Vertical and horizontal patterns of intra-industry trade between EU and candidate countries

Abstract:

Trade between the European Union (EU) and the transition economies is increasingly characterised by intra-industry trade. The decomposition of intra-industry trade into horizontal and vertical shares reveals predominantly vertical structures with decisively more quality advantages for the EU and less quality advantages for transition economies whenever trade has been liberalised. Empirical research on factors determining this structure in an EU-transition economies framework lags behind theoretical and empirical research on horizontal and vertical trade in other regions of the world. The main objective of this paper is to contribute to the ongoing debate on trade structures existing between the EU and transition economies by offering an explanation of vertical trade. We use a cross-country approach in which relative wage differences, country size and income distribution play a leading role. We find first that relative differences in wages (per capita income) and country size explain intra-industry trade when trade is vertical and completely liberalised, and second that cross-country differences in income distribution play no explanatory role. We conclude that EU firms have been able to increase their product quality and to shift low-quality segments to transition economies. This may suggest a product-quality cycle prevalent in EU- transition economies trade.