Re-estimating International Elasticity of Substitution – A Preliminary Study of Impact of Quality on Trade

Thannaletchimy Thanagopal, Paul Zagamé, Arnaud Fougeyrollas and Pierre Le Mouel

Increasingly many developed countries are losing their export market shares to lower priced emerging countries. Emerging countries unlike higher wage developed countries are able to produce a similar product to be traded at a lower cost. To regain its competitive streak, developed countries would need to compete in terms of higher quality products rather than lower priced products. This paper, thus, attempts to quantify the effect of higher quality goods trade within Europe. Using a panel data comprising of 11 European countries for a total of 15 manufacture goods sectors ranging over 14 years (from 1990 to 2003), the paper attempts to re-estimate import elasticities of substitution and quality elasticities to determine the relative strength of Europe in terms of offering lower prices or higher quality products. This paper concludes that improving product quality is important for trade and such product improvement is much more beneficial to European countries in sectors that produce differentiated goods rather than homogeneous ones.