Investigating the composition of product-level specialization

Abstract

Intra-industry trade has practical implications for the extent of direct competition countries face. Our paper contributes to the literature by proposing a new index of intra-industry trade that incorporates information from product-level trade data. The new index categorizes trade as intra-industry only if exports and imports are close substitutes as measured by the average proximity of their prices. This criteria of qualifying as intra-industry trade is based on product characteristics unlike the traditional Grubel–Lloyd (GL) index which is based on the level of data aggregation. GL index rises automatically with data aggregation creating serious questions regarding its dependability as a reasonable measure. By capturing substitutability of exports and imports, the new measure remains true to the theoretical definition of intra-industry trade irrespective of the level of data aggregation. The new index estimates intra-industry trade was, on average, only 14% as compared to the 21% estimated by the GL index for the US between 1989 and 2001. Furthermore, the new index yields estimates that have no predictable relation to data aggregation and remain quite stable as the level of aggregation changes.