Working Paper: CEPR ID: DP12602
Authors: Lisandra Flach; Florian Unger
Abstract: This paper introduces endogenous quality innovations in a multi-country heterogeneous firm model and derives implications for the gravity equation. Using aggregate trade data and firm-level data, we confirm the theoretical predictions: fixed costs have a lower impact on exports and on the share of exporters in industries with a high degree of vertical product differentiation. Quality innovations change the trade elasticity with respect to fixed costs through the extensive margin, whereas the elasticity with respect to variable costs remains unaffected. We estimate the parameters of our model and simulate a reduction in fixed trade costs. Accounting for quality lowers gains from trade and leads to more heterogeneous effects across industries compared to a model without vertical differentiation.
Keywords: international trade; heterogeneous firms; gravity; product quality
JEL Codes: F12; F14; L11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| fixed costs (D24) | export flows (F10) |
| fixed costs (D24) | share of exporters (F10) |
| quality innovations (O35) | trade elasticity (H30) |
| fixed costs + quality differentiation (L15) | trade elasticity (H30) |
| decrease in fixed trade costs (F12) | low productivity firms entering export markets (F12) |
| new entrants in high vertical product differentiation industries (L19) | stiff competition from established high-quality firms (L15) |
| high vertical product differentiation industries (L19) | lower gains from trade (F11) |