What is 'Linder Hypothesis'

Linder Hypothesis is an economic hypothesis that posits countries with similar per capita income will consume similar quality products, and that this should lead to them trading with each other. The Linder hypothesis suggests countries will specialize in the production of certain high quality goods, and will trade these goods with countries that demand these goods. The theory was proposed by Staffan Linder in 1961.

BREAKING DOWN 'Linder Hypothesis'

Linder proposed his hypothesis in attempt to address problems with the Heckscher-Olin theory, which suggests that countries export goods that use their factors of production the most intensely. Because the production of capital-intensive goods is associated with higher income levels compared to labor-intensive goods, this means that countries with dissimilar incomes should trade with each other. The Linder hypothesis suggests the opposite.         

The Linder hypothesis works off the assumption that countries with similar income levels produce and consume similar quality goods and services. Research has shown that both export prices and demand are strongly correlated with income, specifically for the same quality of goods, though income is used as an approximation for demand. In this vein, countries with high incomes likely consume more high quality products.

The hypothesis focuses on high quality goods because the production of those goods are more likely to be capital-intensive. For example, while many countries produce automobiles, not all countries have healthy export markets for these products. Japan, Europe, and the United States actively trade automobiles.

The Linder hypothesis presents a demand-based theory of trade. This is in contrast to the usual supply-based theories of trade involving factor endowments. Linder hypothesized that nations with similar demands would develop similar industries. These nations would then trade with each other in similar, but differentiated goods.

Proving the Linder Hypothesis

Despite anecdotal evidence suggesting that the Linder hypothesis might be accurate, testing the hypothesis empirically has not resulted in definitive results. The reason why testing the hypothesis has proven difficult is because countries with similar levels of per capita income are generally located close to each other geographically, and distance is also a very important factor in explaining the intensity of trade between two countries.

Studies that do not support Linder have only counted countries that actually trade; they do not input zero values for the dyads where trade could happen, but does not. This has been cited as a possible explanation for their different findings. Also, Linder never presented a formal model for his theory, which resulted in different studies testing the Linder Hypothesis in different ways, under varying conditions.

Generally, a Linder effect has been found to be more significant for trade in manufactured products versus non-manufactured products, and among manufactured products, the effect is more significant for trade in capital goods than in consumer goods and more significant for differentiated products than for similar, more standard products.

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