Quality, Distance and Trade: a Strategic Approach

This paper contributes to the vast and growing literature on trade and quality by providing a parsimonious explanation of the observed increase in unit values (and thus quality) of shipped goods with the distance of the country of destination. This mechanism is based on the influence of distance on firms strategic behavior when the quality level of goods is a choice variable for firms, and complements the ones already proposed in the literature. Our approach differs from the extant literature in that it does not rely on technology or preference/income differentials to identify the determinants and drivers of trade flows. Moreover, it allows to clearly disentangle between the price setting and quality choice of firms. We find that distance has an unambiguously positive effect on the average quality of traded goods, as well as a negative one on the likelihood of trade zeros . Our results suit the acquired empirical evidence on distance and quality and contribute, therefore, to the research on the determinants of trade performances of firms and countries. Also, our model suggests some useful insights on the relation between distance and free-on-board prices.