VERTICAL PRODUCT DIFFERENTIATION, MINIMUM QUALITYSTANDARDS AND INTERNATIONAL TRADE

This paper extends a well-established vertical product differentiation model toan international duopoly with two segmented countries, where firms compete inquality and price. The framework is used to analyse governments’ incentives forunilateral minimum standard-setting as well as the scope and effects of cooperativeagreements in minimum standards. Endogenous national standards resultfrom a standard-setting game between governments whose objective function isto maximise national welfare. Cross-country externalities can be are either positiveor negative, depending on the quality of traded goods. Four unregulated Nashequilibria in minimum standards are shown to exist, two symmetric and two asymmetric,which correspond to the four different combinations of externalities thatmay arise between the two countries: symmetric positive externalities, symmetricnegative externalities, or asymmetric positive and negative externalities. Unilateralminimum standards can be inefficiently high or low relative to world optimumsymmetric standards and operate as non-tariff barriers to trade. Harmonisationof minimum quality standards through cooperation is both feasible and mutuallybeneficial in the symmetric case, but the scope for mutually beneficial cooperationis significantly restricted when countries are asymmetric and lump-sum transfersare not possible. The resulting cooperative standards are asymmetric and do notmaximise world welfare....