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Weekly UpdatesAbstract The aim of this paper is to examine the relation between the integration process and the intensity of intra-industry trade between two countries of different levels of development. Our theoretical model and results indicate that trade liberalization and the establishment of the Free Trade Areas between the Balkan countries and the EC have led to the growth of the intra-industry trade between Greece--EC member state--and those countries. The main instruments of this process have been the Europe Agreements and the Stabilization and Association Agreements between the Balkan countries and the EC. The paper presents a model in vertically differentiated products in a Free Trade Area context and proceeds to depict the intensity of intra-industry trade between Greece and the Balkan countries.
Keywords Intra-industry trade * Customs Union * Transition economics * Balkan countries
JEL F14 * F15
Introduction
Intra-industry trade, i.e., the simultaneous exports and imports of the same good, is associated with differentiated products and with intermediate goods, (Grubel 1967; Grubel and Lloyd 1971, 1975; Balassa 1963, 1965, 1986; Gray 1973, 1980; Greenaway et al. 1994; Tharakan 1981; Ethier 1979, 1982). Regarding product differentiation, vertically differentiated products (i.e., products close substitutes to consumption) represent the main volume of intra-industry trade. While horizontally differentiated products (i.e., close substitutes to both production and consumption) concern mainly trade among industrial countries, vertical differentiation is the dominant pattern of intra-industry trade in the case of countries of different levels of development, (Gray and Martin 1980; Willmore 1978; Lancaster 1979, Ch. 6 and 8, 1980; Caves 1981; Caves and Williamson 1985; Brander 1981; Shaked and Sutton 1987).
The purpose of this paper is to specify the extent of intra-industry trade between Greece, a member-state of the European Community (EC) and the Balkan countries in the light of the Europe Agreements and the Stabilization and Association Agreements. These agreements launched a trade liberalization process, between the Balkan countries and the EC member-states, through Free Trade Areas, Free Trade Areas and Customs Unions represent a second best solution (relatively to a global trade liberalization), which have a positive impact to intra-industry trade (Loertscher and Wolter 1980; Havrylyshyn and Civan 1983). Europe Agreements were the first step of integrating Bulgaria and Romania to the EC, ending to their accession to the EC in 2007. Stabilization and Association Agreements also represent the first step of integration of Western Balkan countries to the EC. Their future entry is estimated to take place in the horizon of 2015. This process brings up interesting questions about its impact to their trade pattern.
The first chapter depicts the process of integration of the Balkan countries to the EC. The second one presents a model on intra-industry trade based on vertical differentiation. The third chapter refers to the measurement of intra-industry trade. The fourth measures the extend of intra-industry trade between Greece, member-state of the EC and the countries under examination; the fifth aims to estimate the relation between the expansion of the Greek Multinational Corporations (MNC's) to Balkan countries and the intra-industry trade.
The Process of Integration
The political and economic transformation in Central and Eastern Europe, during the, last 17 years accelerated the process of their transition from centrally planned to market economies. This transition process effectively meant a movement from a system of state managed trade, to a gradual trade liberalization and opening of the previously centrally planned economics. Furthermore the breaking up of the multinational states led to a new political and economic geography in this region. This process was followed by the Europe Agreements (e.g., Association Agreements) between the EC and the aforementioned countries. These agreements of the 1990s were the first step of integration of Eastern and Central European countries to the EC. The recent accession of a large number of Eastern and Central European countries is the second step of their integration to the Customs Union of the EC.
Among the Balkan countries, Slovenia, although not strictly speaking a Balkan country, was the only one to join the EC in 2003. Bulgaria and Romania, which signed the Europe Agreements, became full EC members in 2007, while the remaining Western Balkan countries follow. The Western Balkan countries have signed or are in process of signing with the EC, the Stabilization and Association Agreements, which are similar to Europe Agreements. The main goal of the above mentioned agreements is the trade liberalization process, between the above mentioned countries and the EC, through Free Trade Areas.
During the early transition period it is difficult to identify the patterns and dynamics of trade since completely opposite forces operated with some Eastern and Central European and Balkan countries moving on the basis of inertia and most simply abandoning the patterns of the past by cutting off their imports from their eastern former partners. However they did prove to be very successful in placing their products in the markets of their new western ones. The trade deficits that emerged for most Eastern, Central European and the Balkan countries simply manifest the chaotic and desperate initial developments.
Greece was one of the EC member-states mostly affected by this re-orientation of trade of the Balkan countries because of its geographic proximity, economic structure, and political expediencies. In fact, Greece turned out to be a basic trading partner especially for Bulgaria, Romania, FYROM and Albania.
A Model on Vertical Differentiation
Empirical findings in the 1960s suggested that most of the world trade is taking place among developed--capital endowed in H-O terminology--countries, (Kojima 1964; Balassa 1986). Furthermore a look to the structure of trade between the developed countries revealed that related or even similar products were traded. A number of explanations were put forward. Although many authors point out that factor abundance approaches can explain intra-industry trade, (Falvey 1981; Falvey and Kierzkowski 1984; Hansson and Lundberg 1989), some stressed that the perfect competition-product homogeneity assumption is unrealistic since a great deal of imperfect competition (e.g. monopolistic competition and oligopoly) market structures, economies of scale and product differentiation could provide more plausible explanations to this pattern of trade, (Helpman 1981; Krugman 1979; Lancaster 1980; Markusen and Melvin 1981; Saggi 2006). Finally, the role of demand and consumers preference for variety was also put forward. All these approaches however came under the general heading of the theory of intra-industry trade, focused mainly on vertical differentiation.
The analysis which follows, concentrates on trade in vertically differentiated products in a Free Trade Area context. A main characteristic of such products is that household income determines the quality of goods demanded. For manufacturing products Linder (1961) argued that the principal determinant of the distribution of demand between high and low quality varieties would be the level of per capita income. Households with high incomes would not only consume more cars, for example, but also high quality cars. We draw on their specification of technology and preferences in order to build a simple model which examines the effects of a Free Trade Area between an existing member-state of the EC and a Balkan country. A similar model has been developed by Mardas and Moutos (2002).
We identify Greece (G) as the member-state of the EC and a Balkan country, as a trade partner (T). For simplification reasons we put Albania in the place of the Balkan country. It is assumed that Greece is a more technologically advanced economy compared to Albania. In terms of comparative advantage this assumption is translated into a definite pattern of intra-industry trade in vertical differentiated products: Greece exports high or middle quality varieties of differentiated products because it has comparative advantage in those products, whereas Albania has a comparative advantage in low quality varieties. In tandem with this assumption regarding the technological capabilities of the two countries it is assumed that Greece is a country with a higher per capita income, compared to Albania. Based on these assumptions the theoretical analysis (which follows) indicates the consequences of the establishment of a Free Trade Area in terms of intra-industry trade flows.
The model assumes the existence of two goods and two countries. The first good is a non-traded homogeneous good, whereas the second good is a vertically differentiated product, which is traded between the two countries under consideration.
Supply and Demand Conditions
The homogeneous good, H, is produced under perfectly competitive conditions in all countries, with the use of labor, L, only. The production function is assumed to have the form:
[H.sub.i] = [B.sub.i][L.sub.i] [B.sub.i]> 0, i = G, T (1)
which implies that the price of the homogeneous good in each country will be equal to:
[P.sub.H,i] = [W.sub.i]/[B.sub.i] i = G,T (2)
where [P.sub.H,i] is the price of the homogeneous good in country i, [W.sub.i] is the wage rate and [B.sub.i] is a productivity parameter.
The vertically differentiated product, Y, is also produced under perfectly competitive conditions. It is assumed that this traded good, which is differentiated according to quality, quality is measured by an index Q in the range [1, [infinity]] and that there is perfect information regarding the quality index. Costs in the two countries depend on quality. It is assumed that each unit of a given quality is produced at a constant cost, which differs across countries. The production function for Greece is given as
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