Quality in Open Markets: The Sumo Conjecture

The spectacular growth in China?s export volume over the past two decades has resulted in a sharp increase in the global market share of these products.?This situation has significantly affected the industrial structure of developed countries.?Facing strong competitive pressure, many sectors in the EU and the USA (e.g., textiles, toys, steel, aluminum, photovoltaic cells) have seen significant portions of their traditional production disappear.?This rapid emergence of a developing country as a major player in international trade is unprecedented, and the comparative cost advantage of China in many areas cannot be the unique explanation.?In this paper, we identify major reasons for this situation.?Using a theoretical model of industrial organization applied to international trade, we investigate the effects of the entry of a large emerging country in the global market.?The firms? strategies are the quality and quantity of the produced good in a framework of bilateral trade.?In each country, we adopt a representative firm for each industry.?We consider a sequential game framework in which the emerging country firm plays first in quality and quantity.?We show that choosing a lower quality allows the firm from the large emerging country to enter and settle in the market of the other country.?We study the conditions under which this may lead to a less diversified offer and lower quality for consumers.?The likelihood of this strategy?s success, which we call ?sumo,? increases with the size of the emerging country and decreases with the difference in willingness to pay for quality among consumers in both countries. JEL Codes: F10, F12, F14, C72, L13.