The theory was a dramatic departure from the H-O in that it is exclusively demand oriented.

The H-O approach was primarily supply oriented. Linder theory focuses on the manufactured goods

The tastes of consumers are determined by their income levels. The pattern of tastes will determine the demand for the manufactured products. The demand will generate a production response of that country. So the production pattern of country would reflect the income levels.

Which goods will be traded? Trade will occur in goods that have overlapping demand.

International trade in manufactured good will be more intense between countries with similar income levels than between countries with dissimilar income levels.

The Linder theory did not specify the direction of the trade. This could alternatively be explained by product differentiation or intra-industry trade.

Tests of the Linder hypothesis regress a measure of trade intensity on the following variables

a measure of the difference in per capita incomes (Linder) b. and a dummy variable whether the country is a EU country or not (D) Trade= 1 + 2 LINDER + 3DEU +
a.

Interpretation

LINDER= the variable representing the Linder effect. It is the absolute value of per capita income differences in Germany and the trading partners. The finding of a negative and statistically significant effect of differences in per capita income would provide evidence in favour of the Linder hypothesis dummy variable capturing whether trading country was a member of the EU or not. The finding of a large positive and statistically significant effect would reaffirm that the elimination of trade barriers increases trade, whereas the magnitude will indicate by how much it increases.

Data source for imports and exports is the IMF direction of trade statistics (DOT) Our sample size is 46 European countries over a 6 year time period from 2002-2007 (N= 276)

Results provide strong evidence in favour of the Linder hypothesis that hold at the 1% level It indicates that a $100 increase in the difference in per capita income between Germany and its trading partner on average reduces Germanys imports from that trading partner by $38 million

Analysis Contd

Per capita income differences play a much greater role for Germanys exports than for its imports. It reduces Germanys export by 42m$ Second, the analysis of the EU-membership variable suggests that Germany primarily caters its exports towards European countries with similar demand structures Results suggest that EU-membership greatly increases Germanys imports and exports. It increases Germany Imports by 500mn $ and Exports by 808mn $ The adjusted R-square is 0.612 and 0.831 for imports and exports, respectively. This implies that my econometric model explains as much as 61(83) percent of the variation in Germanys imports (exports)

The import constant shows that if the per capita income of Germany and the partner country is the same and the partner country is a non EU country i.e trade barriers exists , then the imports are 25238mnUS$.Similarly in this case exports are 24636mn US$. R-square is not very high in our model. This may be due to the fact that there are other variables like GDP which effect the levels of imports and exports which are not explicitly included in our model.

Thanks