Intra-industry Trade (IIT) has become a common phenomenon in contemporary international trade, which has drawn attention from scholars in the past decades. Due to the difficulties of explain IIT when using traditional theories, people develop new theories including economies of scale and imperfect competition to give explanations. In the Euro-zone, IIT becomes more important and prevalent, which is tightly associated to the area’s development and even the Euro’s existence. Whether the Euro-zone is successful as the first area which adopt single currency, and what the future of Euro will be, are serious problems in the international trade studies.


There are three major sections in this passage. First, the cause of intra-industry is specified, with introducing the theory of external/internal economies of scale and the difficulty H-O model met in explaining IIT. The second section is about utilizing IIT theory in explaining Euro-zone’s situation, by using IIT index to measure member countries in the Euro-zone in their trade statistics. The extent and pattern of the IIT in the Euro-zone, and how the IIT contributes to the trade creation in the Euro-zone are to be discussed. In the third section, the discussion is about whether Euro-zone is a optimal currency area, with the assistance of theoretical analysis and empirical evidence. A brief prospect of Euro’s future according to the discussion is given. Three sections are concluded in the last part of the passage.


Section One: Economies of Scale and Intra-industry Trade


1.1 External and internal economics of scale


Economies of Scale, also known as ‘increasing returns to scale’, can be defined as the situation where ‘an increase in the level of output produced implies a decrease in the average costs per unit of output for the firm’ (Marrewijk, 2007). From the definition, the change of average cost can be shown in Figure 1 (when the output increases, the average cost falls). As distinguished by Scitovsky (1954), there are two main types of economies of scale, external economies of scale and internal economies of scale.


Figure 1: Economics of Scale


Internal economies of scale happen when the drop in average costs per unit results from the increase of the size of the firm itself. In contrast, external economies of scale happen when the decrease in average costs per unit is brought about by the output increase of the entire industry. To distinguish the two concepts, an example can be helpful here: assume there is a car industry, which contains five companies, each of which produces 100 cars per year, which makes the industry’s annual production 500 cars. If the overall production of the industry increases to 1000 cars per year by adding five companies with the same productivity, and the efficiency of those firms are improved, then the situation is external economies of scale; if the overall production is still 500 cars per year, but the number of companies declines to two, and the average cost per car also decreases, then the situation is internal economies of scale.


The influences of the two types of economies of scale on the market structure are different. Pure external economies of scale can present many small companies in the perfectly competitive market, while internal economies of scale always bring higher market power of particular large companies (Krugman and Obstfeld, 2000). The external and internal economies of scale strongly impact the intra-industry trade which is explained later.


1.2 Heckscher-Ohlin model and intra-industry trade


On the basis of Ricardo’s classical theory that the comparative advantage is the cause of trade flows in the international environment (Ricardo, 1817), Heckscher and Ohlin developed a famous model which indicates the international trade is determined and drived by the differences between the factors of production of each country (Ohlin, 1933). In the H-O theory, it is assumed that perfect competition is in all markets of the countries in trade and there are constant returns to scale in production in the long run. On these assumptions, H-O theory suggests that different countries have their comparative advantages because of different factor endowments. They utilize their abundant factors to produce the abundant factor intensive products and export to other countries, while import products which are produced with the factor less intensive in them. It also predicts that free trade is beneficial for the welfare of countries in trade, and will eliminate or reduce the differences in the factor input prices of those countries (Caves, 1976).


The phenomenon of increasing intra-industry trade in the modern world has been studied by many scholars in the recent decades. The intra-industry trade (IIT) is the trade between countries in which the trading countries import and export similar products simultaneously, within the same industry. As predicted by H-O theory, the trading countries would converge in the ratio of factors of production, which would contribute to the slowing down of international trade, and it is not possible to make the countries trade in the same industry or the same sector because the international trade could only be initiated by the differences of factor endowment, i.e. it only could be inter-industry trade. Therefore, it is difficult for the H-O model to explain the existence and prosperity of intra-industry trade, especially in the developed and industrialized countries. For example, the UK import and export many kinds of products in the same categories, which is difficult for the traditional theory to explain.


This is because the assumptions of H-O theory are problematic. It assumes perfect competition; however, there is hardly perfect competition in practice. Instead, the common situation in the market is the mixture of competition and monopoly, according to Chamberlin (1933). Dixit and Stiglitz (1977) also established the monopolistic competition theory in the international trade on the basis of Chamberlin’s theory, which shows the imperfect competition impacting the international trade. Another assumption of H-O theory, the constant returns to scale, is also not true in practice. Actually, economies of scale and the imperfect competition are the initiatives of intra-industry trade, which is specified in the following part.


1.3 Explanation of Intra-industry trade


There are different types of intra-industry trade, and the major type is about the intra-industry trade of differentiated products, which is also the typical IIT. From the perspectives of the economies of scale, there are two major explanations of intra-industry trade:


External economies of scale


The first explanation can still be built on the basis of perfect competition. actually, this kind of economies of scale was assumed to be compatible with perfect competition (Herberg and Kemp, 1969). Either (1982) developed a model which shows countries with larger scale can benefit from the international trade.


Specifically, the external economies of scale help the intra-industry trade with the knowledge spillover effect, as shown in the model of Romer (1987). In Romer’s model, the knowledge spillover comes from the specialization within particular industry, which ultimately results from the increasing scale of the industry. This facilitate the trade flow between countries in the same industry category.


Although the external economies of scale are usually related to perfect competition, Suga (2010) studied it in the monopolistic competition. To sum up, the external economics of scale can reduce the average costs per unit in one sector of the industry, thus make the firms in that sector benefit from the knowledge spillover and export their competitive products, and the intra-industry trade is formed due to the specialization.


Internal economies of scale


This is based on the Neo-Chamberlin model developed by Dixit and Stiglitz (1977), and also developed by Krugman (1979), shows that the monopolistic competition is compatible with internal economies of scale, and facilitate the IIT.


Specifically, how the model works can be explained with an example: Assuming a monopolistic competitive industry, a company can gain high market power by increasing its scale (because of the internal economies of scale, in which the costs decrease with increasing outputs). Therefore, companies try their best to expand their scale which limits their varieties of products. Similarly, a specific country cannot produce all varieties of products. When the demands of customer tend to pursue products in more varieties, the intra-industry trade is initiated between countries. It is obvious that in the traditional H-O model, the perfect competition without increasing returns to scale cannot lead to intra-industry trade, only inter-industry trade.


Section Two: IIT in the Euro-zone


2.1 ITT index


To measure the extent of IIT, the most adopted index is developed by Grubel and Lloyd (1975). For a certain industry, the GL index is:

T = 1- |X-M|/(X+M)

Here, X means the exports of the industry and M means the imports of the industry. It can be seen the GL index ranges from 0-1. When the exports equal the imports, X=M, T=1, and the trade is total intra-industry. By contrast, when either of the X and M is zero, then T=0, and it is total inter-industry trade. With this index, it is possible to study the IIT of the countries within the Euro-zone. The statistics are mainly gathered from the database Eurostat (2009).


2.2 IIT in the Euro-zone countries


In this part, some examples of Euro-zone countries are specifically analyzed with their statistics within particular industries. As the major country in the Euro-zone, in 2007, Germany has 27.4% of the exports share of the EU and 19.0% of the imports of the EU (Eurostat, 2009). Therefore, to understand the situation of Germany is vital for understanding the whole Euro-zone situation. Trade of Germany by product is shown in Table 1 (All the currency is Euro in this passage).


Table 1: Germanys trade by product (Eurostat, 2009)


Roughly, it can be seen from the table that most of the trade in Germany is in manufactured goods, both in exports and imports (88.8% and 76.8% in 2007), and the trade volume of primary products is relatively lower. Specifically, the IIT index of each industry of Germany in 2007 can be calculated and presented in Table 2.





IIT index



Food and beverages




Crude materials














Machinery and vehicles




Other manufactured goods




Table 2: Germanys IIT indexes in each industry in 2007 (Eurostat, 2009)


Obviously, for most of the industries in Germany, the IIT index is high, which means the imports and the exports in the same industry is close. The only exception is in the industry ‘energy’ which is significantly lower than the others (0.435), and the exports are much lower than the imports.


To examine whether the situation is the same with it in Germany, three other euro-zone countries are chosen with different trade share in the EU, which are France, Spain and Greece. The IIT indexes of these three countries are shown as well as Germany’s indexes in Table 3.



IIT index







Food and beverages





Crude materials

















Machinery and vehicles





Other manufactured goods






Table 3: Germany, France, Spain and Greece: IIT indexes in each industry in 2007 (Eurostat, 2009)


From the statistics, it can be found that most Euro-zone countries have high level intra-industry trade in most industries, especially in the industries of manufactured goods. In the primary products, there are exceptions like the energy industry, which has much lower IIT indexes in those Euro-zone countries. This can be explained because the energy industry has strong dependence upon the natural resources, which is difficult to change radically, and the inter-industry trade is still arguably prevalent in this industry. Among all the examined countries, Greece is a particular exception with much lower IIT indexes in all industries of the manufactured goods. This mainly because that, for Greece, the imports of manufactured products greatly exceed the amount of exports. This might show the lack of manufacturing capacity and scale of Greece compared to other Euro-zone countries.


After examining the trade statistics, it can be concluded that most Euro-zone countries have significantly high levels of IIT (excluding Greece). Mostly, the IIT are in the industries which are technology intensive or capital intensive. This shows the strong reliance among the Euro-zone countries, and might be helpful for the common welfare of those countries.


2.3 IIT and trade creation in Euro-zone


Trade creation is a term firstly developed by Viner (1950), which means the phenomenon occurs inside the customs union, in which the member state’s domestic products with high producing costs are replaced by those with lower costs from other member states, and the trade is ‘created’ in this constant process. From 2.2, it can be seen that mature IIT exists in the trade of Euro-zone countries, which indicates the economies of scale have been formed in this area and most members are enjoying the welfare. In this process, the Euro-zone countries share a common market with little limitations for trade, which expands each country’s target market and creates extra trade. Additionally, the high IIT indexes in most of the Euro-zone countries is the result of their high economic development and industrialization, which means the demands in their markets are various and could create specialization among them, and the effect of trade creation is even more obvious. The exception is Greece with low IIT indexes, which shows relatively lower productivity in manufacturing industries (caused by lack of particular factors of production) and might have difficulty in benefiting from the customs union.


Section Three: Optimal Currency Area, Euro-zone and Euro


3.1 Optimal Currency Area


The theory of optimal currency area is firstly developed by Mundell (1961). A currency area means countries within this area set a fixed exchange rate between them (or using single currency). The advantages of this are obvious because the fixed exchange rate (or the single currency) decrease or eliminate the cost in trading and uncertainties, as well as improve the free flow of factors of production and facilitate the common welfare in the area. Also, the disadvantages should also be seriously considered: The countries in the currency area share the risk of radical change of macro factors, which might result in very unstable employment and price levels in that area. The ‘optimal’ currency area should have the ability to keep stable when facing the shocks like those.


There are several criteria which could help to examine whether the currency area is ‘optimal’, including: high mobility of labour; high openness of economy; high integration level of the monetary market and commodity market; flexible wages and prices; diverse economic structure; and high level of financial integration (Mundell, 1961; McKinnon, 1962; Ingram, 1962; Kenen, 1969). In this section, the discussion about whether Euro-zone is an optimal currency area is majorly based on the analysis in Section Two and the analysis of the labour mobility in the Euro-zone.


3.2 Examination of Euro-zone: optimal or not


To examine whether Euro-zone is a optimal currency area, there are three indicators considered in this passage: economic development difference, economic convergence level, and labour mobility.


Economy development


According to the report to Eurostat (2011), the GDP per capita in the European countries are not equal, some southern European countries like Portugal and Greece, which are less developed in the whole Euro-zone area. According to the different development levels in different European countries (Figure 2), there are worries about that the countries with relatively lower economic strength are more vulnerable when facing asymmetric shocks externally.


Figure 2: GDP per capita in European countries in 2009 (Eurostat, 2011).


Economic Convergence


From the analysis of Section Two, it can be seen the economies of scale has been built in most areas within the Euro-zone and the intra-industry trade phenomenon is significant. However, whether this is beneficial for the countries in the asymmetric shock is to be decided. As Krugman (1993) suggested, because of the tight trading relationship, there would be several specialized areas for production within the Euro-zone, which would not lead to the convergence of economic structure between countries, and the currency area would make the countries more vulnerable to shocks. An opposite argument, developed by Frankel and Rose (1996), claimed that the IIT would make the economic structures and business cycle more convergent and makes the possibility of asymmetric shocks less. By analyzing the data of 20 industrialized countries, Frankel and Rose (1996) proved the rightness of the latter. Therefore, it is fair to say that the IIT prosperity is beneficial for the convergence of the economies of Euro-zone countries and make the currency area more favourable. However, some countries (like Greece) still have substantial difference between other countries in the Euro-zone, which would cause problems and instability.


Labour Mobility


Labour mobility is of great importance because those areas because it helps to reduce imbalances, such as in unemployment rates ( ). In the Euro-zone area, according to Bonin et al. (2008) the labour mobility across the Europe is relatively low (Figure 3).


Figure 3 Share of Citizens Living in Another Country Relative to the Population of the Country of Citizenship in 2006 (Bonin et al., 2008).


Due to the culture, language and other problems, labour flow within Europe is not active (except for a few countries). As suggested by Zimmermann (2009), this would lead to the increasing number of unemployment among the low-skilled labour, and high-skilled workers are limited from flowing across the European countries. In Euro-zone, this is not favourable, since this would increase the uncertainty and make it more likely to be exposed in the shocks.


To sum up, the economic development of Euro-zone countries present an imbalanced situation and less labour mobility might contribute to more problems. Even though the convergence of those countries is in progress, there are still countries which increase the risk of damage caused by asymmetric shocks. Therefore, it is not appropriate to claim Euro-zone as an optimal currency area.


3.3 The future of Euro


As a single currency, Euro faces two most severe problems, which could cause a series vicious cycle now and in the future. The first is the imbalance of economy in the Eurozone. The peripheral countries of Euro-zone have different development levels, more financial and economical problems compared to the leading countries such as Germany, France, etc. Especially, Greece is far from the standard of the normal Euro-zone countries – From the IIT indexes it can be seen that the economy of Greece is not on the same level of other Euro-zone countries yet. Therefore, Greece is the most vulnerable country faced with crisis, which has proved to be true.


Another great problem is the lack of labour mobility. Although in the Euro-zone, the capital and products mobility is already realized, however, due to various reasons, labour mobility is still not high enough, which causes the inflexibility of Euro-zone facing crisis. Without enough labour mobility, the financial coordination tool can only have limited effect, which increase the possibility of constant crisis.


The future of Euro as a single currency is difficult to estimate. To give solution to this without break up Euro, Euro-zone should try to make the standard of the area stricter and make extra financial assistance to the less developed countries. And the labour mobility should be tackled by driving the cooperation between countries in education and employment, as well as using appropriate immigration policies. Anyway, there is a long way to go before Euro-zone can be an optimal currency area.




The three sections mainly focus that using IIT theory to explain Euro-zone’s situation and problems. Both theoretical analysis and empirical evidence are used to contribute to the conclusions of each of the three sections.


In the first section of this research, the intra-industry trade (IIT) phenomenon with both external and internal economies of scale, which shows IIT is the result of the increasing returns to scale and imperfect competition, and also explains that the reason why H-O model cannot explain IIT is because of the wrong assumption. In the second section, by using IIT indexes, Germany, France, Spain and Greece are studied as the examples of Euro-zone countries. It reveals that most of the Euro-zone countries have high level of IIT, focusing technology intensive and capital intensive industries, while Greece has much lower level of that. IIT phenomenon helps the Euro-zone in its trade creation. In the third section, Euro-zone area has been analyzed using particular indicators and is determined as not a optimal currency area. The main problem is the imbalance of the economies of the countries, and low labour mobility. Because of those reasons, Euro has much difficulty ahead as a single currency.



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原文链接:International trade & economics