Deconstructing Intra-Industry Trade With Special Reference to EU-Trade

An important refinement of the methodology in analysing intra-industry trade (IIT) has been to divide two-way bilateral trade flows into a horizontal and a vertical part. Most econometric analyses have used these parts as a proportion of total trade to test different underlying theories of IIT. The results are, however, not particular robust and in many cases they contradict the predictions of the theories, especially within the European sphere. One of the problems could be the result of using the different proportions separately, since the denominator consists of inter-industry trade plus horizontal and vertical IIT, while the econometric analyses test the different theories of IIT one at a time. In this paper we will try to integrate two complementary theories of IIT, and test hypotheses regarding the share of horizontal IIT in total IIT. The econometric analysis shows rather robust results that support both the underlying theories and therefore underline the importance of dividing total IIT into a vertical and a horizontal part. The results stress that similarities in factor proportions, especially human capital, and demand pattern, measured by per capita income levels and spatial closeness, are important determinants of the share of horizontal IIT in total IIT. Furthermore, the market sizes matter and we found that the interaction between the average and the difference in market sizes are important