Quality Differentiation and Trade Intermediation

Abstract

Existing studies show that intermediaries can help verify or screen product quality for buyers. This paper examines this claim both theoretically and empirically in the context of international trade. We develop a heterogeneous-fi…rm model that features vertical and horizontal differentiation of products, a coexistence of direct exporting and indirect exporting through intermediaries, and firms' investment in marketing. When complete contracts are not available, intermediaries underinvest in marketing from the perspective of the producer. For products that are more horizontally differentiated, weaker competition permits even the low-quality …firms to export, but via intermediaries. These two mechanisms yield a negative (positive) cross-product relation between vertical (horizontal) differentiation and the prevalence of trade intermediation. Intermediation is more prevalent in the more (both physically and culturally) distant destinations, especially for the more differentiated (vertically and horizontally) products. We find supporting evidence using Chinese product-level data.

Keywords: Trade intermediation, vertical differentiation, product differentiation

JEL Classification: F12, L15