Adjustment to the European single market: inferences from intra-industry trade patterns

1. Introduction During the negotiation and implementation stages of the " 1992 " single market programme, prominent economists anticipated that the pressures for industrial restructuring among EU[1] countries would be considerably stronger than during previous episodes of European integration. Krugman (1987, p. 364) put it as follows: " The question now is whether the further expansion of trade in progress will be equally easy to cope with. The unfortunate answer is, probably not ". Greenaway and Hine (1991, p. 620) suggested that " specialisation in Europe may have entered a new phase, and that this could pose greater problems for adjustment ". These expectations were based on two main developments, both of which were connected to the phenomenon of intra-industry trade (IIT), the two-way exchange of goods with similar production requirements. First, the discovery of high and growing IIT levels in the 1970s had produced a wave of new thinking by trade theorists, which shifted the emphasis of the models away from country-specific trade determinants, generically termed " comparative advantage " , towards industry-specific factors such as increasing returns and external economies. Models of the " new trade theory " , although explaining the existence of IIT, generally predicted that a fall in trade barriers would promote concentration and re-location of industries near their largest markets[2]. Second, a popular, albeit loosely defined, hypothesis has emerged in the literature, according to which high levels of IIT were indicative of relatively low trade-induced adjustment costs[3]. Some studies in the late 1980s found evidence of stagnating IIT growth, and therefore concluded that adjustment pressures were becoming more severe. The rapid growth of trade flows among EU countries (Table I) was therefore expected to result in growing factor-market friction