Estimating Import Price Elasticities, Adjusting for Quality

1. Estimating Import Price Elasticities, Adjusting for Quality Fougeyrollas, N. Lancesseur, T. Thanagopal ERASME (Ecole Centrale Paris) WIOD Meeting - May 25th-26th-27th 2011 - IPTS, Sevilla

2. feedbacks • Exchange rates can be different between sectors and if we use output, or Intermediate consumption or Value added as a benchmark. • Output minus intermediate consumption don’t always give the right Value added.

3. Outline • The following estimations are a very preliminary work • Two questions : • Does the three demand types exhibits the same price elasticities ? • If we take “quality effects” into account, are the elasticities modified ?

4. I. First model I.I. Specification (1) • M imports, P relative prices and DT total demand addressed to the sector • i country of origin, • s industry • d demand type (Consumption ….)

5. I. First modelI.II. Methodology (1) • For testing we pooled imports coming from 7 countries (DEU, BEL, ITA, JAP, USA, NLD and ESP) • Fixed effect approach : least squares dummy variable (LSDV) regression model. We define a set of dummy variables where is equal to 1 in the case of an observation relating to individual i and 0 otherwise. The model can be rewritten as follows:

6. I. First modelI.III. Methodology (2) • We noticed autocorrelation that for some sectors errors (using the Breush-Godfrey test) • corrected using Cochrane-Orcutt procedure

7. I. First modelI.III. Results (1)

8. I. First modelI.IV. Results (2) • The price elasticities of import differ depending on the type of demand • The elasticities are higher in the case of final consumption (compared to IC and GFCF)

9. II. Second modelII.I. Introduction • Import price elasticity tends to be underestimated since the prices do not take into account the quality effects • Quality innovation is becoming more and more important particularly in developed countries, as such, ignoring the influence of product quality might bias import price elasticity and therefore debates on trade competitiveness.

10. II. Second modelII.II. Specification • We used a gravity model (Bergstrand [2002]) and we introduced a quality proxy. This model concerns exclusively imports demanded by consumers. • reflects the value of manufactures imports from country i (exporter) to j (importer) for goods produced by the sector s

11. II. Second modelII.II. Specification (2) • reflects export potential of country j in sector s • refers to the price index of importer in sector s • is a proxy for the quality of foreign goods • records the distance between the two trading partners • refers to the importer-industry fixed effects • refers to the elasticity of substitution between domestic and foreign goods

12. II. Second modelII.III. Variables (1) • Export potential: • Theory says (Melitz [2003]) that the probability of a firm to export is increasing with its size. • Hence, we wanted to use a data which could capture this information but it does not exists, so we use the number of employees in the sector as a proxy. • Price index • Prices are derived from unit values i.e they are obtained by dividing the value of trade by its volume

13. II. Second modelII.III. Variables (2) • Quality proxy variable: • The knowledge variable of the NEMESIS model is used: it is calculated as the R&D expenditures (EUKLEMS data) of a sector and R&D expenditures from other sectors (spillovers) are added via technology flow matrices. • The quality of products should improve with the R&D expenditures of the corresponding sector. Thus, it should also increase the competitiveness on the international markets of this sector. • Distance • Distance isobtained by calculating the distance between the largest city in the country (CEPII data)

14. II. Second modelII.IV. Sample • We use a sample of 9 countries (DE, DK, ES, FI, FR, IE, IT, NL, UK) • Time frame: 1996-2003 • Citiesconsidered for distance: Essen, Copenhagen, Madrid, Helsinki, Paris, Dublin, Rome, Amsterdam and London • Data obtained for 18 sectors (onlygoodssectors) • Data sources: cepiiwebsite, EUKLEMS, Wiod

15. II. Second modelII.V. Methodology • Wedidtwo panel regressions, pooling imports by country and then by sector • Three estimation method: • OLS (withfixedeffect) • 2sls (usinglag as instruments) • Poisson regression : to account for missingtrade values (Westerland and Wilhelmsson [2006]) • The following tables concern OLS resultsbecausetheywere the mostrobust

17. II. Second modelII.VI. Results (1) • Adjusting for quality does increase the import price elasticities under all estimations except for the Poisson estimation • For most of the sectors, the impact of quality innovation is positive and highly significant • A 1% increase of product quality leads to higher imports varying between 0.2% and 2%. • Distance, as expected, varies negatively and significantly with trade flows

19. II. Second modelII.VI. Results (2) • All the countries in the sample do improve their import price elasticities when they have been adjusted for quality effects • In conclusion of the second section, although it was a very preliminary work, we showed with all these model that the import price elasticities were underestimated when the quality was not taken into account. • It means that industrial policies should also enhance R&D expenditure to improve quality of products as well as competitiveness.