Vertical intra-industry trade (VIIT), i.e. trade in products that are differentiated by their quality, accounts for a very large share of total trade between similar countries. So far, the theoretical literature has identified one main determinant of this kind of trade, namely the difference in relative actor endowments across countries. This explanation of VIIT, which was primarily developed by Falvey (1981), is based on the assumption that the production of higher-quality goods requires a higher quantity of capital per unit of labour. This approach seems inconsistent with a twofold empirical evidence: VIIT is very high between countries characterized by similar factor endowments and VIIT is observed even at a very disaggregated level of statistical classifications, hat is to say even within goods which have very similar factor intensities. The purpose of this paper is to explain trade in goods of different quality that are produced with he same factor intensity at any relative factor price, i.e. trade in “perfectly intra-industry goods”, according to Davis (1995). Therefore, we extend the definition of “perfectly intra-industry goods” o the case of vertically differentiated products, but differently from Davis (1995), we model explicitly the demand side of the economy, in order to define goods as intra-industry and vertically differentiated from both a production and a consumption point of view. With regard to production, we assume that in all countries the production of one unit of the higher-quality good requires more capital and more labour than one unit of the lower-quality good, and we allow for Hicks-neutral differences in technology across countries. With regard to consumption, we introduce heterogeneous preferences concerning quality across the individuals, but we assume that all consumers will demand only the high-quality good if its price relative to the low-quality is equal or ower than one. In this framework, we show that VIIT arises between countries characterized by similar factor endowments, and that it is driven by (even small) technological differences across countries, whereas inter-industry trade is driven by great differences in factor endowments and / or in echnology across countries.
