How Does Industrialization Affect the Structure of International Trade? The Japanese Experience in the Pacific Basin, 1975-85


WP/94/95-EA
How Does Industrialization Affect the Structure of International Trade?
The Japanese Experience in the Pacific Basin, 1975-85
by Sayuri Shirai and Dongpei Huang

Over the years, a great deal of research has focused on the expansion
of intra-industry trade among the member countries of the European Union.
Traditional international trade theories based on assumptions of constant
returns to scale and perfect competition (e.g., the Hecksher-Ohlin model and
the Ricardian model of comparative advantage) have been modified to explain
this phenomenon (e.g., Helpman and Krugman, 1985). More recently, intra-
industry trade has expanded between industrialized and newly industrializing
countries, such as between Japan and Pacific Basin countries. In this
context, international trade theories must again be modified to take into
account the influence of industrialization.

Japan's intra-industry trade is more extensive with Singapore, Korea,
and Thailand than with Indonesia, Malaysia, and the Philippines because,
like Japan, the countries in the first group are relatively rich in skilled
labor and capital, whereas those in the second group are relatively rich in
natural resources. However, although Japan has maintained large-scale,
inter- industry trade with the latter group, it has also expanded intra-
industry trade by increasing manufactured imports as these countries have
progressed toward industrialization. Intra-industry trade among all six
countries has expanded since Japan's foreign direct investment in these
countries increased owing to the sharp appreciation of the yen after 1985.
As each country has become more specialized in certain manufactured
products, Japan has formed production networks with them. This
industrialization process is closely related to an increase in the variety
of manufactured products (horizontal product differentiation) as well as an
improvement in their quality (vertical product differentiation).

This paper provides a theoretical model to explain how industrializa-
tion affects the structure of international trade. Using conventional
economic concepts such as economies of scale and monopolistic competition
and considering both horizontal and vertical product differentiation, the
model explicitly focuses on industrialization and its impact on the volume
and share of intra- and inter-industry trade. The paper considers two
processes: one that increases the quality of manufactured products and one
that shifts labor from the agricultural to the manufacturing sector. The
model shows that the volume and share of intra-industry trade increase when
the quality of products in a developing country improves and when the
difference in relative factor endowments between an industrial and a
developing country shrinks. It also suggests that the faster a developing
country industrializes, the faster intra-industry trade increases.

This paper investigates empirically the structural changes in Japan's
international trade with Indonesia and Korea for 1975 and 1985. These
countries were chosen because they differ in their relative factor
endowments and technology.