Income Effects and Vertical Differentiation in International Trade

We analyse a trade model with non-homothetic preferences and different quality versions of each product. Income effects drive the quality composition of consumption, production and trade flows. We show that a rise in local population fosters local asymmetric specialization in high-quality production and exports while it harms low income groups. By contrast, an increase in local productivity may generate specialization in high quality production, which in turn may trigger an immiserizing growth process. Weaker comparative advantages induce firm to move and make a local productivity improvement more likely to increase production of higher quality goods everywhere.