Explain how intra- industry trade might be expanded via formation of regional trading agreements and custom unions. Are these international trading arrangements always trade creating?

 

The so-called intra-industry trade refers to the certain industry has products with similar inputs and consumer alternatives. In other words, intra-industry trade is a phenomenon, which certain countries both exports and imports within the same industry. The two kinds of trading agreements: free trade area and custom union constitute of the regional trading agreement. Free trade area refers to a economic organization which several countries use the abolition of tariff barriers and non-tariff barriers. The formation of regional trading agreement and custom unions is a relative mature and stable form which enables free trade and trade barriers towards external business partner.

 

With the formation of regional trading agreement, the products and services can be traded freely through member states which can stimulate the competition and encourage the development within the same industry (Paul, Maurice and Marc, 2007/2008). The competition can improve the level of operation management, enhance the trade development and expand the market with acquiring the goods and services cheaply. The member states of regional trading agreement adopted a uniform restriction to non-member countries which to some extent can minimize the competition from non-member countries so that the profit of member states can be protected.

 

After forming custom unions, there are several factors lead to the improvement of intra-industry trade, which can enhance the trade between member states. Firstly, the trade barrier can produce trade creation effect and trade divertion effect due to the uniform tariff barriers toward non-member states when the member states implement trading within custom unions. However, the effect on intra-industry trade is not static, the lower tariff barriers can both improve the intra-industry trade and enhance the inter-industry trade at the same time. For instance, there are many export areas adopting the policy of decreasing tariff which can enhance the development within intra-industry area in export areas dramatically. Recently, developing countries set up several special economic zones to strengthen cooperation with developed countries in order to lead into technology and capital. As a result, the trade barriers of custom unions can improve the development between developing countries and developed countries effectively(Charles, 2002).

 

Secondly, the economic of scale, to some extent, can lead to monopoly in most manufactured goods. The products are similar and easy to be substitute, so they compete each other. In addition, the products are not identical, there are some certain differences between each other which due to monopoly in their own market. Under the conditions of economies of scale and monopolistic competition, the average cost will decrease with outputs increasing and the demand will go up with price going down in a long-term (Charles, 2002). Before participating in international trade, enterprises are facing domestic demand solely; there is some limitation of lowering cost through expanding the scale of production, which leads to maintain a higher level of production costs and prices. If the firms are willing to participate in international trade, the market they faced will enlarge which enterprise can realize the economies of scale and lower the cost of production in order to be more competitive in both international market and local market and expand broader market. Therefore, a country will expand the products with a certain type of alternative when they are facing the booming demand of the whole international market in order to acquire economies of scale in some certain industry. The scarcity of resources requires that the country had to import other products to meet the domestic demand in this industry which will lead to intra-industry trade.

 

Thirdly, the technology development of a new products will experience three phase: new production phase, mature phase and standardized phase. When a country introduce a new technology, they can not realize the economies of scale and less recognition can be received by international markers, therefore, exports will be relative less. In the period of maturing phase, the production process will be stable gradually and economies of scale will be realized which leads to decrease in cost of production and increase in demand from all over the world. Finally the technology starts exporting to other countries. In the phase of standard, the former imports country can export even to the original export countries with the former advantage or later advantage. The country with original technology will introduce new technology and new products gradually and export to other countries which will imitate the original one to produce. Therefore, the technology gap between different enterprises due to the development of new technology will lead to improvement in intra-industry trade (Steven and Michael, 2007).

 

Fourthly, the direct investment and trade can substitute and drive each other. The effect of scale will be obvious especially in the products with complicated process. The concentration on production of these goods will gain more profits, therefore, the direct investment on them will rise the level of intra-industry of trade.

 

Fifthly, the degree of the difference of products is also an important factor of effect on intra-industry trade. Generally speaking, the higher the degree is, the higher level the intra-industry trade owns. There are several factors which we can evaluate the degree such as the species, differences in exports price, the ratio between sales can cost and the ratio between sales and the research and development expenditure. The increased degree will lead to enhance the level of intra-industry trade.

 

Lastly, the effect of economies of scale on intra-industry trade is analyzed from the supply perspective. The demand factors also will affect the intra-industry trade dramatically. Due to various kinds of demand of customer, there are still differences in demand of similar products. With limitation of resources, a country cannot produce all of the products needed in this industry which lead to the trade of imports and exports within the same industry. Therefore, when GDP is relative lower, the diversification of demand on some certain products will increase gradually, the trade in intra-industry will increase.