Intra-Industry Trade between Japan and European Countries: a Closer Look at the Quality Gap in VIIT

In this paper, we provide an overview of the development of intra-industry (IIT) trade between Japan and various European countries, including both old and new EU members, as well as emerging Eastern European countries. For the measurement of intra-industry trade, we construct a vertical intra-industry trade (VIIT) measure for various margins of unit price ratios, in addition to a Grubel-Lloyd index. By varying the margins from zero to significantly large values, the share of VIIT in total IIT changes from unity to zero, corresponding to the distributional characteristics of VIIT for each European country. Our empirical model attempts to explain the distributional characteristics of VIIT through foreign direct investments and country characteristics, in addition to traditional determinants of IIT, such as differences in GDP per capita, average GDP, and smaller and larger GDPs. Our sample covers 1988 to 2004 for bilateral trade between Japan and 31 European countries. Our econometric methodology for this panel data uses fixed-effect model estimation for static IIT. We find that intra-industry trade between European countries and Japan increases with their corresponding GDPs. Our preliminary results indicate that it is important to measure a wider range of quality based on relative prices rather than the traditional ratio used in the literature