333

Netherlands: GDP per capita in


Crude materials 23.6 18.3 0.87351 Energy 53.1 60.5 0.93486 Manufactured goods 275 250.4 0.95318 Chemicals 62.3 44.5 0.83333 Machinery and vehicles 131.7 119.6 0.95185 Other manufacturedproducts 80.9 86.4 0.96712

Austria: GDP per capita in


Crude materials 4 5.1 0.87912

Energy 3.2 11.2 0.44444 Manufactured goods 103 94.1 0.95485 Chemicals 12.3 13 0.97233 Machinery and vehicles 49.4 43.6 0.93763 Other manufacturedproducts 41.3 37.4 0.95044

Poland: GDP per capita in Primary products 15.9 23.1 0.81538

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200754 Food and beverages 9.5 7.1 0.85542

Crude materials 2.6 4 0.78788 Energy 3.9 12 0.49057 Manufactured goods 86.3 94.8 0.95306

Chemicals 7.5 15.7 0.64655 Machinery and vehicles 41.8 43.1 0.98469 Other manufacturedproducts 37 36 0.98630

Portugal: GDP per capita in


Crude materials 1.8 2.1 0.92308 Energy 1.7 8 0.35052 Manufactured goods 29.4 40 0.84726

Chemicals 2.7 6.4 0.59341 Machinery and vehicles 12 17.6 0.81081 Other manufacturedproducts 14.7 16 0.95765

Romania: GDP per capita in

2007 Primary products 4.7 10 0.63946 42 Food and beverages 0.9 3 0.46154

Crude materials 1.6 1.5 0.96774 Energy 1.6 5.5 0.45070 Manufactured goods 24.6 40.9 0.75115 Chemicals 1.7 5.2 0.49275 Machinery and vehicles 10 19.4 0.68027 Other manufacturedproducts 13 16.2 0.89041

Slovenia: GDP per capita in

2007 Primary products 2 4.9 0.57971 88 Food and beverages 0.9 1.5 0.75000

Crude materials 0.7 1.3 0.70000 Energy 0.4 2.1 0.32000

Manufactured goods 20 18.1 0.95013 Chemicals 2.8 2.6 0.96296 Machinery and vehicles 9.1 8.2 0.94798 Other manufacturedproducts 8.1 7.3 0.94805

Slovakia: GDP per capita in


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68 Food and beverages 1.4 2.2 0.77778 Crude materials 0.9 1.3 0.81818 Energy 2 4.7 0.59701 Manufactured goods 37.7 35.5 0.96995 Chemicals 2.1 3.8 0.71186

Machinery and vehicles 22.8 19.4 0.91943 Other manufacturedproducts 12.8 12.3 0.98008

Finland: GDP per capita in


Crude materials 3.8 6.2 0.76000 Energy 3.6 8.3 0.60504 Manufactured goods 54.2 41.7 0.86966 Chemicals 3.8 5.8 0.79167

Machinery and vehicles 28.1 22.8 0.89587 Other manufacturedproducts 22.3 13.1 0.74011

Sweden: GDP per capita in


Crude materials 7.7 4.4 0.72727 Energy 6.8 12.3 0.71204 Manufactured goods 104.3 85.9 0.90326 Chemicals 13.6 12 0.93750 Machinery and vehicles 54.3 43.1 0.88501 Other manufacturedproducts 36.4 30.8 0.91667

United Kingdom: GDP per capita in


Crude materials 8 14.7 0.70485 Energy 34.1 42.9 0.88571 Manufactured goods 246.2 337.3 0.84387

Chemicals 56.9 52 0.95500 Machinery and vehicles 110.1 159 0.81828 Other manufacturedproducts 79.2 126.4 0.77043

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Q3: Explain what you understand by an optimum currencyarea. Is Euro-zone an optimal currency area? Discuss withreference to the key theoretical and empirical indicatorsincluding your analysis of the extent and pattern of intra-industry trade within the Euro-zone trading area in (b), and ananalysis of the extent of labour mobility in Euro-zone area.What are the implications of the theoretical predictions andempirical evidence concerning the future of the Euro as asingle currency? Discuss.

3 .1 What is an Opt imum Currency Area .

O p ti m um C u rr e n cy A r ea c a n b e d e fi n ed a s t h e g e o g r ap h i ca la r e a i n w h i c h t h e b e n e f i t s f r o m t h e c o m m o n m u t u a l c u r r e n c ya r e h ig h er f or t he i nv ol ve d c ou n tr y t ha n t he b en ef it s o f t he

l o ca l c u r re n c y. i n c o u nt r ie s w i th c o mm o n c u r re n cy i t w i l l b eb et t er t o d ea l w ith an d o ve rc om e a ny e xte rn al s ho ck s i nadd i t ion t o more e f f i c i en tl y reduc i ng t he a f f ec t o f t hese shocks( M on g e ll i , 2 0 05 ) .H o we v e r i n o r d er f o r t h e c o un t r ie s t h at a r epa r t o f t he common cu r rency t o be ab l e t o ach i eve t h i s ce r t ai np re requ is i t es o r c r i t e r i a s need t o be ob t a ined . Some o f t hesec r i t e r i a s a r e t h e m o b i l i t y o f l a b o u r a n d c a p i t a l i n a d d i t i o n t ot he mob i l i t y o f t he f ac t ors o f p roduc t i ons . The mob i li t y o f bo t ht he l abou r and cap i t a l he l ps t o suppor t t he econom ic shock i nt he a rea i n o rde r t o reg i ona l l y d i s t r i but e t he asymmetr i c e f f ec t(Munde l l , 1961) .another new cr i t e r ia s i nc lude s im i la r i t i es o f

The s t ruc t u re o f economy i n t hese coun t r i es i n add i t i on t o t heex t en t o f t rade be t ween t hese coun t r i es . A l l t hese reasons andc r i t e r ia s a re so impor t an t because coun t r i es who a re memberso f a m o n e t a r y u n i o n n e e d t o h a v e t h e s a m e r e a c t i o n s f o r a n ye co no mic s ho ck in o rd er f or t he c om mo n c ur re nc y t o b ee f f i ci en t . A l l (Monge ll i , 2005 ; F rankel & Rose , 1998 ) a rgues t ha tt h e a p p li c at i on o f c o mm o n c u r re n c y s u p p o rt s t o a c h ie v e t h eprerequ is i tes and c r i t e r ia s .

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3.2 Advantages and Disadvantages of an Opt imum CurrencyArea

Why should Europe count r i es be jo ined as an Economic and MonetaryUnion ?

Many d i f f e ren t reasons comes to m ind when th ink ing about th i sques t ion spec ia l l y i n the case o f Europe these reasons expandsb e y on d e c on o m ic a l r eason s, fo r some coun t r i es i s i t a l soh i s t o r i ca l l y o r po l i t i ca l l y impor t an t t o j o i n t he Eu ropean un ionf or s om e n at i on s , e ve n th ou gh s om et i mes t he e co no mi cbene f i t s f o r j o i n i ng a re l ess t han t he po l i t i ca l o r psycho l og i ca lb e n e f i t s b u t s t i l l i t i s i m p o r t a n t f a c t o r s i n f a c t B a l d w i n ( 2 0 0 6 )a rg ue s t ha t p ol it ic al r ea so ns w er e h ig hl y i mp or ta nt i n t hec rea t i on o f Eu ro i n add i t i on A r t i s (2003 ) exp l a i ns t ha t po l i t i ca lreasons are as impor tan t as economica l reasons .

Monge l l i ( 2005 ) a rgues t ha t t he re a re no measu rab l e t es t s f o r coun t r i es t ha t a re pa r t o f an op t imum cu r rency a rea t o bene f i tf r om t h i s common cu r rency . K rugman & Obs t f e l d (2003 ) o f f e rss om e h in ts , d i ag ra m s a nd s c he d ul es b u t n ot a c le ar a ns w er wea t he r t he Eu ro Zone a re an e f f i c i en t op t imum cu r rency a reao r n o t , i n m o s t o f t h e c a s e s t h e g i v e n a n a l y s i s s u g g e s t t h a tsome count r ies o f the euro zone migh t be cons idered as par t o f the op t imum cur rency area bu t i n genera l the conc lus ion i s tha te ur o z on e d oe s n ot r ep res en t a n o pt i mu m c ur ren cy ar eas i tua t ion (McDowel l ,2006; Krugman & Obst fe ld , 2003) .

F ro m e co no mi c p er sp ec ti ve t he c os t o f u si ng t he E ur o a scommon cur rency occurs a t the macr o leve l wh ich means tha t i nt he c as e o f e co no mi ca l r ec es si on o r e co no mi ca l b oo m t henat iona l exchange ra te f l uc tua t ions can no t work as a s tab i l i ze r ( Fe ld st ei n, 19 97 ). H ow ev er t he i mp li ca ti on o f t hi s d if fe rs

be t ween member coun t r i es depend ing on t he econom ic s i ze o f t h e c o u n t r y w h i c h a f f e c t s t h e c o u n t r y i n f l u e n c e o n t h e w o r l dmarke t , f o r i ns tance i f a smal l count ry w i th a smal l economy i su si ng a n at io na l c u rr en cy , a l l e ls e e qu al , a nd w he re t hed egree o f uncer ta in ty for i nves tment w i th a mor e r iskye n vi ro nm e nt i nc r ea se t he n t he c ou n tr y w i l l b e f ac in g m or ee c o n o m i c r i s k s t h e r e f o r e i n o r d e r t o t r y t o a v o i d t h e s e r i s k ssma l l er coun t ri es t end t o adop t a more w ide l y used cu r renc i es

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s u c h a s t h e E u r o i n o r d e r t o i n c r e a s e t h e c o u n t r y c r e d i b i l i t y(Ba ldw in , 2006) .

A c om mo n c ur re nc y c re at es m or e e co no mi c i nt eg ra ti on i na dd it i on a c om mo n cu rr en cy r em ov es th e e xc ha ng e r ate

be t ween member coun t r i es so t hese p rev i ous ra t es can no t bef l oa ted o r deva l ued i n t he f u t u re (De Nard i s & V i ca rel l i , 2003 ) .I n add i t i on a common cu r rency c rea t es a un i f i ed marke t whe rea l l t he goods pr i ces are denominated in the same nomina l va lues o c o u n t r i e s t h a t a r e p a r t o f a c u r r e n c y u n i o n w i l l h a v e m o r et rade be tween them and inc reases the economic in tegra t ion (DeN a r d i s e t a l . 2 0 0 8 ) . C o m m o n c u r r e n c y a r e a w i l l c r e a t e m o r ee f f i ci ency because o f a l l t he i nc rease i n compe ti t i on wh i ch w i l ll ead t o more e f f i c i en t use o f f ac t o rs o f p roduc t i ons , resou rcesand more spec ia l i za t ion be tween count r ies (M icco e ta l ., 2 0 03 ) .f u r th e r mo r e a n i n c re a se o f t r ad e b e tw e en c o m mo n

c u r re n c y c o un t r ie s w i l l a l so i n cr e as e t h e p o li t ic a l i n te g r at i onbetween them wh ich on the long te rm w i l l l ead to more s tab i l i t yand peace (Rose, 2000) .B a l d w i n ( 2 0 0 6 ) a r g u e s t h a t t h e i n c r e a s e o f t r a d e b e t w e e n t h eeuro zone count r ies i s a resu l t o f reduc t ion o f the f i xed cos ts o f i n t roduc ing a new produc t to European marke t .

To summar i ze t he above , t he advan t ages o f hav i ng a commonc ur re nc y i nc lu de s a n e ff ic ie nt a ll oc at io n o f r es ou rc es , a ni n c re a se o f p o li t ic a l i n te g r at i on a n d f o r s m al l c o un t ri e s w i thsma l l economy an i nc rease o f coun t ry c red i b i l i t y and o f cou rset he ma in advan t age w i l l be an i nc rease o f t rade , howeve r t hed is ad va nt ag es o f h av in g a c om mo n c ur re nc y f or s tr on ge r count r ies w i l l be the loss o f i t s i ndependent monetary po l i cy bu taga in t hese advan t ages and d i sadvan t ages do d i f f e r f rom onecount ry to another i n the case o f Euro .

3 .3 Labor Mobi l i ty and Opt imum Currency Area .

Munde l l (1961) emphas ized on labour mob i l i t y as a way toovercome any economic shock in count r ies w i th common

cur rency however Monge l l i (2005) a rgues tha t Labor i s no tmob i le i n the shor t - run and cannot there fo re ac t as a s tab i l i z ingmechan ism o ther than in the long- run , where mob i l i t y becomesimpor tan t i n o rder to ach ieve low unemployment , i n add i t i onand fo r the case o f Europe i t i s we l l no t i ced tha t the labour does no t move a l o t a roun d Europe. Desp i te the fac t tha t theborders have no bar r ie r fo r the mob i l i t y o f l abour bu t s t i l l t hereare the cu l tu ra l and language bar r ie rs be tween the count r ies

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(Monge l l i , 2005) .Another reason fo r the low labour mob i l i t yw i th in Europe i s the unemployment p ro tec t ion laws (Huber ,2004)

4 References:

A r t i s ,M.J . (2003) Re f lec t ions on the Opt ima l Cur rencyArea (OCA) C r i te ra in the L igh t o f EMU In te rna t iona lJourna l o f F inance and Economics , Vo l . 8 , No. 4 , pp .297-307

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