Elsevier

Economics Letters

Volume 74, Issue 1, 20 December 2001, Pages 127-132
Economics Letters

Economies of scale and the volume of intra-industry trade

https://doi.org/10.1016/S0165-1765(01)00519-5Get rights and content

Abstract

Using a model of monopolistic competition with traded and non-traded goods, this paper establishes a positive link between scale economies, the volume of intra-industry trade and the share of trade in total production. These results are consistent with empirical findings.

Introduction

The main contribution of this note is to establish a positive causal link between the degree of economies of scale and the volume of intra-industry trade as well as with the share of industry trade in total production. These links are obtained by introducing traded and non-traded goods into the workhorse model of intra-industry trade.

It is well known that the presence of scale economies is an important ingredient for the existence of intra-industry trade in differentiated products.1 Krugman (1980) made this point 20 years ago and his seminal articles have spawned an entire literature. However, the workhorse model of the literature on intra-industry trade (i.e. Krugman, 1980) predicts that, in equilibrium, the industry volumes of production and trade are independent of the degree of scale economies.2 Indeed, although an increase in the degree of scale economies (through an increase in fixed cost) raises an individual firm’s output and export, it decreases the number of firms and these two effects have exactly the same magnitude. Recognizing this absence of continuous causal relationship between volume of trade and magnitude of scale economies, Harrigan (1994) qualifies as purely ‘descriptive’ his regressions linking these two variables but finds that the volume of trade is larger in industries where there are larger scale economies. His widely quoted results are believed to capture important empirical regularities.3 The present paper is best interpreted as establishing a robust continuous causal relationship between volume of trade and degrees of scale economies.

In the next section, we develop a model of monopolistic competition where firms face different fixed cost of exporting, allowing some of them to trade and others to sell at home only. In Section 3, we show how an increase in the degree of economies of scale increases the number of trading firms, the volume of trade, as well as the share of industry trade in total production.

Section snippets

The model

Consider the standard model of intra-industry trade à la Krugman (1980). There are two identical countries, Home (d) and Foreign (f). Consumers in each country have identical preferences and the utility of each of them is represented by:U=icidθ+jcjdθ+lclfθ,θ∈(0, 1)where cid is the consumption of traded good i, cjd is the consumption of non-traded good j, and clf is the consumption of imported good. Consumer’s income is the sum of individual labor income and the share of the profits from all

Technological changes and volume of trade

We define the volume of trade as the volume of exports net of the units devoted to transportation and thus as:T=naΦ(γ̃; α)xfwhere naΦ(γ̃; α) is the number of traded goods that depends on the critical fixed cost of exporting which in turn depends on the level of the fixed cost of production. We model an increase in the degree of scale economies by an increase in α relative to the variable unit cost. Differentiating (6), the overall effects on export volume of a change in α are:dTT=αna dnadα+αΦ

Conclusion

In this paper, we have shown that, unlike in the standard model of intra-industry trade, the total volume of intra-industry trade and the share of trade in total output increase with the degree of economies of scale when one allows for firms’ heterogeneity with respect to export markets and, in particular, for products to be non-traded. Harrigan (1994)’s findings that the volume of trade tends to be higher in sectors with larger scale economies constitute a direct confirmation of the relevance

Acknowledgements

We thank Daniel Bernhofen for useful discussions and comments on an earlier draft of this paper. Zhihao Yu is grateful to the Leverhulme Trust for financial support under Programme Grant F114/BF.

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