Quality Selection, Chinese Exports and Theories of Heterogeneous Firm Trade

Recent empirical and theoretical studies have identified product quality as an important determinant of bilateral trade flows. Yet relatively little is understood about the relationship between the characteristics of the export market and the quality of products. In this paper we examine this link using Chinese data. We find evidence that product unit values vary with standard gravity variables in a different manner across sectors of the Chinese economy, and also run contrast to earlier findings in the U.S. More interestingly, these results are not fully compatible with existing heterogeneous firm trade models e.g. the original Melitz (2003) model and its extensions with heterogeneous product quality at firm level by Baldwin and Harrigan(2007). To explain these differences we propose a heterogeneous firm trade model with quality differences and spatial price discrimination based on Melitz and Ottaviano (2007) that generate predictions consistent with our findings as well as other existing studies.