Human Capital, Product Quality, and Bilateral Trade

In this paper, I develop a quantitative, general equilibrium theory of product quality and international trade. In the model, producers make choices regarding the quality/technology of their intermediate inputs given the set of endowments they have access to. This choice affects the producers ability to produce goods domestically and internationally, thus shaping the pattern of bilateral trade. In otherwise identical countries, optimizing behavior results in: (i) the high human capital country importing a relatively small volume of goods from the low human capital country and (ii) the low human capital country importing a relatively large volume of goods from the high human capital country --- qualitatively consistent with the observed volume of bilateral trade between rich and poor countries. I quantify the theory for a sample of 77 countries and show that it explains up to 90 percent of the variation in bilateral trade; twice the amount of alternative models with no role for human capital and product quality.