World Trade Patterns and Prices: The Role of Productivity and Quality Heterogeneity

This paper analyzes the role of product quality and labor efficiency in shaping the trade patterns and trade intensities within and across two groups of countries, the developed and richer North and the developing South. Recent empirical literature identifies a positive relation between income per capita and both export and import prices, and also the import prices conditional on exporter. Instead of relying on specific demand side mechanisms such as non-homothetic preferences, we focus on the North-South differences in technology in a four country North-South trade model with two dimensions of firm het- erogeneity. Differences in firms’ product qualities and cost efficiencies result in a price distribution generating different consumption bundles and the observed export and import prices across rich and poor countries. Furthermore, the resulting total expenditure allocation across quality shows that the North (South) spends a larger share of its income on high (low) quality even with the same homothetic preferences across regions.