China does a brisk trade in wristwatches. Last year, it exported $2.6 billion worth of them. And it also imported $2 billion worth.

That kind of back-and-forth, in which similar goods cross national borders in both directions, is a relatively recent phenomenon, but more than a quarter of all trade now fits this pattern. Why do many countries import the same things they export? The answer speaks to taste, growth in emerging markets, and what it means to be a rich country.

It hasn’t always been this way. Historically, countries traded for things they couldn’t produce themselves: cars to the United Kingdom, corn to Costa Rica, metals to South Korea, soybeans to China. Those needs were thought to explain most of the global economy.

But in the 1970s, economists Herbert Grubel and Peter Lloyd observed that a lot of trade didn’t seem to follow basic laws of supply and demand. Grubel recalled in an interview, “You even found ski boots were being imported and exported by Australia,” where it rarely snows.

The economists called this dynamic “intra-industry trade,” and wrote a book by the same name. Since publication, intra-industry trade has grown three-times faster than the old-fashioned way of trading across industries.

Why trade for things you already have?



Economic theory has a hard time explaining why a country would trade for something it can make for itself. To understand, consider cheese.

Belgium, France, Germany, Italy, and the Netherlands are all major exporters of cheese. Each has similar access to natural resources and comparable labor costs. Yet these countries import $2 worth of cheese for every $3 they export.

Rich countries trade cheese because their residents can afford to buy what they want. The preferences of high-income consumers drive imports of products ranging from cell phones to cars. It doesn’t matter that domestic equivalents of similar quality may exist. Large exporters specialize in producing particular varieties and consumers are free to pick whichever they like.

In other words, some Germans simply prefer French cheese.

But intra-industry trade isn’t only a matter of taste. Some of this activity is the result of global supply chains bringing together related materials and exporting a finished product. In other cases, trade is driven by quality and price. The watches that China exports are mostly cheap, made with quartz crystal oscillators. The imports tend to be expensive, Swiss-made varieties preferred by wealthy Chinese and tourists.

Global estimates of intra-industry trade depend heavily on how industries are defined. One comprehensive set of estimates was generated by economists Cameron Thies and Timothy Peterson for their recent book. They found that in 2010 intra-industry trade accounted for an average 2.7% of trade between any two countries. But it varies widely by what kind of country we’re talking about.

Rich countries are far more likely to engage in intra-industry trade. For instance, more than 50% of trade between large European countries is intra-industry. In Asia, only three trading partnerships exceed 30%. In Africa, only two are over 10%. Worldwide, Thies and Peterson found, 27% of all value traded is within industries.

As countries get richer, they tend to produce goods that are more similar in quality to those of other rich countries. In order to compete, they specialize. Rich countries also tend to be the ones that have the money to buy those new specialized products. For example, over the last thirty years, American, German and Japanese car manufacturers have all converged on models that are very similar in quality and cost. In order to distinguish themselves, auto manufacturers specialize in creating the most luxurious or most environmentally friendly cars.

The developing countries

As emerging economies continue to develop, they will produce and consume more specialized goods, like rich countries. How will the economy change if Brazil or India begins to export its own versions of popular products?

One place to look for answers is eastern Europe. When 10 former eastern bloc countries joined the European Union in 2004 and 2007, they gained expanded access to the markets of western Europe. A study by the Institute of Developing Economies found that intra-industry trade with their European partners increased immediately (pdf). Initially, their exports were concentrated in products that were of lower quality and price than equivalents elsewhere in the EU. However, the same study found that the quality of those exports was improving and becoming more similar.

This effect is also visible in China, where new, high-end watch manufacturers are trying to compete with imported Swiss brands. Other Chinese entrepreneurs are planting vineyards and establishing luxury clothing lines. Whether or not these products are exported outside China, they will enter a highly specialized market for luxury goods.

After 50 years of rapid growth, it is easy to imagine intra-industry commerce eventually accounting for the vast majority of global trade. However, the world is a very long way from a free-trade utopia where all countries do is swap expensive cheeses. Economist Charles Sawyer said in an interview that per-capita GDP must reach between $7,000 and $10,000 before global buying habits start to develop. That means today at least half of countries and 70% of the world’s population are shut out of the preference-driven economy.