Title: Factor Adjustment and Intra-industry Trade: An Application of the Adjustment Costs Model
Reference Number: 1025
Publication Date: February 2001

Tina Yiping Chen
Hong Kong Institute of Economics and Business Strategy

The hypothesis of the adjustment costs associated with factor adjustments under intra-industry trade are lower than those under inter-industry trade is initially supported by a specific-factor model analysis theoretically. Yet there is no comprehensive empirical evidence to support that. This paper therefore, tested the hypothesis that factor adjustment under intra-industry trade specialisation predominantly occurs within industries rather than between industries using a dynamic factor demand system.

The test was carried out in three steps. First, the optimal solutions of factor demand and output supply were derived for the dynamic adjustment costs model when the function of production is assigned in a quadratic form. Secondly, using data obtained from the OECD's international sectoral database in the quasi-fixed input demand equations, adjustment coefficients were estimated at the subdivision level of ISIC manufacturing industries. This derivation was employed to Canada, Germany and the United States due to the availability of data. Thirdly, specifying two effects--a trade specialisation effect and a structural change effect--in the empirical model to explain the determinants of labour and capital adjustment coefficients. The results reveal strongly that if an industry has a high degree of intra-industry trade specialisation, the factor adjustments are more intra-industry oriented.

Last modified: 07/25/2002