DP1721 | Determinants of Intra-Industry Trade between East and West Europe

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The share of intra-industry trade (IIT) in total trade between Central and East European nations and the EU is among the highest of all the EU?s bilateral trade flows. IIT is broken down into horizontal and vertical components and the determinants of each is investigated. Vertical IIT (exchange of similar goods of different quality) is found to account for 80-90% of total IIT and is positively associated with product differentiation, labour intensity of production, economies of scale, and foreign direct investment (FDI). Controlling for country effects, a statistically significant positive association is found between horizontal IIT (the exchange of close substitutes of similar quality) and FDI, product differentiation, and industry concentration; a significant negative relationship is found for scale and labour intensity. These results do not hold if country effects are not controlled for, suggesting that country-specific factors are key determinants of horizontal IIT. The estimation results are more robust than those in previous studies, reflecting the specific characteristics of the endowments of, and ongoing restructuring process in, transition economies.