Vertical and Horizontal Patterns of Intra-Industry Trade between EU and Candidate Countries

The decomposition of intra-industry shares in trade between EU and candidate countries reveals predominantly vertical structures with decisively more quality advantages for the EU and less quality advantages for candidate countries. This paper offers an explanation for the increasing share of vertical intra-industry trade. It utilises a country approach, in which relative wage differences, country size and income distribution play the leading roles. We find first that relative differences in wages (per capita income) and country size explain intra-industry trade when trade is vertical and completely liberalised, and second that cross-country differences in income distribution play an explanatory role. We conclude that EU firms have been able to increase their product quality and to shift low-quality segments to candidate countries. This suggests a product-quality cycle prevalent in trade between both regions.