Horizontal and Vertical Intra‐industry Trade: An Empirical Test of the ‘Homogeneity Hypothesis’

Abstract

AbstractIn this paper, we study if and how country‐specific factors affect intra‐industry trade (IIT) when heterogeneity among sectors is allowed for. The paper is novel in that it is the first that addresses an issue raised by Greenaway et al. (Oxford Bulletin of Economics and Statistics, 1999, 61, 365). Specifically, employing data on a sample of OECD countries over a 10‐year period (1997–1998), we build on and take forward a methodology pioneered by Balassa and Bauwens (Economic Journal, 1987, 97, 923) to study the determinants of horizontal and vertical IIT using a multi‐industry approach. In doing this, we seek to avoid the more extreme measurement problems by allowing for heterogeneity among sectors when country‐specific factors are analysed and among countries when industry‐specific factors are considered. The results are compared to those obtained using the traditional method that does not consider intersectoral heterogeneity. We find that the two models yield statistically different results. Moreover, the tests regarding the choice of model – that is, econometric tests designed to compare one model with another when different sets of explanatory variables are used – confirm the relevance of intersectoral heterogeneity in affecting IIT. To the best of our knowledge, a similar analysis has not yet appeared in the empirical literature on IIT.