Trade Variety and Productivity in Canada

• Published date: 01 August 2013
• Author: Bo Chen
• DOI: http://doi.org/10.1111/rode.12040
• Date: 01 August 2013

Trade Variety and Productivity in Canada

Bo Chen*

Abstract

This paper combines the effects of import and export variety growth on technological development in a

monopolistic competition model with endogenous technology. Using highly disaggregated international

trade data at the national and provincial levels from 1988 to 2006, it is found that export variety and import

variety account for 10.41% and 1.57% respectively of the variation in Canadian provincial productivity dif-

ferences, and for 9.92% and 6.95% of within-province productivity growth. Evaluated at the sample mean,

Canadian productivity gained 0.74% as a result of trade variety growth: export variety contributed 0.41%

and import variety contributed 0.33%. While the USA is the single most important source of export-led

Canadian productivity growth, its relative importance is much less on the import side. Emerging markets in

Asia, especially China, contributed significantly to Canadian productivity growth by increasing import

variety for Canadian producers.

1. Introduction

As documented in Broda and Weinstein (2006) and many other sources, trade variety

(extensive margin) has grown rapidly in the past two decades. The usual explanation

for the growth in trade variety is the wave of globalization which started in mid-1980s.

Reductions in transportation costs, a sharp fall in tariff barriers, better and more sym-

metric information flows across markets, the proliferation of global production net-

works, etc., are all part of the explanation for a rise in trade variety.

Using monopolistic competition models (MC), economists can examine how trade

variety affects productivity through the effects of input and output variety.

The input variety effect is similar to that found in endogenous growth models

(Romer, 1990; Grossman and Helpman, 1991), where a greater variety of inputs leads

to higher productivity. This effect is based on the assumption of diminishing marginal

productivity of factors of production. Under the assumption that imports are used as

intermediate inputs in production, an expansion in import variety will boost produc-

tivity growth.1Broda et al. (2006) find that new imported varieties on average account

for 10% of productivity growth.

The output variety effect predicts that the expansion of export variety (as final

output variety) can boost the exporting country’s productivity. This hypothesis is

based on the assumption of diminishing technical rate of substitution or economies of

scope (Panzar and Willig, 1981). More export varieties (final output varieties) may

improve productivity because of the effect of “economies of scope”. Empirically, the

link between export variety and productivity has been found by Feenstra et al. (1999)

for South Korea and Taiwan; by Funke and Ruhwedel (2001) for East Asian coun-

* Chen: Shanghai University of Finance and Economics, 100 Wudong Road, Shanghai 200433, China.

E-mail: chen.bo@mail.shufe.edu.cn. I thank Richard Harris, David Jacks, Nicolas Schmitt, Paul Beaudry,

Yuen Pau Woo, and the participants at the 3rd IEFS-China conference for helpful comments. I am also

very grateful to financial supports from the Asia Pacific Foundation of Canada (PRG-08-06), the Natural

Science Foundation of China (71103116), and the Innovation Program of Shanghai Municipal Education

Commission (12ZS071).

Review of Development Economics, 17(3), 414–429, 2013

DOI:10.1111/rode.12040

© 2013 John Wiley & Sons Ltd

tries; by Chen (2011) for China; and by Feenstra and Kee (2008) for a sample of 48

countries (both developed and developing).

The existing literature on productivity gains from trade variety, however, has two

limitations. First, most studies focus on either export variety or import variety. The

total effect of both export and import variety and their interaction (gross substitute or

complementary effects) has not yet been investigated in a unified framework. In this

respect, Tybout (2003) points out that simple aggregation of individual (export or

import) effects may result in a serious bias on their joint effects on productivity.

Second, studies using multi-country panel data have had to assume that the key

parameters (price elasticities of supply and demand) are identical across countries in

the panel. This assumption, however, is too strong given the large variation in tech-

nology and taste across countries, which will have an effect on price elasticities.

By extending Feenstra and Kee’s (2004) model to include both export and import

variety,2this paper uses Canadian international trade data at the provincial level to

analyze the effects of trade variety on productivity. This paper differs from Feenstra

and Kee (2004) and other related studies in the following three ways: First, the paper

looks at the effects of import and export variety on productivity based on a unified

framework; second, by using Canadian provincial data, this paper is able to estimate

the country-specific effect of trade variety and productivity based on within-country

data without relying on the strong assumption of common elasticities across countries;

third, following the method in Chen and Jacks (2012), I calculate the contributions of

specific trading partners’ export and import variety to Canadian productivity growth

between 1988 and 2006. By determining the productivity contributions of specific

markets, this paper provides an insight to the benefits of more expanded trade with

countries from fast growing regions such as Asia, and especially with China. My

results show that the USA is still the single most important source of Canadian

productivity enhancement on the export side. Emerging economies such as China,

however, have contributed significantly on the import side. This finding provides a

fresh argument for trade liberalization that has so far received very little attention in

the international trade and development economics literature.

The rest of the paper is organized as follows: section 2 summarizes the danymics of

Canadian trade margins from 1988 to 2006. Section 3 introduces the mechanism

through which import/export variety affects productivity and a system of equations

relating sectoral shares and import shares as well as total factor productivity (TFP) to

trade variety. The estimation results are reported in section 4. Section 5 presents the

impact on Canadian provincial productivity differences and productivity growth,

broken down by export and import variety. The productivity contributions of specific

trading partners are also presented. Section 6 concludes.

2. The Trade Margins: An Overview of Canadian Trade 1988–2006

Researchers typically adopt Armington’s (1969) definition of a trade variety as a

country-good pair, i.e. a harmonized system (HS) category. This paper defines export/

import varieties based on the trade data provided by Trade Analyser, which provides

data at the HS 10-digit level for imports and at the 8-digit level for exports (this

dataset is the most disaggregated trade data available for Canada). Therefore, an

import variety is defined as a country-specific good such as “live sheep from France,”

and an export variety is defined as a province-specific good such as “live sheep from

Ontario, Canada.” The concept of “country” for the USA is “abused”a little bit by

treating each US state as an independent “country” as Chen and Jacks (2012).

TRADE VARIETY AND PRODUCTIVITY IN CANADA 415

© 2013 John Wiley & Sons Ltd