Export Quality, Exports, and Domestic Trade: A Theoretical and an Empirical Analysis

We explore the impact of export quality on the levels of exports and domestic trade. First, we developed a theoretical framework, using the two-country oligopolistic model with quality differentials in product. We find that a consumer-preference driven increase in export quality improves export performance of a country but it reduces domestic trade, in the absence of any constraint on production capacity. We then test the theoretical findings empirically, using annual bilateral inter-country and intracountry trade data for 142 countries from 1963 – 2014 and by applying the gravity model of trade. We use the IMF’s Export Quality Index to estimate a two-stage gravity model and to examine the effects of exports quality on both exports and domestic trade. Our empirical findings are consistent with our theoretical predictions. The empirical findings suggest that a one percent increase in quality leads to an increase in total exports by 1.08% and a fall in intra-national trade by 2.69%. We also find that the effect of export quality is more pronounced for OECD member countries than the non-OECD member countries.