Estimating Import Price Elasticities, Adjusting for Quality

A. Fougeyrollas, N. Lancesseur, T. Thanagopal

ERASME (Ecole Centrale Paris)WIOD Meeting - May 25th-26th-27th 2011 - IPTS, Sevilla

feedbacks

• Exchange rates can be different between sectors and if we use output, or Intermediate consumption or Value added as a benchmark.

• Output minus intermediate consumption don’t always give the right Value added.

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Outline The following estimations are a very preliminary

workTwo questions :

Does the three demand types exhibits the same price elasticities ?

If we take “quality effects” into account, are the elasticities modified ?

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I. First model I.I. Specification (1)

M imports, P relative prices and DT total demand addressed to the sector

i country of origin, s industry d demand type (Consumption ….)

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I. First modelI.II. Methodology (1)

For testing we pooled imports coming from 7 countries (DEU, BEL, ITA, JAP, USA, NLD and ESP)

Fixed effect approach : least squares dummy variable (LSDV)

regression model. We define a set of dummy variables where is equal to 1 in the case of an observation relating to individual i and 0 otherwise. The model can be rewritten as follows:

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I. First modelI.III. Methodology (2)

We noticed autocorrelation that for some sectors errors (using the Breush-Godfrey test)

corrected using Cochrane-Orcutt procedure

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I. First modelI.III. Results (1)

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Consumption GFCF Intermediate Consumption

Price elasticity R² Price elasticity R² Price elasticity R²

Textiles and Textile Products 2.12*** 0.87 - - 0,47*** 0.98

Wood and Products of Wood and Cork

2.17*** 0.88 - - 0,12 0.96

Coke, Refined Petroleum and Nuclear Fuel

1.13*** 0.89 - - 0,92*** 0.92

Chemicals and Chemical Products

1.08 0.34 - - 1,94** 0.95

Other Non-Metallic Mineral 1.83*** 0.73 - - 0,65*** 0.91

Basic Metals and Fabricated Metal

1.19** 0.91 0.47 0.9 0,16 0.85

Electrical and Optical Equipment 0.3 0.4 1.37*** 0.95 1,91*** 0.92

Transport Equipment 2.78*** 0.76 0.8*** 0.91 0,72*** 0.91

I. First modelI.IV. Results (2)

The price elasticities of import differ depending on the type of demand

The elasticities are higher in the case of final consumption (compared to IC and GFCF)

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Import price elasticity tends to be underestimated since the prices do not take into account the quality effects

Quality innovation is becoming more and more important particularly in developed countries, as such, ignoring the influence of product quality might bias import price elasticity and therefore debates on trade competitiveness.

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II. Second modelII.I. Introduction

We used a gravity model (Bergstrand [2002]) and we introduced a quality proxy. This model concerns exclusively imports demanded by consumers.

reflects the value of manufactures imports from country i (exporter) to j (importer) for goods produced by the sector s

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II. Second modelII.II. Specification

reflects export potential of country j in sector s refers to the price index of importer in sector s is a proxy for the quality of foreign goods records the distance between the two trading partners refers to the importer-industry fixed effects

refers to the elasticity of substitution between domestic and foreign goods

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II. Second modelII.II. Specification (2)

Export potential:

Theory says (Melitz [2003]) that the probability of a firm to export is increasing with its size.

Hence, we wanted to use a data which could capture this information but it does not exists, so we use the number of employees in the sector as a proxy.

Price index

Prices are derived from unit values i.e they are obtained by dividing the value of trade by its volume

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II. Second modelII.III. Variables (1)

Quality proxy variable:

The knowledge variable of the NEMESIS model is used: it is calculated as the R&D expenditures (EUKLEMS data) of a sector and R&D expenditures from other sectors (spillovers) are added via technology flow matrices.

The quality of products should improve with the R&D expenditures of the corresponding sector. Thus, it should also increase the competitiveness on the international markets of this sector.

Distance Distance is obtained by calculating the distance between the largest

city in the country (CEPII data)

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II. Second modelII.III. Variables (2)

We use a sample of 9 countries (DE, DK, ES, FI, FR, IE, IT, NL, UK)

Time frame: 1996-2003Cities considered for distance: Essen, Copenhagen,

Madrid, Helsinki, Paris, Dublin, Rome, Amsterdam and London

Data obtained for 18 sectors (only goods sectors)Data sources: cepii website, EUKLEMS, Wiod

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II. Second modelII.IV. Sample

We did two panel regressions, pooling imports by country and then by sector

Three estimation method:

OLS (with fixed effect) 2sls (using lag as instruments) Poisson regression : to account for missing trade values

(Westerland and Wilhelmsson [2006])

The following tables concern OLS results because they were the most robust

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II. Second modelII.V. Methodology

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 Name Initial σ R-square Adjusted σ R-square Quality

Agriculture 0.707 0.261 0.715 0.291 -0.050

GasDistribution 2.441 0.214 2.532 0.211 0.624

Refined Oil -0.434 0.131 -0.588 0.104 0.259

Electricity 0.463 0.277 0.396 0.278 0.301

Ferrous and Non-Ferrous Metals 0.761 0.132 0.962 0.104 1.382

Non-metallic mineral products 0.892 0.178 1.113 0.191 0.837

Chemicals -0.576 0.134 0.864 0.176 1.869

Metal Products 0.465 0.182 0.963 0.186 0.540

Agricultural and Industrial Machines -0.682 0.286 0.021 0.236 0.965

Office Machines 0.499 0.446 0.500 0.441 -0.019

Electrical Goods -0.142 0.221 0.592 0.236 1.202

Transport Equipment -0.057 0.164 1.719 0.175 0.992

Food, Drink and Tobacco 0.008 0.221 0.274 0.193 0.235

Textiles, Cloth and Footwear 1.817 0.132 2.125 0.143 0.273

Paper and Printing Products -0.084 0.160 0.466 0.231 0.628

Rubber and Plastic 1.217 0.154 1.748 0.168 0.401

Other Manufactures -0.812 0.327 -0.265 0.323 0.583

Adjusting for quality does increase the import price elasticities under all estimations except for the Poisson estimation

For most of the sectors, the impact of quality innovation is positive and highly significant

A 1% increase of product quality leads to higher imports varying between 0.2% and 2%.

Distance, as expected, varies negatively and significantly with trade flows

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II. Second modelII.VI. Results (1)

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Importing Country Initial Import Price

Elasticity

R-square Adjusted Import Price

Elasticity

R-square

DE (Germany) 0.796 0.238 1.124 0.534

DK (Denmark) 0.418 0.294 0.487 0.421

ES (Spain) -0.746 0.453 -0.563 0.487

FI (Finland) 0.169 0.283 0.230 0.354

FR (France) 0.787 0.296 0.887 0.485

IE (Ireland) 1.291 0.245 1.557 0.454

IT (Italy) -0.247 0.263 0.232 0.425

NL (Netherlands) 1.481 0.293 1.577 0.450

UK (United Kingdom) 0.218 0.140 1.243 0.424

All the countries in the sample do improve their import price elasticities when they have been adjusted for quality effects

In conclusion of the second section, although it was a very preliminary work, we showed with all these model that the import price elasticities were underestimated when the quality was not taken into account.

It means that industrial policies should also enhance R&D expenditure to improve quality of products as well as competitiveness.

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II. Second modelII.VI. Results (2)