Trade Margins, Price, and Product Quality Adjustments to Non-Tariff Measures: Evidence from French Firms

Globalization has increased interdependencies between countries and therefore the need for effective regulation. The enforcement of minimum quality standards such as sanitary and phytosanitary (SPS) measures and technical barriers to trade (TBTs) allows governments to guarantee the absence of negative externalities. For instance, SPS measures have been adopted in response to growing human health concerns. As an example, governments may set a maximum amount of pesticide residues acceptable for food products. As for TBTs, they have been adopted in response to human safety concerns. Motor vehicles must be equipped with airbags and anti-lock braking systems.

While NTMs that are quality-focused can be viewed as welfare-improving tools by addressing market failures such as information asymmetry on product quality (Leland, 1979; Ronnen, 1991; Crampes and Hollander, 1995), they may also induce distortions, being regarded as non-tariff barriers (Das and Donnenfeld, 1989). Consumers may be worse off as a result of the introduction of a public standard because their favorite varieties have been excluded from the market or the prices of the remaining varieties have gone up (Gaigné and Larue, 2016). The impact of public standards on trade has received considerable attention and, in most cases, it has been shown that they negatively affect trade (Andriamananjara et al., 2004; Disdier et al., 2008; Hoekman and Nicita, 2011; etc.). Nevertheless, the bulk of evidence comes from macroeconomic trade models, based on aggregate trade flows. Although very informative, these studies fail to capture microeconomic effects and disregard the quality effects.

In this paper we study the impact of quality-focused non-tariff measures (NTMs) on export decisions of firms (participation, export values and price) and average quality of products. We develop a firm-based trade model with three main ingredients. First, firms sell horizontally and vertically differentiated products and are characterized by their productivity and the quality of their product, which are both considered as exogenous. Second, we assume information asymmetry on product quality, meaning that producers know exactly the quality of their product, whereas consumers only know the average quality of products available in the market (“lemons problem” popularized by Akerlof, 1970). Third, in order to correct market failures associated with information asymmetry, governments impose minimum quality standards that have to be met by all products marketed in the domestic market, whether they are manufactured domestically or abroad. Our model leads to theoretical predictions concerning the effect of public quality standards on both the extensive and the intensive margins of trade.

We show that the enforcement of a minimum quality standard by the government will force some low-quality firms out of the market, as they are not able to keep up with the new regulations. More precisely, standards will induce the exit of both low-productivity and high-productivity low-quality firms. However, high-quality high-productivity firms cease also to serve the country with a stricter minimum standard. Hence, we document a negative impact of minimum quality standards on the extensive margin of trade and an ambiguous effect on average quality of products delivered by firms. The intuition is the following. By forcing low-quality firms to exit the domestic market, a stricter minimum quality standard makes competition tougher among incumbent firms and induces a reallocation of demand from low-productivity to high-productivity ones supplying a quality just above the minimum quality. For a given productivity, the incumbent firms providing the lowest quality have the highest market shares because they set the lowest price (due to the lowest marginal costs) and the consumers make their choice based on average quality. We document a positive effect of standards on incumbent firms’ export sales and even more so for the most productive firms.

Next, we proceed to the empirical assessment of the main predictions derived from our model. We first focus on the food industry because SPS and TBT measures play a prominent role in this industry as food products may often be affected by epizootics, bacterial contamination and because food standards have become important dimensions of trade agreements. We then consider the manufacturing industries where TBT measures play a tremendous role (while SPS measures concern mainly the food industry).

Relying on the most recent and comprehensive dataset on quality standards, we conduct estimations to assess the effect of SPS and TBT measures on both the extensive and the intensive margins of trade for individual French exporters. We also analyze the reallocation effect from less productive to more productive firms. We control for other traditional trade policy instruments and tariffs imposed in the destination markets, as they may also impact the exports of the French firms.

Impacts of SPS and TBT measures on probability to export, export value, quality-adjusted prices and average quality

As predicted by the model, we find a negative effect of SPS and TBT measures on the extensive margin of trade. Thus, the presence of a firm into a certain product-destination market pair is discouraged by public quality standards such as SPS and TBT measures. However, the high-productivity firms have a higher participation into a certain product-destination market pair with SPS and TBT measures. We also show that more SPS measures (respectively, more TBT measures) raise the market share of high-productivity firms at the expense of low-productivity incumbents and average quality of products in the food industry (respectively, in the manufacturing industries).

When it comes to prices, we focus on quality-adjusted prices and on average quality of products delivered by firms set up in France. We show that SPS measures induce a positive effect on average quality of products and quality-adjusted prices in the food industry, while TBT measures have the same effects in the manufacturing industry. However, the price effects of SPS and TBT measures are lower for the more productive firms.

Authors: joint with Anne-Célia Disdier and Carl Gaigné


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