How Geography Affects Quality

Abstract

This is the first paper to provide a theoretical model that connects the quality of product-level bilateral trade flows with the geographic position of the exporter. We show that, in addition to commonly used importer characteristics, quality increases (i) in trade-weighted specific transportation cost to the destinations other than the importer and (ii) in trade-weighted preference for quality of destinations other than the importer. The two channels represent extensions of the familiar Alchian-Allen and Linder quality theories to multilateral setting. The model implies that market access to high-income and remote importers can improve quality of exports from low-income countries.The data confirm the theoretical prediction. Exporters of differentiated goods that face a stronger demand for quality from richer countries charge 5-9% more for all destinations. At the same time, countries whose demand is especially distorted by the Alchian-Allen effect charge 14-24% more. Moreover, geography is more significant to the quality choice of developing countries. Multilateral geographic factors explain 7.6% of the price variation for the non-OECD exporters, and only 4.2% for the OECD exporters. The Alchian-Allen effect influences an exporter's quality roughly two to three times as much as the proximity to rich importers does.