Industry-Specific Analysis: Methodology and Data

The theoretical discussion in Chapter 1 is the basis for the industry-specific hypotheses that are going to be tested empirically. As in the country- specific analysis the hypotheses often differ for horizontal and vertical IIT :

♦ The share o f horizontal IIT will be smaller in industries with scale economies; vertical IIT could be either positively or negatively associated with economies of scale.

The expected sign for scale economies on horizontal IIT is negative as low scale economies will lead to easier entry, a greater number o f monopolistically competitive firms and thus more varieties and increased IIT. The predicted effect o f scale economies on vertical IIT depends on market structure and may therefore be positive or negative.

♦ Horizontal product differentiation in an industry will be positively associated with horizontal IIT and negatively associated with vertical IIT.

In the context o f the large numbers models, mentioned in the theoretical overview, we would expect horizontal IIT to be positively related to product differentiation. Conversely, the expectation is for negative relation between product differentiation and vertical IIT.

♦ The level o f IIT will depend on the market structure within an industry: horizontal IT will be positively associated with monopolistic competition and “large numbers” o f firms; vertical IIT could be associated either with oligopolistic competition and “small numbers” o f firms or with “large numbers”.

The above expectations for horizontal IIT derive from the models with large numbers o f firms as well. The larger the number of firms is within an industry, the more room there will be for product differentiation and monopolistic competition. The theoretical predictions are not as robust for vertical IIT, where either large or small numbers of firms could dominate.

♦ The level o f IIT will be dependent on the level o f outward processing trade (OPT) between two countries.

OPT has not been integrated so far in analyses o f IIT. It is regarded by this study as an important factor for IIT between the EU and the associated countries from Central and Eastern Europe and should be put among the institutional determinants. OPT is a special customs regime of trade under which enterprises in the EU may ship components abroad for processing and re-import the processed commodities free o f duty or quantitative restrictions. Very often the processing consists o f rather basic operations and the goods go back to the EU within the same product categories, which results in intra-industry trade in these goods. The implications o f OPT for economic development and integration are very different from those o f “normal” IIT, which is why the study deems it important to establish the influence o f this variable on horizontal and vertical IIT.

♦ The level of horizontal and vertical IIT will vary for industries with different factor intensities and at different levels o f processing, reflecting the factor endowments and the relative economic development of the trading partners

Controlling for factor intensities and level o f processing through industry dummies is also an exercise, which has not been practised in empirical analyses. It is deemed relevant in this study, as it is expected to provide valuable information about the pattern of integration o f the Bulgarian economy with the EU. As mentioned in the theoretical overview, horizontal IIT dominated by two way exchange o f primary or intermediate goods would be an evidence o f more trivial determinants o f IIT, in line with North- South trade patterns, rather than more sophisticated, Chamberlinian type o f IIT. The capital and skill intensities of the horizontally exchanged products are also o f interest in this context.

The industry-specific hypotheses are tested with the following equations:

IITj=ao+ aiSEj+ a2PDj+ asMSj^040PTj+ a5HITECDUMj+CC6CAINDUMj+ aiLAINDUMj

+asFINISHDUMj+ej

The expected signs are aj(+/-), 6D(+/-), m(+/-), m (+)

VIITj=0»+ aiSEj+ a2PDj+ a3MSj+ O40PTj+ asHITECDUMj+ CC6CAINDUMJ+ œlAINDUM

j+asFINISH DUM j+ej

The expected signs are a i (+/-), 6D(-), m(+/-), m(+/-)

HIITj=Oo+ aiS E j+ a2PDj+ a3MSj+ O40PTj+ a5HITECDUMj+ a6CAlNDUMj+ aiLAINDU

Mj+ CCsFINISHDUMj+ej

The expected signs are m (-), <%(+), m (+), m(+)

Following is a description of the industry-specific variables and their proxies:

H IIT l VIITj Horizontal or vertical IIT between EU and Bulgaria in industry j

SEj Proxy variable for scale economies in industry j: the average size o f a Bulgarian establishment (net output per establishment)

PDj Proxy variable for product differentiation in industry j: number o f 6 digit Harmonised System categories within each 2-digit HS industry

M Sj Measure o f market structure in industry j: number o f Bulgarian enterprises in a 2-digit HS industry

OPTj

Measure o f outward processing trade in industry j: Grubel-Lloyd index of outward processing IIT between the EU and Bulgaria multiplied by the value of OPT flows

HITECDUM Dummy variable for high-tech or skill intensive industries

CAINDUM Dummy variable for capital-intensive industries

LAIND U M Dummy variable for labour-intensive industries

FINISH D U M Dummy variable for industries producing finished goods

The dependent variable here is arrived at in a somewhat different way than for the country-specific analysis. First, industry-specific IIT was calculated at the 6-digit level o f disaggregation, and then disentangled into horizontal and vertical IIT with the already familiar price differentials. As at this level each product group is solely either within the horizontal or vertical IIT category, the data is aggregated back to the 2- digit “industry” level o f the Harmonised System. Thus, a satisfactory level o f separation is achieved between horizontal and vertical IIT within each industry. It is worth noting that the way o f division o f the industry-specific data is more sensitive to the price differential than the one for the country-specific data. This makes separate estimations for 15% and 25% differentials, and watching for differences in the results even more necessary than for country data.

Figures on the number o f establishments in a Bulgarian industry and their output were taken from publications of the Bulgarian National Statistical Institute. Data on outward processing trade was obtained from the EU’s Eurostat COMEXT database, as reported according to the Combined Nomenclature, which is equivalent to the Harmonised System.