The theoretical explanations of intra-industry trade have focused on the presence of product differentiation

and economies of scale. Intra-industry trade is said to occur in industries where there are a variety of
products differentiated by various characteristics. Product differentiation is cited as a major factor leading
to intra-industry trade.
Intra-industry trade among countries is intense if the average of their levels of development is high. First,
highly developed countries command a high capability to innovate and, hence, an important precondition to
develop and produce highly differentiated goods. Second, these countries are characterized by a highly
differentiated demand which allows for the exploitation of economies of scale in the production of a wide
variety of individual commodities. And third, highly developed countries enjoy highly developed
information and communication linkages. All these factors enlarge the scope for the realization and
expansion of trade in highly differentiated products.
Intra-industry trade among countries is intense if the difference in their levels of development is relatively
small. On the one hand, a similar level of development means similar consumer preference structures and
similar factor price relations; production of only slightly differentiated goods and intense intra-industry
trade are thus likely.
Intra-industry trade among countries is intense if the average of their market sizes is large. In large
markets, many (differentiated) goods can be produced under conditions of economies of scale. At the same
time there is a voluminous demand for foreign (differentiated) goods so that the potential for intra-industry
trade is high.
Intra-industry trade among countries is intense if the difference in their market sizes is small. Obviously, if
the markets of both countries are large, there is more scope for intra-industry trade than in cases where
the markets are of very different sizes.
Intra-industry trade among countries is intense if barriers to trade are low. In this context, barriers to trade
have to be understood in their broadest sense; i.e., not only tariff barriers but also non-tariff barriers,
including information, communication and transportation costs, have to be taken into account. Cheap
information and communication linkages are a precondition for a substantial exchange of highly
differentiated goods. Geographical proximity, which often goes hand in hand with similar preference
patterns and habits, further facilitates intra-industry trade.
Intra-industry trade in an industry is intense if the potential /or product differentiation is high and market
entry in narrow product lines is impeded by significant barriers. Here, an industry is meant to constitute
a conglomerate of firms supplying goods which are close substitutes in production, but not necessarily in
consumption. In the presence of economies of scale in narrow product lines, a country's specialization in
particular varieties may result from its "representative demand"; in ease of close substitutes in consumption,
additional market entry barriers such as patents or trade marks may hinder domestic firms from precisely
imitating imports [Willmore, 1979]. Since not all consumers have a preference for their respective
domestically produced varieties, across industries the scope for intra-industry trade can be expected to vary
in accordance with the notion mentioned above.
Intra-industry trade in an industry is intense if transaction costs are low. Transaction costs can be posited to
significantly determine the extent to which a given degree of product differentiation will be exploited
and, hence, materializes in extra trade flows.

Two other industry characteristics were included as possible determinants of intra-industrytrade: the
research and development intensity of an industry and the average wage of production workers in an
industry. Research and development intensity may indicate a high turnover of products within an industry
and a shorter product life cycle, in which case there may be greater product diversity in an industry as well
as the manufacture of more mature product lines abroad, particularly in NICs. Both of these can increase the
level of intra-industry trade. The wage characteristic of an industry may also affect intra-industry trade. On
the one hand, industries with high average wages for production workers may tend to be concentrated in an
industrial country where skilled labor is more likely to be found. On the other hand, low average wages may
mean that the manufactureof standardized products is involved. In that case, the production of goods can be
done in the industrial country, in the NIC, or in both, increasing the likelihood of intra-industry trade.