Room to move: why some industries drive the trade-specialization nexus and others do not

In this paper, we investigate which industries drive the trade-specialization nexus in the European Union over the 1997-2006 period. We follow Melitz (2003), and argue that industries need 'room to move' in order for increasing trade openness to translate into increased specialization. Our paper finds that the true drivers of the trade-specialization nexus are productive firms, who benefit from the increase in trade-openness and can appropriate resources from less productive firms. This causes the industry in which they operate to expand, at the expense of other industries, in which there is no room to make such moves. We argue and find that the potential for reallocation in industries determines whether there is a trade-specialization nexus; in industries with little potential for reallocation, increased trade openness has no or a negative effect on that industry's share of total value added. As a result, the trade-specialization nexus is driven by a small number of industries, who nevertheless have a significant impact on concentration patterns.