The policy orientations of East Asian governments, discussed in the previous chapter, are based on assumptions that recognize important linkages between trade and FDI. By encouraging foreign firms' investment in key industries such as autos and electronics, comparative advantages in industrial production have been created. With these industries, opportunities for product differentiation have also grown, contributing, in turn, to the growth of intra-industry trade and the horizontal division of labour. In this chapter, patterns of inter-industry and intra-industry trade are first examined and the reasons for intra-industry trade (IIT) are then studied. Determinants of IIT include converging income differentials, economic structures and geographic proximity. FDI should also be a significant explanatory variable because of its role in the evolution of domestic industrial structures beyond reliance on natural resource and labour endowments.

Beginning with inter-industry trade, also referred to as the “vertical division of labour”, trade patterns are established by differences in endowments of land, labour, capital and technology, and by countries specializing in things they do well. A simple gravity analysis in Table 3 of the intensity of bilateral trade ties in 1988 suggests that Japanese and U.S. trade with the East Asian economies is still characterized by inter-industry trade. Gravity coefficients compare the bilateral export shares of each pair of economies with the export shares they have with all the others in order to measure the relative strength of each bilateral trade tie. The close ties between Singapore and Malaysia are evident in coefficients of greater than 5; ties between Singapore and Hong Kong and their immediate neighbours come next with values greater than 2. Japan's strongest ties are with Indonesia (because of raw materials) and the United States; while U.S. ties are strongest with Taiwan and Korea (because of exports by the latter of capital and labour-intensive consumer goods, respectively). Beyond that, coefficients around 1 indicate bilateral trade ties no stronger than the average, while coefficients less than 1 indicate low levels of integration.