This paper presents theory and evidence from highly disaggregated Chinese data that tariff reductions induce a country's producers to upgrade the quality of the goods that they export. The paper first documents two stylized facts regarding the effect of trade liberalization on export prices and its relation with product differentiation. Next, the paper extends Melitz's (2003) model of trade with heterogeneous firms by introducing endogenous quality choice. The model predicts that a reduction in the import tariff induces an incumbent importer/exporter to increase the quality of its exports and to raise its export price in industries where the scope for quality differentiation is large while to lower its export price in industries where the scope for quality differentiation is small. The predictions are consistent with the stylized facts based on Chinese data and robust to various estimation specifications. JEL: F12, F14

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This paper presents theory and evidence from disaggregated Chinese data that tariff reductions induce a country's producers to upgrade the quality of their exports. The paper first documents stylized facts regarding the effect of trade liberalization on export prices.Next, an analytic framework is developed that relates a firm's choice of quality to its access to imported intermediates. In the model a reduction in import tariffs induces a firm to increase export quality and to raise its export price in industries where the scope for quality differentiation is large while to lower its export price in industries where the scope is small. The predictions are consistent with the stylized facts and are highly robust econometrically. JEL: F12, F14Over the last twenty years many developing countries have abruptly and substantially lowered tariffs and scaled back other trade barriers. This policy change has created the opportunity to observe the extent to which trade barriers affect the behavior of individual firms. A rapidly growing literature shows that trade liberalization has led to a surge in imports of intermediate inputs and that the improved access to foreign made inputs has had a large impact on firm productivity and the scope of product offerings at the firm level. 1 Given the transformative impact of trade liberalization on documented productivity, it is natural to consider the effect trade barriers may have had on firms'decisions regarding the quality of the products that they produce. This paper asks whether lower tariffs on imported intermediates induce firms to upgrade the quality of the goods that they export. Such a link between trade liberalization and export quality is important because the production of high-quality goods is often viewed as a pre-condition for export success and for economic development (Amiti and Khandelwal, 2013). 2 To address this question, we present theory and evi-1 For instance, greater access to foreign intermediate inputs has been associated with higher firm-level productivity (Amiti and Konings, 2007, among others), and other firm-level adjustments such as domestic product scope (e.g., Goldberg, Khandelwal, Pavcnik and Topalova, 2010).2 Schott (2004) shows that international specialization is less about the industrial composition of a country's exports and is more about the level of quality of a fixed set of goods.1 524 dence from highly disaggregated Chinese linked firm-level production data and customs data that tariff reductions induced Chinese exporters to upgrade the quality of the goods that they export, particularly in industries where the scope for quality variation is high.Chinese firms that enjoy the largest tariff reductions are observed to raise the prices of their exports to existing export markets and to shift their export volumes geographically from countries where demand for high quality goods is relatively weak to markets where demand for high quality goods is strong.We first document two stylized facts regarding the relationship between the arguably exogeno...

This paper examines (i) the relationship between the credit constraints faced by a firm and the unit value prices of its exports, as well as (ii) the relationship between the export prices of a firm and its productivity. The paper extends Melitz's (2003) model of trade with heterogeneous firms by introducing endogenous quality, credit constraints and marketing costs. There are three key findings. First, there exists a positive relationship between firm productivity and export prices because the choice of higher-quality inputs is associated with higher productivity. Second, tighter credit constraints faced by a firm reduces its optimal prices as its choice of lower-quality inputs dominates the price distortion effect resulting from credit constraints. Third, if one adopts the alternative assumption that quality is exogenous across firms, then completely opposite results would be expected: there would be a negative relationship between prices and productivity; prices increase as firms face tighter credit constraints. An empirical analysis using Chinese bank loans data, Chinese firm-level data from the National Bureau of Statistics of China (NBSC), and Chinese customs data strongly supports the predictions of the endogenous-quality model, and confirms the existence of the quality adjustment effect: firms optimally choose lower quality when facing tighter credit constraints. Our finding of a significant impact of credit constraints on export prices indicates the prevalence of heterogeneity of product quality across firms. JEL: F1, F3, D2, G2, L1

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