Trade in quality and income distribution: an analysis of the enlarged EU market.

This paper contributes to the understanding of the determinants of country-level comparative advantages in terms of quality. More precisely, while the literature has mainly focused so far on supply-side determinants of such comparative advantages, we investigate both theoretically and empirically the role played by income distribution (average income and level of inequalities) of a country on the quality of its exports. Doing so, we provide new insights on the existence of demand-based determinants of the quality content of a country’s exports, in line with the Linder (1961) hypothesis, claiming that firms produce and export goods suited to the specific tastes of their local consumers. We build a model with economies of scale where non-homothetic preferences and within-country income differences determine the quality composition of production and exports. Having neutralized any supply-side comparative advantage, we show that richer countries produce and export higher quality goods, while the level of inequalities has an heterogenous impact, positively affecting the quality content of exports for rich enough countries only. We then corroborate our theoretical predictions on bilateral trade data for the enlarged European Union (EU), an integrated market displaying significant heterogeneity in terms of both average income and within-country inequalities of its members. Furthermore, we are able to show that in terms of magnitude of the effects, inequalities are a second-order demand-based determinant of the quality of exports as compared to average income.