Statistical Discrimination, Endogenous Quality and North–South Trade

We consider a Southern industry engaged in the production of an experience good whose quality cannot be observed prior to purchase. Consequently, Southern consumers rely on the country-of-origin labels to statistically discriminate between a Northern import and the Southern product. We provide a framework to analyze the formation of such quality perceptions and point out its self-fulfilling nature when consumers' willingness to pay and interact with producers' incentive to determine equilibrium average quality of the Southern product. As a theory of the determination of trade volume, our framework shows that the sign of the income effect of import demand is endogenously determined, depending only on the relative perceived quality of the Northern vis-á vis the Southern product. We also derive conditions under which temporary import restrictions may have a permanent effect on the dynamic path of quality perceptions and thus alleviate the Southern industry from a low quality-trap.