Julien Martin
email: julien.martin@ensae.fr@www.crest.fr

Isabelle Méjean
email: isabelle.mejean@polytechnique.edu

Maria Bàs

Julian Di Giovanni

Lionel Fontagné

Jean Imbs

Guy Laroque

Florian Mayneris

Low-Wage Countries' Competition, Reallocation Across Firms and the Quality Content of Exports *

Keywords: Firm-Level Data, Quality Heterogeneity, Low-Wage Countries' Competition, Within-product specialization. JEL Classification: F12, F14

What is the impact of low-wage countries' competition on the quality of high-wage countries' exports? To answer this question, we develop a new method that uses firm-level data to measure quality changes in sectoral exports. Over 1995-2005, we measure a 11% increase in the mean quality of France's aggregate exports, driven by a reallocation of demand in favor of higher quality producers. The phenomenon is significantly more pronounced in markets where the penetration of developing countries has increased while it is negative where firms face increased competitive pressures from high-wage countries. These results are consistent with within-product specialization along the vertical dimension. They suggest that, over the period, France has specialized in the production of higher quality goods. In our data, around one fifth of the measured quality improvement in France's aggregate exports is attributable to low-wage countries' competition. In turn, its increasing specialization in higher quality goods has limited France's market share loss over the period.

Introduction

One of the most discussed phenomenon in international trade is the growing share of emerging countries in world exports, and its impact on developed countries' export patterns. According to the neo-classical theory of international trade, the increasing participation of developing countries in international markets should lead rich countries to specialize in the production of capital-intensive goods. However, recent empirical evidence suggests that emerging economies are now becoming competitive not only in labor-intensive sectors, as theory would predict, but also in capital-intensive sectors (see Amiti & Freund, 2010, on Chinese data). If their goods substitute the ones traditionally produced in developed countries, it may well be that low-wage countries are going to concentrate most of the world production of manufacturing goods in the near future. This scenario has not yet been realized, however, as high income countries continue exporting manufacturing goods. Schott (2004) shows that the US now imports the same products from both developed and developing countries, and that the reason why these varieties can coexist is that they are vertically differentiated. Hence, those Chinese goods that compete with OECD countries' products are of lower quality, on average (Schott 2008, Fontagné, Gaulier & Zignago 2008).

According to Schott, these patterns of international trade are inconsistent with factor-proportion specialization across industries but suggest specialization occurs within industries (Schott, 2004, 2008). International trade leads countries to specialize in vertically differentiated goods. Thus, developed economies continue exploiting their comparative advantage by producing better qualities. This paper develops a new method to test whether increased competition from low-wage countries induces such a shift in the specialization of rich nations in favor of better qualities. Our methodology allows to quantify changes in the mean quality of a country's export basket due to a biased reallocation of market shares across vertically differentiated exporting firms. In a world of within-industry specialization, such shifts in the quality composition of exports are induced by changes in competitive pressures faced by exporting firms in international markets. To test this assumption, we relate the magnitude of quality changes in French exports, measured for each sector and destination market, to various measures of international competition. We show that quality upgrading is more pronounced in markets where French exporting firms face increased competitive pressures from goods produced in low wage countries, notably in China. In the meantime, 1 competition from high income countries is shown to have the opposite impact on the mean quality of French exports. To the extent that low wage countries have a comparative advantage in the production of standardized, low-quality varieties, these patterns are consistent with within-industry specialization along the quality dimension. To our knowledge, we are the first ones to identify such dynamic specialization patterns in firm-level data.

We start the analysis with an illustrative model describing the conditions under which changes in the competitive environment modify the quality composition of a country's export basket. Our framework borrows from the industrial organization literature, notably Gabszewicz & Thisse (1979).

We consider a highly simplified economy in which two firms located in a high-income country compete with a low-wage country's producer to sell goods in the same foreign market. Firms are differentiated along the quality dimension and the low-wage country is assumed to offer the lowest quality. 1,2 In this setting, increased competitive pressures from the low-wage country's producer are disproportionately felt by the lowest quality produced in the rich country while the highest quality is somewhat protected by the differentiation of its product. This asymmetry triggers a reallocation of market shares in favor of the high quality firm, and an improvement in the mean exported quality. 3 This example emphasizes a potential relationship between the mean quality of a country's exports and the nature of competition it faces in foreign markets. In particular, increased competition from low-quality producers in emerging countries should induce a quality upgrading in rich countries' exports. In the words of Schott (2008), developed countries respond to competition from low-wage countries by "moving out, that is, by [...] dropping the least-sophisticated varieties from their export bundle." In the empirical exercise, we use the heterogeneity across sectors in the de-gree of vertical differentiation, as well as the heterogeneity across markets in the penetration of developing countries, to ask whether this mechanism is at play in the data.

The empirical exercise is conducted using firm-level data on French exports. Our measure of quality changes relies on the methodology proposed by Aw & Roberts (1986) and Boorstein & Feenstra (1987) and recently used by Harrigan & Barrows (2009) on sectoral data. Boorstein & Feenstra (1987) propose that the aggregate quality of a basket of goods is measured by the mean utility its consumption induces per unit of good. Using this definition, they show how to quantify changes in the mean quality of a basket of goods by comparing time-variations in its unit value and ideal price index. The intuition is straightforward. The unit value of a consumption basket is a weighted average of its components' prices (U V it = i w it p it with i denoting varieties of the considered consumption good, p it the price of variety i and w it its weight in the consumption basket). Changes in the unit value either come from individual price adjustments (changes in the p it prices) or from composition effects (changes in the w it weights). After controlling for price adjustments using a well-defined ideal price index, the remaining time-variations in unit values thus reveal changes in the composition of the consumption basket. In particular, an increase in the unit value that is not met by an equivalent increase in the price index indicates that consumption has been reallocated in favor of more expensive goods. From the point-of-view of the consumer, this is optimal if and only if these varieties are also of better quality. Boorstein & Feenstra (1987) show analytically that this reasoning holds true for a large class of preferences. In our empirical exercise, we use two alternative assumptions on the underlying preferences, namely that there are CES or translog.

We adapt this methodology to our data and measure quality changes in France's exports due to market shares being reallocated across firms producing differentiated qualities. 4 In firm-level data, particular attention has to be paid to entry and exit of firms from the export markets. We thus disentangle quality improvements due to a reallocation of market shares toward high-quality producers from those caused by a net entry of better qualities in the export market. Our estimates suggest that, over the 1995-2005 period, the overall quality of French exports has improved by 11%. Three quarters of the improvement are attributable to extensive margin adjustments, namely the net entry of high quality producers in export markets.

Despite the trend in aggregate quality, our data exhibit a huge amount of heterogeneity in the direction and magnitude of quality changes. In particular, the variance in quality patterns is high between sectors, and across destination markets within sectors. Our empirical analysis discusses how this heterogeneity is related to changes in the form of competition French firms face in foreign markets. Namely, we show that quality upgrading is positively correlated with the raise of low wage countries' market share in foreign countries. On the contrary, the quality content of France's exports tends to reduce in those markets where other high wage countries have significantly increased their position. This is consistent with our intuition that competitive pressures in foreign markets can explain some reallocation of market shares among vertically differentiated firms, thus driving average quality changes. Over the considered period, low wage countries, in particular China, have strongly increased their share in world trade (from 8% to 16%). Their increased penetration in France's foreign markets explains around 15% of the growth in the mean quality of French exports that we identify in the data. We interpret these results as evidence in favor of factor-proportion specialization within products, with France being increasingly specialized in high-quality goods.

The result that low-wage country competition induces a flight to quality has important macroeconomic implications. A specialization of rich countries in high quality goods is expected to modify the relative demand of skilled and unskilled workers with an end effect on wage inequality and employment rates. This may help explain the increased wage premium between skilled and unskilled workers observed in a number of developed countries.5 A change in the mix of exported products could also affect growth potential, as discussed in Hausmann, Hwang & Rodrik (2007). If high quality goods are associated with higher productivity levels, a country specialization toward high qualities should increase its aggregate prospects. Finally, quality upgrading may be a way for developed countries to maintain their level of exports in a world of increasing competitive pressures from low-wage countries. Specializing in high-quality goods will insulate them from wage movements in developing countries (Khandelwal 2010).

Based on Khandelwal's argument, we conduct a counterfactual exercise that quantifies the impact of quality upgrading on France's export performances. Namely, we compare the actual evolution in the value of exports to the one that would have prevailed without any reallocation of demand across heterogeneous qualities. In our data, more than 20% of the increase in France's exports (in value) is explained by quality upgrading. This means that, absent the reallocation of demand towards high quality producers, France would have lost more than 40% of its aggregate market share in world markets. This represents an additional 10 percentage points with respect to its actual loss.

Our paper is related to a growing literature analyzing the impact that competition from lowwage countries has on developed countries' performance. In particular, a number of recent papers study North-South trade and its heterogeneous impact on firms located in developed countries. Bernard, Jensen & Schott (2006) show that competition from low-wage countries reallocates production towards capital-intensive plants while labor-intensive ones are pushed out of the market. This is consistent with evidence discussed in this paper if the production of better quality goods is more capital intensive. 6 Our results allow us to go one step further and interpret the reallocation as driven by quality differentiation across firms.

Recently, the literature has focused on within-firm technology upgrading induced by Chinese competition (see Bloom et al. 2009, Mion et al. 2009, Mion & Zhu 2011). These papers show that increased competitive pressures from China makes firms adopt production process that are more intensive in skilled and non-production workers (Mion et al. 2009,2011+) and rely more on innovation (Bloom et al. 2009). Such technology upgrading may be related to the firm increasing the quality of its products. Our methodology neglects this possibility. Namely, we assume quality to be constant at the firm-level and focus on aggregate quality upgrading driven by a reallocation of sales across firms. If any, the previous papers suggest that within-firm quality upgrading goes in the same direction as the reallocation we measure. Our estimate of the impact of low-wage countries' competition on the aggregate quality of French exports is thus probably a lower bound.

Our work is also related to the literature studying quality heterogeneity in international trade.

While the theoretical dimension of the problem has been extensively discussed, testing these models is still in its infancy because of obvious data constraints. Most of the literature uses proxies to measure the relative quality produced by firms or exporting countries. While the bulk of the literature focuses on raw proxies such as unit values, some papers use objective criteria that are directly related to quality. 7 Another approach is based on revealed preferences. It uses the information on consumed quantities and observed prices to infer measures of quality. This approach is used in Kugler & Verhoogen (2010), Hallak & Schott (forthcoming) and Khandelwal (2010). The method we use, based on Boorstein & Feenstra (1987), takes the same strand, the main difference being that, instead of revealing the level of quality, it allows us to identify changes in the mean quality of trade flows.

In this literature, the paper the most closely related to ours is Khandelwal (2010). Using estimates of the relative quality of products exported by different countries in the US, he shows that Chinese competition is more painful -in terms of employment in the US -in sectors with less quality heterogeneity (shorter "quality ladders"). This suggests that vertical differentiation protects the most developed economies against competition from low-wage countries. We go one step further and argue quality upgrading is a natural consequence of competition from emerging countries. In our example, the mean quality of a country's exports increases when firms face competitive pressures from low-quality producers. Countries thus climb the quality ladder which in turn should reduce their sensitivity to competitive pressures.

The rest of the paper is organized as follows. Section 2 describes the mechanism we have in mind to explain the link between low-wage countries' competition and the aggregate quality of exports. Section 3 presents the strategy and data we use to test the prevalence of this mechanism.

We present a stylized model illustrating how increased competition from low wage countries can affect the quality composition of developed countries' exports. Our logic is based on the assumption that low-wage countries have a comparative advantage in the production of low quality goods.

If this is indeed the case, competitive pressures coming from emerging markets should be felt disproportionately by low-quality producers in developed countries. One may thus observe a redistribution of market shares in favor of high-quality varieties when competition from low-wage countries becomes more intense.

Our example builds upon a model of quality differentiation based on Gabszewicz & Thisse (1979) and Tirole (1988). There are three firms in the economy that compete in prices to sell goods in the same import market. Two firms are located in a rich country, called North, while the third one is in a low-wage country, called South. Firms are assumed to be endowed with a quality level, while they are able to choose their prices strategically. In the following, we use L, M and H to denote the low, medium and high quality, respectively. We assume the Southern firm offers the lowest quality L. 8 In this framework, we consider what happens to the relative sales of Northern firms when competition from the low-wage country becomes more intense. Stronger competition is modeled as an exogenous reduction in the export price of the Southern firm. The relative price shock can come from various sources, e.g. the Southern firm becoming more productive, its cost of exporting reducing, Southern wages decreasing, or the country's currency depreciating. The nature of the shock is irrelevant from our standpoint. We do not try to explain why emerging markets represent an increasing share in world markets but what consequence this has on the mean quality and price of developed countries' exports. In the following, we use the term "trade cost shock" as a shortcut.

Demand side: Following Tirole (1988), the demand side of the market consists of a large number of consumers with discrete preferences. Utility is increasing in the quality of the consumed variety.

Consumers are heterogeneous in terms of their marginal rate of substitution between income and quality. This assumption is equivalent to supposing income is heterogeneous across consumers: a higher marginal rate of substitution has the same impact as the consumer being poorer.

The utility of the consumer, with marginal rate of substitution 1/θ, is equal to U = s i -1 θ τ i p i if she consumes the quality s i . With s L < s M < s H , utility is increasing in quality. The price τ i p i of the variety is the product of an ad-valorem cost τ i (> 1) that is exogenous to the firm and the FOB price p i that she chooses strategically. In the following, τ i is assumed country-specific:

τ M = τ H = τ , τ L = τ *
where τ (respectively τ * ) is the exogenous cost faced by Northern (resp.

Southern) firms.

There is a mass one of consumers with marginal rates of substitution uniformly distributed over [θ, θ]. Following Tirole (1988), it is assumed that i) the market is covered, i.e., all consumers consume the differentiated good, and ii) all qualities are sold in equilibrium. 9 In this framework, the poorest consumers choose the lowest quality L, while the richest ones buy the highest quality H. The consumer with θ = θLM is indifferent between consuming the lowest and the medium quality, with θLM such that U ( θLM , s M , τ p M ) = U ( θLM , s L , τ * p L ). Similarly, the consumer with a θ just equal to θMH is indifferent between consuming the medium and the high quality.

The demand faced by each producer can be expressed as a function of the distribution of incomes and the previously defined income thresholds. For the high, medium and low quality pro- 9 In analytical terms, the first condition is fulfilled as long as there exists at least one variety i the poorest consumer is willing to buy. This occurs if θs i > τ i p i . The second condition is met when the delivered price per unit of quality increases in quality:

τ * p L s L < τ p M s M < τ p H s H . D H = θ -F ( θMH ) (1)
D M = F ( θMH ) -F ( θLM ) (2)
D L = F ( θLM ) -θ (3) with θLM = τ p M -τ * p L s M -s L , θMH = τ p H -τ p M s H -s M .
Supply side: Firms are differentiated in terms of the quality they sell, and compete in prices. As in Gabszewicz & Thisse (1979), we assume quality is an exogenous characteristic of the firm.10

Each quality level is associated with a marginal cost c i , which is increasing in s i . Without loss of generality, the maximum quality gap is normalized to unity: s H -s L = 1. We further call:

s H -s M = α and s M -s L = 1 -α.
The profit function of firm i is given by

π i = (p i -c i )D i (τ * p L , τ p M , τ p H ).
Using the demands (1)-( 3), one can compute the best response functions associated to each firm:

BR H = c H 2 + 1 2τ τ p M + αθ BR M = c M 2 + 1 2τ [ατ * p L + (1 -α)τ p H ] BR L = c L 2 + 1 2τ * [τ p M -(1 -α)θ] .
This implicitly defines optimal mark-ups as a function of the firm and its competitors' marginal and ad-valorem costs (see details in the Appendix A).

Relative price shock: Using the optimal price strategies just derived, it is easy to show how Northern firms react to a change in the Southern relative competitiveness. Here, we model the shock as a drop in the Southern ad-valorem cost τ * . The shock is exogenous from all firms' standpoint. It increases the relative price of Northern firms and induces a strategic reaction. In particular, the response of Northern firms is

dp H dτ * = αc L 6τ > 0 and dp M dτ * = αc L 3τ > 0.
Both Northern firms reduce their price following the shock in order to partially counteract increased competitive pressures from the Southern firm.11 However, the price adjustment is more pronounced for the firm producing the medium quality: dp H dτ * < dp M dτ * . This firm is directly hurt by increased competitive pressures induced by the Southern shock and must reduce its mark-up. On the other hand, the highest quality producer is only indirectly impacted, through the price adjustment of its local competitor.

Despite price adjustments, the demand faced by Northern firms diminishes following the shock:

dD H dτ * = c L 6 > 0 and dD M dτ * = c L 3(1 -α) > 0.
and is redistibuted to the Southern firm, which market share thus increases:

dD L dτ * = - 3 -α 6(1 -α) c L = - dD H dτ * - dD M dτ *
Once again, the medium-quality firm is more strongly affected than its high-quality competitor. As a consequence, its market share loss is more pronounced: dD H dτ * < dD M dτ * . In some circonstances, the medium quality can even be pushed out of the market. This happens if the shock is large enough (see details the in Appendix A).

When the Southern firm produces the lowest quality in the market, our example thus shows that an improvement in the South competitiveness reduces the aggregate market share of Northern firms in foreign markets. Northern firms reduce their sales to the benefit of the Southern one.

Moreover, as they also contract their mark-up while the Southern one is left unchanged, North's aggregate market share loss is even more pronounced in nominal terms.

Besides its negative impact on the North's market share, the shock also modifies the allocation of sales between firms located in the North. Namely, market shares are redistributed in favor of the high-quality firm, as the medium-quality producer is more vulnerable to competitive pressures exerted by the Southern low quality. Once again, this is true in real and in nominal terms (since both the price and the demand of the medium-quality firm reduce in a more intense way as those of the high-quality producer). This result also holds true at the extensive margin: when Southern costs continue to go down, the medium-quality producer is the first one to exit the market.

All in all, these results suggest that stronger competition from low-quality producers induces an improvement in the mean quality exported by the rich country. 12 The quality upgrading is induced by intensive margin adjustments, a redistribution of market shares in favor of high-quality producers, and by extensive margin adjustments, the exit of the lowest qualities from export markets.

3 Measuring quality changes in the data

Definition

In our example, quality changes are driven by a reallocation of demand across firms serving the same market with different qualities of the same good. There are two challenging issues to deal with when it comes to measuring this phenomenon in the data. First, one obviously needs firmlevel data to capture reallocations of demand across heterogeneous firms. Second, one needs a method that measures aggregate quality changes induced by a reallocation of market shares across firms producing vertically differentiated varieties.

Because we want to have a method that is general enough and covers the whole set of exporting firms, we choose to measure quality changes using the approach developed by Aw & Roberts (1986) and Boorstein & Feenstra (1987), and recently used by Harrigan & Barrows (2009). Boorstein & Feenstra (1987) define the "quality" of a basket of goods as the mean utility its con-sumption induces per unit of goods:

Q t = g(c 1t , ..., c It ) I i=1 c it ,
where Q t is the quality index, c it is the consumed quantity of variety i, g(.) is an aggregate of the I consumed varieties, and I i=1 c it is the aggregate volume of consumption. This definition is general in the sense that it does not associate the "quality" of a variety to any specific observable characteristic. Instead, it relies on revealed preferences and considers a variety that induces more utility to consumers, conditional on the quantity consumed, as being of better quality.

A nice feature of Boorstein and Feenstra's quality index is that its computation requires little information on the considered set of varieties. Namely, changes in the aggregate quality index can be inferred from the comparison of the unit value and ideal price indices computed over the set of varieties under consideration:

∆ ln Q t = ∆ ln UV t -∆ ln π(p t ), (4)
where ∆ is the first-order difference operator. Here, ∆ ln Q t is a percentage change in the quality composition of the considered basket of goods, ∆ ln UV t is the growth of its unit value and ∆ ln π(p t ) denotes changes in the ideal price index. 13 The intuition surrounding the decomposition is the following. A change in the average price of the good, measured by ∆ ln UV t ≈ ∆ ln I i=1 w it p it , can either come from a price adjustment (changes in the p it s) or a change in the relative weight of each variety in aggregate consumption (changes in the w it s). With a well-defined ideal price index, price adjustments are captured by the ∆ ln π(p t ) term in equation ( 4). The remaining changes in the composition of the consumption basket are then assimilated to quality changes (∆ ln Q t ). This decomposition thus says that any increase in the unit value index that is not fulfilled by an equivalent price increase is the result of consumption being reallocated toward more expensive varieties. From the point of view of consumers, the reallocation is optimal only to the extent that these varieties are of better quality.

The aggregate quality index increases as a consequence.

Quality improvements captured by Boorstein & Feenstra (1987)'s index are thus the result of consumption being reallocated across varieties of different quality. In their model as in Section 2, the quality produced by a given firm is assumed exogenous. It may well be the case that changes in competitive pressures also induce within-firm quality adjustments. Such changes in the nature of exported goods are not captured by our measure of quality upgrading. We however suspect that they should go in the same direction as the reallocation of demand we observe. This means our measure of quality upgrading is probably a lower bound.

Data

We measure changes in the quality composition of French exports using firm-level data provided to us by the French customs. The dataset exhaustively describes exports by French firms toward each of their export markets between 1995 and 2005. The empirical analysis however focuses on the sub-sample of partner countries that represent at least 1% of French exports, less Taiwan, Nicaragua, Kuwait, Kazakhstan for which we were unable to construct the explanatory variables used in the econometric analysis. The restriction insures that our sample contains destination markets that are served by a large enough number of French firms, even at the disaggregated sectoral level. Together, those markets represent 85% of French exports.

We also drop exports in non-manufacturing industries that are less likely to be vertically differentiated, as well as the tobacco industry, which is very concentrated in France, and the industries of "Other food products, not elsewhere classified" and "Miscellaneous products of petroleum and coal." These restrictions leave us with a sample of 49 countries and 24 ISIC sectors that covers 65% of French exports. In this sample, observations are identified by a firm ID (f ), a product category (p) defined at the 8-digit level of the combined nomenclature (cn8), a destination market (c) and a time period (t). We call "variety" a firm × product × destination triplet and assume the quality of each variety is constant over time. The dataset is a panel describing how the exported value and quantity of these varieties evolve between 1995 and 2005.

The time-series can be aggregated across firms selling the same good in a given market to compute a sector-and market-specific quality index Q kct . The index measures changes over time in the quality of French exports in sector k and country c due to a reallocation of demand across "varieties" (i.e. across firms and/or products). As the measure of quality upgrading is an index, it can be compared across sectors and/or destination countries to study the relative evolution of quality in different export markets. It has to be noted however that it does not say anything about the absolute quality level in market (k, c).

For varieties to be comparable in terms of the utility they induce and the quantity consumed, they have to be similar enough. In what follows, quality indices are computed at the 6-digit level of the harmonized system (hs6). A "good" is thus a hs6 sector, while a variety is the product sold by a particular firm in that sector.14 Since the analysis uses the time dimension of the panel, particular attention has to be paid to potential changes in the nomenclature. Before computing the quality indices, product data are concorded over time using a procedure similar to the one used by Pierce & Schott (2009) for the US "hs" nomenclature. After the harmonization, the data cover 238,842 firms producing goods in 7,741 cn8 categories.

For each bilateral flow (each "variety"), the customs data record the "free-on-board" value in Euros (v f pct ) as well as the exported quantity in tons (q f pct ). This allows us to compute the unit value index for good k, defined as

∆ ln(U V kct ) = ∆ ln (p,f )∈I kct v f pct (p,f )∈I kct q f pct = ∆ ln (p,f )∈I kc v f pct (p,f )∈I kc q f pct Intensive component + ∆ ln λkct -∆ ln λ kct Extensive component (5) with λ kct ≡ (p,f )∈I kc v f pct (p,f )∈I kct v f pct , λkct ≡ (p,f )∈I kc q f pct (p,f )∈I kct q f pct
where I kct is the set of varieties of good k exported in country c in year t. The unit value index is the log-difference of the total value of exports divided by the total quantity. One can easily show that this index can be decomposed into an intensive and an extensive components as in equation ( 5).

The intensive component is computed from the sub-sample of firms that export in a given market over two consecutive periods (I kc = I kct ∩ I kct-1 ). The extensive component is the difference between the value and the volume shares of new varieties in the overall sample of bilateral trade flows at time t minus the difference between the value and the volume shares of disappearing varieties at time t -1 .

As is clear from equation ( 4), our measure of quality changes is crucially affected by the assumption on preferences, that determines the form of the ideal price index (∆ ln π(p t )). In order to check the robustness of our results to this assumption, we construct two alternative series of quality changes, based on two alternative preference assumptions.

As in Harrigan & Barrows (2009), the ideal price index for good k is first built using the Sato-Vartia-Feenstra formula, which assumes g() has a CES form:15

∆ ln π kc (p t ) = (p,f )∈I kc w f pct (I kc )∆ ln(p f pct ) Intensive component + 1 σ k -1 ∆ ln λ kct Extensive component (6)
where w f pct (I kc ) ≡

s f pct (I kc )-s f pct-1 (I kc ) ln s f pct (I kc )-ln s f pct-1 (I kc ) (p,f )∈I kc s f pct (I kc )-s f pct-1 (I kc ) ln s f pct (I kc )-ln s f pct-1 (I kc ) with s f pct (I kc ) ≡ v f pct (p,f )∈I kc v f pct .
The first component of equation ( 6) is the ideal price index computed over the sub-sample of intensive trade flows. The second part of equation ( 6) corrects the price index for extensive margin effects. As discussed in Feenstra (1994), an entry (resp. exit) of firms into the market represents a drop (resp. increase) in the ideal price index since the price of the variety falls from above the consumer's reservation price to the newly observed price (resp. increases from the previously observed price to above the consumer's reservation price). The end effect on the aggregate price index is all the more important since the share of the new/dropped varieties in consumption is high. This is what the λ ratio of equation ( 6) captures. Moreover, a lower elasticity of substitution between varieties, σ k , implies a larger utility effect of these virtual price adjustments. 16 We also compute quality adjustments based on an alternative form of preferences, namely a translog function. As shown by Feenstra & Weinstein (2010), the ideal price index with translog preferences is defined as follows

∆ ln π kc (p t ) = (p,f )∈I kc 1 2 (s f pct (I kc ) + s f pct-1 (I kc ))∆ ln(p f pct ) Intensive component + -1 2δ k    (p,f ) / ∈I kc s 2 f pct (I kct ) -s 2 f pct-1 (I kct-1 ) Extensive... + 1 I kc     (p,f ) / ∈I kc s f pct (I kct )   2 -   (p,f ) / ∈I kc s f pct-1 (I kct-1 )   2      ...component (7)
where

s f pct (I kc ) ≡ v f pct (p,f )∈I kc v f pct and s f pct (I kct ) ≡ v f pct (p,f )∈I kct v f pct
Once again, it can be decomposed into an intensive and an extensive components, with the intensive side being a Tornqvist index computed on the sub-sample of "intensive" firms ((p, f ) ∈ I kc ) and the extensive side measuring the welfare effect of new/disappearing varieties. While the welfare effect of extensive flows is scaled by the elasticity of substitution σ k in the CES case, the magnitude of extensive price changes in ( 7) is conditional on the δ k parameter that determines the magnitude of the own price and cross-price elasticities in the translog case (see details in Feenstra & Weinstein 2010). Based on the median estimate obtained by Feenstra & Weinstein (2010), we calibrate the value of δ k to 0.5, whatever the sector under consideration.

The ideal price indices ( 6) and ( 7) aggregate price adjustments observed at the variety (firm) level. These individual prices are proxied by unit values:

p f pct ≡ v f pct q f pct .
As noted by Kravis & Lipsey (1974), unit values are a biased measure of prices because of quality composition effects. In our data, changes in the quality composition of a firm's exports in one particular product are indeed assimilated to price adjustments. Our indicator of quality assumes away those within-firm changes in quality and is downward biased, in absolute terms. Given the very high level of disaggregation, however, we expect these measurement errors to be small. At least in the medium run, most quality adjustments should occur between rather than within firms.

Unit values may however be polluted by other measurement errors, notably misleading reports on the value or quantity of exports. We account for this possibility using a trimming procedure.

Namely, we drop from the sample annual growth rates in unit values larger than 300% (in absolute value). The number of observations shrinks by less than 3% as a consequence.

Using the previous unit value and ideal price indices computed at the product-level, ( 5) and ( 6) or (7), we can infer a quality index from the decomposition in (4). For each index, the annual growth in aggregate quality is computed on the whole sample, and on the "intensive" sample, In what follows, the product-and market-specific quality indices (Q kct ) are either used as regressors or aggregated at the country-or sector-level to obtain a broader picture of aggregate quality changes. The aggregation of hs6-specific quality indices into more aggregated indicators either uses a Sato-Vartia formula (when the quality index is based on the price index in ( 6)) or a Tornqvist formula (when it is based on ( 7)). Finally, we measure quality changes on a year-by-year basis. We then chain-weight quality indices to compute the growth rate in quality over the whole 1995-2005 period.

Results

Patterns in the quality of French exports

At the ISIC level, our sample contains 1,453 (market-and sector-specific) time-series. Table 1 gives summary statistics on the corresponding end-period quality indices, as well as their components. The top panel in Table 1 corresponds to quality indices computed under a CES preference assumption, while the bottom panel assumes preferences to be of the translog type. The comparison of both panels illustrates the robustness of our results to the preference assumption: whatever the price index formula we use, average quantitative results are very similar. Over 1995-2005, the mean quality has increased by 18%. Most of the quality upgrading comes from adjustments at the extensive margin, i.e., from a net entry of firms selling goods of better quality.17 At the intensive margin, the quality index has increased by about 7%. In the meantime, firm-level export prices grew by 7.5% on average. 18 These summary statistics do not account for the composition of the French export basket across sectors and destinations. Figure 1 These aggregate evolutions hide a strong degree of heterogeneity, however, as shown by the large distribution of quality growth rates around the mean (first row of each panel in Table 1).

Despite the average upward tendency, the quality of the French export basket reduces in about 40%

of the 1453 destination markets we consider. The heterogeneity is strong in both the geographic and sectoral dimensions. This is illustrated in Figures A. 3 andA.4 which compare the evolution of quality across export destinations and sectors, respectively. 20 Together, these additional pieces of evidence illustrate the double dimension of heterogeneity the analysis has to account for.

On the geographical side, pendix. On the sectoral side, quality upgrading is on average stronger for textile, leather products, footwear, machinery and measuring equipment while almost zero for food, wood, paper products, printing and metal products. But the sectoral differences are not homogeneous across countries.

For furniture for instance, the mean quality of exports to Sweden, UK and Japan has decreased between 1995 and 2005 while it has increased for sales to Germany, Portugal and Italy. In fact, a variance decomposition based on the sector-and country-specific quality indices reveals that more than 75% of the total sum of squares is due to determinants that have the double geographic and sectoral dimension (see Table A.1). The important role of sector-specific determinants is consistent with the IO literature, which explains vertical differentiation by structural features related to 19 Between 1995 and 2000, export prices decreased by 6%, in part because of the depreciation of the effective exchange rate (3.7% over the period). After 2000 however, the price index started increasing while the euro was appreciating (+4.7% between 2000 and 2005 when the effective exchange rate appreciates by 7.8%). The correlation between the price and exchange rate index is equal to -.87 in our data. It is slightly smaller (-.79) when we neglect the price impact of entries and exits. 20 For sake of conciseness, Figure A.3 is restricted to France's 15 main partners. Results for the rest of the sample are available upon request. the production technology. However, our results suggest that quality changes are also affected by determinants that are market-specific within a given sector.

Quality improvements and export performance

The previous section has documented an aggregate quality upgrading in French exports. We now ask how this "flight-to-quality" affects France's aggregate export performance, by running a counterfactual exercise. Specifically, we ask what would have been the change in the value of France's exports if aggregate quality had stayed constant over the sample period. Given our definition of the quality index, the growth rate in the value of France's exports can be written as:

∆ ln V t = ∆ ln Qy t + ∆ ln π(p t ) + ∆ ln Q t , (8)
where ∆ ln V t , ∆ ln Qy t , ∆ ln π(p t ) and ∆ ln Q t denote the growth rates of the export value, the export quantity, the price of exports and the quality of exports, respectively. In our framework, an increase in the value of French exports can be explained by French firms exporting a larger quantity, by their prices increasing, or by demand being reallocated in favor of more expensive, better qualities. We first use our data to measure this evolution in the value of French exports.

We then compute what would have happened if the mean quality had stayed constant, i.e., we compute:21

∆ ln Ṽt = ∆ ln Qy t + ∆ ln π(p t ).

Since aggregate quality increases in our data, the counterfactual growth rate is going to be smaller than the observed one (i.e., ∆ ln Ṽt < ∆ ln V t ). The difference will be particularly pronounced in those markets where quality upgrading is the strongest.

It has to be noted that this is a ceteris paribus exercise, which implicitly assumes observed changes in prices and the quantity of exports to be independent from the evolution of quality. In that sense, our measure of the impact of quality changes on the value of exports is conservative.

Indeed, aggregate growth rates in the volume and price of exports are probably lowered by the reallocation of demand in favor of high-quality firms. In a world of within-industry specialization, those low quality firms which market share decreases are also the ones that suffer the most from increased international competitive pressures. Their market share losses are larger and they are forced to compress their mark-up more strongly. The downward pressures on the quantity and price of exports are however attenuated at the aggregate level because of the drop in the weight of low-quality producers. This suggests that the growth rate of exports we would have observed if demand were not reallocated in favor of high-quality producers would be even lower than the one we compute based on equation ( 9).

Aggregate results for the counterfactual exercise are displayed in Figure 2. Over the 1995-2005 period, the aggregate value of French exports increases by almost 70% (panel (a), solid line). 22 Absent quality improvements, this growth rate would have been significantly smaller, around 40%.

These fairly large numbers have to be compared to the overall increase in world trade over the period. Panel (b) in Figure 2 thus corrects the index for the growth rate of overall imports in each destination market (expressed in euros). Despite the general increase in the value of its exports,

France loses around 30% of its market share in foreign countries. The market share loss would be substantially larger, however, absent the rebalancing of French exports in favor of high quality goods. Namely, French firms would have lost more than 40% of their market share in foreign markets over the 1995-2005 period.

The impact of quality changes on export performances is thus large. However, it is not homogeneous across countries and sectors. information on the contribution of quality to export performances. This contribution is especially important for richer countries, notably Germany, Japan and Switzerland. At the other side of the spectrum, quality is relatively less important in explaining France's export performance in poorer countries like Poland, Spain, Portugal and Greece. For these countries, the growth of exports is mainly due to French firms increasing the quantity they export. At the industry level, quality is especially important in explaining the growth of French exports in electrical machineries, other machineries, footwear and glass products. In these sectors, the quality component explains more than 50% of export growth.

Impact of low wage countries' competition

In a world of within-industry specialization, the previously described increase in the quality of French exports is in part driven by changes in the competitive environment French firms face in international markets. To test whether this mechanism prevails in the data, we now use the heterogeneity in the intensity of quality changes across sectors and destination countries to ask how it relates to measures of the quality competition. If countries indeed specialize within industries, it must be true that quality upgrading is stronger in those markets in which France faces stronger competitive pressures from low-quality producers.

Our main measure of "quality competition" relies on the growing penetration of goods produced in low-wage countries in France's export markets. As mentioned in the introduction, the share of low-wage countries in world trade has dramatically increased over the last two decades.

Figure 4 compares the evolution in the aggregate market share of low wage countries in world exports with the evolution of France's market share. 23 The market share of low-wage countries has strongly increased, from less than 8% of world exports in 1995 to more than 16% in 2005, with

China accounting for two thirds of this increase. If low wage countries produce lower qualities on average, it must be true that the increased penetration of their products into French exporters' destination countries exert competitive pressures that induce a quality upgrading in French exports.

As preliminary evidence, Figure 5 ). This suggests that the mean quality of French exports increases more over the period in those industries that are more exposed to low-wage countries.

We now use regression analyses to ask whether the previous correlation is explained by a causal impact from changes in competitive pressures exerted by low wage countries on the quality of French exports in each destination market. Our baseline estimated equation is

∆ 95-05 ln Qlty kc = i∈lwc α i ∆ 95-05 M sh i kc + X kc + ǫ kc , (10)
where k and c refer to the sector and the destination country, respectively, and ∆ 95-05 denotes the first difference between 1995 and 2005. ∆ 95-05 ln Qlty kc is the log change in the quality of French exports toward country c in sector k over the period 1995-2005. ∆ 95-05 M ks i kc is the variation in country i's market share, where i is one particular low-wage country. Finally, X kc is a vector of controls. The most basic regression uses country-specific fixed effects to control for all macroeconomic evolutions that may explain an aggregate improvement in the demand for quality expressed by market c. For instance, these effects capture the possibility that the country becomes richer, which tends to increase its aggregate demand of high-quality goods. Some regressions also include sectoral fixed effects that control for overall quality improvements in some specific sectors.

Such sectoral quality changes may reflect technological improvements in the production processes of French firms, or composition effects on the supply side. It has to be noted that the α coefficients is then identified within sectors between countries, which is quite demanding. Finally, some regressions include additional control variables that have the sector and country dimensions. The variance decomposition of Table A.1 indeed underlines the impact of sector and market-specific determinants in explaining the heterogeneity in quality changes.

We first assume that the impact of competition from low-wage countries is the same whatever the particular country we consider within that group. We thus constrain the α i coefficients to equality (α i = α, ∀i). Since most of the rise in low-wage countries' market share displayed in Figure 4 is attributable to China, this country may be an outlier, however. We thus investigate whether competition from China has a specific impact on the quality of French exports, i.e., we allow the α i coefficient to be different for China than for other low wage countries.

A potential caveat of the previous regression framework is that changes in market shares may be endogenous to the evolution in the mean quality of French exports because of reverse causality or omitted variables. Reverse causality may arise if positive changes in the quality composition of French exports allow low-wage countries' firms to increase their market shares in foreign markets.

Omitted variables may also create endogeneity if these determinants of quality changes are also correlated with low wage countries' market shares.

To address endogeneity issues, we first compute low wage countries' market shares in a country's imports excluding sales from French firms:

M ks i kct ≡ IM P ikct l =F rance IM P lkct ,
where IM P lkct is the value of good k country c imports from l at time t. Based on the assumption that the evolution of these market shares is exogenous to France's quality changes, we estimate equation (10) using OLS.

Changes in low-wage countries' market shares may still be endogenous, however. We thus run a set of 2SLS estimations. Namely, we estimate predicted values for changes in low-wage countries' market shares using two instruments. The first one measures the overall evolution of the country's market share in sector k, computed over all destination markets but country c. This instrument conveys some information about the aggregate "performance" of the low-wage country in sector k over the period under consideration. Since the variable does not use information on sales in country c, it is independent from changes in the market structure of that country, notably due to

France increasing the quality of its exports. The second instrument we use measures the relative proximity of the low-wage country to the destination market, in comparison with its competitors.

It is constructed as

RelDist ick = Dist ic 1 N ck N ck l=1 Dist lc
, where i and c are the low-wage country and the destination market we consider, respectively.

Dist ic is the distance between i and c and N ck is the number of countries serving country c in good k. 24 In comparison with the first one, this instrument adds variance in the country dimension of predicted market shares. The exporter's proximity to the destination country is a good predic-tor of its initial market share. Since the level increase of low-wage countries' market shares is negatively correlated to their initial market share, this instrument should be negatively correlated with the instrumented variable. Results for the first-stage regressions are presented in Table A.2 in Appendix.

Our main results are presented in Tables 2345. Table 2 describes results of the estimation of equation ( 10) where the only control variables are fixed effects. The first three columns correspond to estimates based on the whole sample while the next three use quality indices measured from intensive flows. Coefficients estimated on the whole sample (columns ( 1)-( 3)) are all positive and significant which means that the growth of French exports' quality is more pronounced in those markets where the penetration of low wage countries has increased the most. In quantitative terms, a one standard deviation in market shares is associated with an increase in the mean quality of exports of about 4%. This result is consistent with Schott ( 2008)'s argument suggesting that the increasing penetration of low-wage countries in world trade induces developed countries to specialize in higher qualities. This continues to hold true when changes in market shares are instrumented, as in column (2). More importantly, the impact of low wage countries' competition is quantitatively the same when identified in the country dimension, with sector fixed effects used as controls as in column (3). In that case, the coefficient is less significant, which is not surprising given that the degrees of freedom are strongly reduced, but its magnitude is almost unchanged.

The descriptive statistics presented in section 4.1 underlined the important contribution of extensive margin adjustments in comparison with intensive ones to explain aggregate quality changes.

We now ask whether the asymmetry between intensive and extensive quality changes transmits to the relationship between low wage countries' competition and quality changes. To that aim, Columns ( 4)-( 6) in Table 2 reproduce the exact same estimations using quality indices computed on the sub-sample of intensive flows. Estimated coefficients are much lower than the ones obtained on the whole sample and turn non-significant whatever the specification. Together, these results suggest that the impact of low-wage countries' competition on the aggregate quality of French exports mainly works through extensive adjustments. As explained in the model of section 2, competition from low wage countries in France's markets can force the lowest qualities to stop exporting. On the other hand, competition is far less intense on the upper side of the quality ladder, which allows new French firms producing better qualities to enter. The net effect of these entries and exits is a quality improvement.

Table A.3 in Appendix tests the robustness of our results to the sample of countries we consider.

We replicate the regressions of Table 2, focusing on France's 14 main partners, namely Austria, Belgium, Germany, Greece, Italy, Japan, Netherlands, Poland, Portugal, Spain, Sweden, Switzerland, the UK and the USA. In comparison with the whole sample, this sub-sample focuses on countries i) that are relatively homogenous in terms of development and wealth and ii) where a lot of French firms export. This robustness check forces us to moderate some of the previous interpretations. Results obtained on the whole set of exporters are qualitatively similar (columns ( 1)-( 3)).

The impact of low-wage countries increasing their market share is still positive and significant, except with sectoral fixed effects but this is due to the very small country dimension available for the identification. However, the coefficient obtained with the set of quality indices computed from intensive trade flows is now positive and of the same magnitude as the coefficient accounting for extensive adjustments (compare column ( 1) and ( 4) in Table A.3). This suggests that competition from low-wage countries may induce extensive and intensive reallocations across firms in more developed countries.

Table 3 explores the sensitivity of the previous results to our measure of quality and the inclusion of additional control variables. Column (1) and ( 2) thus compare OLS results obtained with quality indices assuming preferences are translog (column (1)) and those computed using a CES assumption (column (2)). Results are not significantly different. In columns (3) to ( 6), we introduce other control variables to test the sensitivity of our results. We first consider the influence of vertical differentiation. Intuitively, we expect quality changes to be more pronounced in sectors that are more differentiated in terms of quality since the scope of potential adjustments is then larger. Neglecting the impact of vertical differentiation may induce spurious correlation in Table 2 if those sectors that are more differentiated are also the ones where market shares for low wage countries' firms increased the most. We control for this possibility in Column (3) of Table 3 using as control the indicator of vertical differentiation estimated by Khandelwal (2010). Khandelwal uses a cross-country identification method to estimate the mean quality of a country's exports in the US, at the highly disaggregated product-level. He then assimilates the maximum quality gap across exporting countries within a given sector to a measure of quality differentiation. A longer "quality ladder" thus corresponds to a sector that is more prone to vertical differentiation. As expected, this indicator enters the estimation with a positive sign, even though the effect is quantitatively small. However, its presence does not affect our main result that increased penetration of low-wage countries induces the quality content of French exports to increase.

Column (4) of Table 3 then control for a measure of the Herfindahl index computed for each sector and country using trade data. 25 The variable is meant to capture the degree of competition faced by French firms in their export market. In particular, quality changes may be driven by the overall market becoming more concentrated. If it is the case, the impact of low wage countries increasing their market share will be in part driven by the consequence it has in terms of the general market structure rather than the within-industry specialization. This does not seem to be the case, however. The impact of the Herfindahl index is found non significant. Moreover, the coefficient on low wage countries' market share increase remains unchanged.

Finally, Column (5) in Table 3 controls for the change in the number of varieties exported by France in the market under consideration. To some extent, this accounts for the magnitude of extensive margin effects captured in the quality index. This variable also captures changes in the intensity of competition between French firms, that may impact the quality competition of the country's exports. The variable has a positive and significant effect on quality changes: new firms participate in the quality upgrading of the French export basket. However, this is not the whole story since the impact of low wage countries' competition is still positive and significant once changes in the net number of suppliers are accounted for. 26 Recent papers discuss the specific impact of Chinese competition on developed countries (eg. Mion & Zhu 2011, Khandelwal 2010). Table 4 presents regressions where the impact of lowwage countries' competition is allowed to be different depending on the identity of the competitor. 25 The Herfindahl index is computed using COMTRADE export data and the following formula:

Herf kc ≡ i s 2 ick
where s ick is the market share of country i in the total imports of country c in sector k. 26 We also tried interacting the previously described control variables with the change in low wage countries' market shares. Results, available upon request, were never significant though.

Namely, column (1) disentangles the effect of low wage countries competition depending on their continent. Increases in the market share of low wage countries from Asia and, to some extent, from Africa have a positive impact on the quality of French exports while competition exerted by European and American countries is not significant. A one standard deviation in Asian low wage countries market shares increases the quality index by 4% against 1% for African countries. This result is confirmed in Column (2) that compares competition from Asian low wage countries to competition from the rest of the developing world. Column (3) goes one step further and differentiates the impact of China from the rest of Asia. We find a positive and significant impact of China while other Asian countries increasing their market share does not affect the quality of French exports. These results are confirmed in columns ( 4)-( 6) that control for sectoral fixed effects. However, coefficients are usually less significant, or even non significant in the case of the Chinese specific impact.

Using our estimates, we can compute the magnitude of quality changes driven by different low wage countries. To that aim, we compute the change in quality predicted by estimated coefficients and the change in market shares we observe for each destination and sector. Then, we aggregate our predictions using a Sato-Vartia index. Between 1995 and 2005, observed changes in low wage countries' market shares are predicted to increase the quality of France's exports by 2%. Alone, China is responsible for 1.7%. With an aggregate quality upgrading of 11%, more than 15% of the quality growth of French exports is explained by tougher competition from China.

Over the period 1995-2005, China's market share has increased in almost all sectors. Therefore, the previously described results cannot explain why France has experienced a decrease in the quality composition of its exports to some destinations or sectors. In our model, the only way the mean quality of Northern exports can decrease is if they face increased competition from high quality firms. For instance, it may be that French exporters are exposed to competitive pressures from German firms in some markets (say Eastern European countries). Given that German firms are well-known to produce high quality goods, such competitive pressures are not expected to drive quality up in France's exports. On the contrary, these markets may be "easier" for low-quality French producers, in which case the aggregate quality of exports may decrease.

To consider this possibility, we build a second measure of "quality competition" that accounts for competition from high wage countries. In each sector and destination we identify the country which experienced the highest market share increase (measured as the difference between its market shares in 1995 and 2005). This country is the "main competitor" and its market share change is called ∆ 95-05 M ainComp kc . We then build two variables that interact the market share change of the main competitor with two alternative dummy variables, one that is equal to one if this competitor is a low-wage country ("LWC" dummy) and 0 otherwise and one that is equal to one when it is a high-wage country ("HWC" dummy), i.e. has a GDP per capita greater than 90% of the US one. 27 We expect the impact of competitive pressures on quality to be different when exerted from low-wage countries that presumably produce low quality goods or from high wage countries that are more likely to export high quality varieties. To test this intuition, we estimate the following equation:

∆ 95-05 ln Qlty kc = α1 lwc ∆ 95-05 M ainComp kc + β1 hwc ∆ 95-05 M ainComp kc + X kc + ǫ kc , (11)
where ∆ 95-05 ln Qlty kc is the change in quality, ∆ 95-05 M ainComp kc is the change in the "Main competitor"'s market share, 1 lwc is a dummy variable equal to one for low wage countries, 1 hwc is a dummy variable equal to one for high wage countries, and X kc are control variables.

Results are presented in Table 5. Considering the whole sample first (columns 1-2), we find that, when the main partner is a low wage country, the impact of competition on quality is positive. This is consistent with previous results. Moreover, the negative coefficient obtained for competition exerted by high wage countries means that the opposite mechanism is also at play in the data. Namely, more competition from a high wage country reduces the quality content of exports. This result holds true with and without sector fixed effects (compare columns 1 and 2). Together, these results suggest that i) changes in the quality content of developed nation exports are partly driven by international competition and ii) the direction of those changes in quality depends on the nature of competition. Once again, these results are mostly driven by the extensive margin of trade. When the analysis is restricted to the intensive sample as in columns (3)-(4) of table 5, the impact of competition from high wage countries turns out non-significant and the magnitude of the coefficient on competition from low wage countries is reduced by half. This confirms the role of net entries in the dynamics of specialization patterns.

Conclusion

In a world of within-product specialization along the quality dimension, competition in international markets has an heterogeneous impact on vertically differentiated producers located in a given country. Competitive pressures exerted by standardized good producers in low-wage countries are felt more strongly by low-quality producers than by high quality firms located in rich countries. This asymmetry induces a reallocation of demand within countries between producing firms.

Our paper discusses the impact that the asymmetry has on the quality composition of a country's exports. Using a simple model of vertical differentiation, we show that increasing competition from low-quality producers should induce a quality upgrading in rich countries' aggregate exports.

We evaluate the pertinence of this mechanism using bilateral export data covering the universe of French manufacturing firms.

We show that the quality of the French export basket has increased by more than 11% between 1995 and 2005. Quality upgrading is particularly pronounced in sectors and countries where French firms face increasing competitive pressures from low-quality producers. Interestingly, higher competition from high wage countries lead to a decrease in the quality content of French exports. The flight to quality is consistent with within-industry specialization along the vertical dimension.

The quality upgrading identified in the data has important consequences. In particular, it allows maintaining high-income countries' exports in a world of increased competition from low-wage countries. Our estimates suggest that at least 20% of the growth of French exports between 1995 and 2005 is due to the recomposition of its export basket in favor of high-quality producers. Absent any reallocation, the share of French products in foreign markets would have reduced at least twice as much as what we observe in the data.

The best response functions for the high, medium and low quality producers are defined as

BR H = c H 2 + 1 2τ H τ M p M + αθ BR M = c M 2 + 1 2τ M [ατ L p L + (1 -α)τ H p H ] BR L = c L 2 + 1 2τ L [τ M p M -(1 -α)θ] .
The Nash equilibrium yields the following optimal prices:

p H = 2 3 c H - α 6 c H + τ M 3τ H c M + ατ L 6τ H c L + α(4 -α) 6τ H θ - α(1 -α) 6τ H θ p M = 2 3 c M + (1 -α)τ H 3τ M c H + ατ L 3τ M c L + α(1 -α) 3τ M (θ -θ) p L = 2 3 c L - 1 -α 6 c L + τ M 3τ L c M + (1 -α)τ H 6τ L c H + α(1 -α) 6τ L θ - (1 -α)(3 + α) 6τ L θ.
Prices equal marginal cost plus a markup. Markups positively depend on the costs of the firm's competitors as well as the size of the market (implicitely defined by θ and θ). Markups negatively depend on the own cost of the firm: Firms incompletely pass their cost through prices. The magnitude of cost pass-through depends on the market power the firm benefits from thanks to vertical differentiation.

Integrating this into the demand functions, one obtains the equilibrium sales of each firm, as a function of trade costs, marginal costs and the income distribution parameters:

D H = - 2 + α 6α τ H c H + 1 6 τ L c L + 1 3α τ M c M + 1 -α 6 (θ -θ) + 1 2 θ (A.1) D M = - 1 3α(1 -α) τ M c M + 1 3(1 -α) τ L c L + 1 3α τ H c H + 1 3 (θ -θ) (A.2) D L = - 3 -α 6(1 -α) τ L c L + 1 3(1 -α) τ M c M + 1 6 τ H c H + α 6 (θ -θ) - 1 2 θ. (A.3)
Case 1: The Southern firm produces the lowest quality: Consider the case in which the lowest quality (L) is produced by the Southern firm while the two Northern firms respectively produce the medium and high qualities. Starting from a situation in which both demands are strictly positive, one can show that a reduction in the ad-valorem cost faced by the Southern firm (∆τ * = ∆τ L < 0)) reduces the demand addressed to each Northern firm, but the demand loss is stronger for the medium quality producer:

0 < dD H dτ * = c L 6 < dD M dτ * = c L 3(1 -α) .
Under some circonstances, one or both firms can even be pushed out of the market. This happens if the trade cost drop is large enough in which case ex-post sales are negative. Calling ∆τ * the absolute drop in the South ad-valorem cost, this means, respectively for the medium-and the highquality firms:

D M (τ * -∆τ * , τ, c L , c M , c H , θ, θ, α) < 0 D H (τ * -∆τ * , τ, c L , c M , c H , θ, θ, α) < 0.
Using the demand functions (A.1)-(A.2), we find that, following the price shock, the mediumquality firm exits the market if the drop in transport costs is larger than

∆τ * M = τ * - τ c M αc L + (1 -α)τ c H αc L + (1 -α)(θ -θ) c L ,
while the high-quality firm exits if the drop exceeds

∆τ * H = τ * + 2τ c M αc L - (2 + α)τ c H αc L + (1 -α)(θ -θ) c L + 3θ c L .
Following a trade cost reduction, the medium-quality producer is the first one to exit the market if:

∆τ * H > ∆τ * M ⇔ τ (c H -c M ) < αθ,
i.e., if the high quality firm has a large "exclusive demand" (large θ), if the cost differential is moderated (c H -c M is low enough) or if the two Northern qualities are not strong substitute (α is high).

Case 2: The Southern firm produces the medium quality: Consider now the situation in which the Southern firm is endowed with the median quality and benefits from a trade cost reduction (∆ S τ * = ∆τ M < 0). Once again, both Northern firms suffer from a sales drop as a result of the Southern firm becoming more competitive:

dD H dτ * = c M 3α and dD L dτ * = c M 3(1 -α)
For the shock to redistribute Northern market shares in favor of the high quality firm, it has to be true that

dD H dτ * < dD L dτ * ⇒ α > 1 2 .
A large fall in the Southern firm trade cost may again induce extensive margin adjustments.

This happens if

D L (τ * -∆τ * , τ, c L , c M , c H , θ, θ, α) < 0 D H (τ * -∆τ * , τ, c L , c M , c H , θ, θ, α) < 0.
The low-quality French producer exits the market if the trade cost drop exceeds

∆τ * L = τ * - (3 -α)τ c L 2c M + (1 -α)τ c H 2c M + α(1 -α) 2c M (θ -θ) - 3(1 -α) 2c M θ,
while the high-quality producer is pushed out of the market if ∆τ * is larger than

∆τ * H = τ * - (2 + α)τ c H 2c M + ατ c L 2c M + α(1 -α) 2c M (θ -θ) + 3α 2c M θ.
Following a trade cost reduction, the low-quality Northern producer is the first one to exit the market if

∆τ * H > ∆τ * L ⇔ τ (c H -c L ) < αθ + (1 -α)θ ⇔ α > τ (c H -c L ) -L θ -θ .
Again, if the Southern firm is close enough from the low-quality producer in the North (i.e., if α is large enough), this firm is more likely to exit the market than its high-quality competitor.

Case 3: The Southern firm produces the high quality: Following the price shock (∆τ * = ∆τ H < 0), both Northern firms suffer from a drop in their sales:

dD M dτ * = c H 3α > 0 and dD L dτ * = c H 6 > 0.
However, the medium-quality firm (i = M ) is more strongly affected as dD M dτ * > dD L dτ * .

The fall in Southern trade costs induces adjustments at the extensive margin if

D L (τ, τ * -∆τ * , c L , c M , c H , θ, θ, α) < 0 D M (τ, τ * -∆τ * , c L , c M , c H , θ, θ, α) < 0.
The medium-quality producer exits the market if the trade cost drop exceeds

∆τ * M = τ * - τ c M (1 -α)c H + ατ c L (1 -α)c H + α c H (θ -θ).
The low-quality firm is pushed out of the market if it exceeds

∆τ * L = τ * + 2τ c M (1 -α)c H - (3 -α)τ c L (1 -α)c H + α c H (θ -θ) - 3 c H θ.
Following a trade cost reduction, the medium-quality French producer is the first one to exit the market if

∆τ * L > ∆τ * M ⇔ τ (c M -c L ) > (1 -α)θ.
The medium-quality firm exits first if the market for the low quality firm is sufficiently large (θ small), if the two Northern qualities are not close substitutes (α large) or if the cost gap between the firms is not too small. Notes: Panels (a) and (b) compare the observed behavior of the value of French exports (solid line) to the one that would prevail absent any quality adjustment (dashed line). The "counterfactual" is computed as the sum of the price and quantity growth rates of French exports while the "observed" serie is the counterfactual plus the growth rate of aggregate quality. Panel (a) uses as reference the total value of French exports. Panel (b) corrects the series from changes in the total value of each destination's sectoral imports (Source: UN-ComTrade). The corresponding figures thus reflect changes in the market share of French products. These decompositions are performed at the sectoral and destination-country level and are then aggregated using adequate weights. (1)

( Notes: The solid and dotted lines correspond to the measured evolution of prices, computed over the whole sample (solid line) and the intensive sample (dotted line). They are compared to the evolution in France's effective nominal exchange rate (dashed line). The effective exchange rate is computed using bilateral exchange rates taken from the IMF-IFS database and trade weights from UN-ComTrade. Notes: Variance decomposition obtained from the following regression:

Q kc2005 = k δ k F E k + c α c F E c + ε kc
where Q kc2005 is the 2005 quality index computed for the ISIC sector k in destination market c, {F E k } is a set of sector fixed effects and {F E c } a vector of country fixed effects. Notes: Robust standard errors in parentheses with a p < 0.01, b p < 0.05 and c p < 0.1

The change in low wage countries' market shares for sector k and destination c is explained by the total change in the country's market share in sector k, computed over all destination countries but c, ("∆ mks global") and the distance between the country and c, in relative term with respect to the "mean" exporter to that destination ("Relative distance"). In columns 2 and 3, the regression is run separately for China and for other low-wage countries.

  i.e., on the sub-sample of trade flows that are present in the data over two consecutive years. The comparison of the aggregate and intensive quality indices conveys information about the sources of aggregate quality changes. Namely, the evolution of the intensive quality indicator can be attributed to the demand being reallocated between firms producing different quality levels. Additional movements in the aggregate quality indicator come from the relative quality of firms entering/exiting the market being different than the mean quality of firms already in the market.

  aggregates the 1,453 series into a multilateral quality index, using a weighting scheme that reflects the specialization of French exports. The evolution of quality is compared to the price index (expressed in the currency of the importer), over the whole sample (panel (a)) and over the "intensive" sub-sample that abstracts from entries and exits (panel (b)).The left panel corresponds to the results based on the CES assumption while translog preferences are assumed in the graphs of the right panel. Once again, results are very similar whatever the preference assumption. The figure confirms that quality adjustments mainly come from the extensive margin. While the aggregate quality index increases by more than 11% over the period, the intensive index is almost flat. The evolution of quality is roughly monotonous over time. This is not true of the behavior of prices, which are strongly correlated with exchange rate fluctuations (see Figure A.2 in the Appendix).19

  Figure A.3 shows that quality upgrading is stronger, on average, in the US, most of the European Union and Poland. On the other hand, quality is almost unchanged, or even deteriorates, for exports towards Greece and Portugal. This holds true in the restricted sample of France' 15 main partners depicted in Figure A.3. On the whole sample, quality changes tend to be positively correlated with the country's growth rate, as illustrated in Figure A.5 in Ap-

  Figure 3 uses equation (8) to decompose the 1995-2005 growth of exports (in value) by destination country (panel a) and by sector (panel b). The relative size of the quality component with respect to the overall growth rate of exports provides us with

  plots the change in the quality of French sectoral exports (averaged across destination markets) against the change in low-wage countries' market share. It shows a positive relationship between quality upgrading and increased competition from low-wage countries, for the whole sample (panel (a)), as well as for the sub-sample of intensive trade flows (panel (b)

Figure 1 :

 1 Figure 1: Evolution of the aggregate price and quality of French exports

Figure 2 :

 2 Figure 2: Impact of quality upgrading on export performances

Figure

  Figure 3: Decomposition of the value of exports

Figure 4 :

 4 Figure 4: Evolution in the market shares of low wage countries and France

Figure 5 :((

 5 Figure 5: Quality & low-wage countries' competition, across industries

Figure

  Figure A.1: Evolution in the number of French export flows

Figure

  Figure A.3: Evolution of quality, by destination country

Figure

  Figure A.4: Evolution of quality, by sector

Figure

  Figure A.5: Quality changes and aggregate growth

Table 1 :

 1 Summary statistics : These summary statistics are computed over the distribution of sector-and destination-specific indices for 2005 (Q kc,05 with Q kc,1995 = 100). Sectors are defined in the ISIC revision 2 nomenclature. The decomposition is either performed on the whole sample ("Intensive + extensive" rows) or on the subsample of intensive flows ("Intensive" rows). Interpretation: Over 1995-2005, the mean growth rate of quality, averaged across markets and sectors, is equal to 18.2%. The corresponding average price increase is equal to 7.5%. In the meantime, unit values were increasing by 21.2%.

	Variable	Mean Std. Dev. pctle 5 pctle 95	N
	CES indices
	Quality (Intensive + Extensive)	118.2	73.9	52.2	211.1	1453
	Quality (Intensive)	106.8	53.4	63.4	154.2	1453
	Price (Intensive + Extensive)	107.5	39.7	61.6	173.7	1453
	Price (Intensive)	111.4	33.7	71.9	169.1	1453
	Unit Value (Intensive + Extensive)	121.2	80.0	53.9	225.9	1453
	Unit Value (Intensive)	117.5	58.0	60.9	203.9	1453
	Translog indices
	Quality (Intensive + Extensive)	118.5	86.4	54.8	213.6	1453
	Quality (Intensive)	105.2	41.6	66.3	149.9	1453
	Price (Intensive + Extensive)	108.0	44.4	59.5	181.0	1453
	Price (Intensive)	110.4	30.7	74.5	162.9	1453
	Unit Value (Intensive + Extensive)	118.7	69.5	57.5	205.4	1453
	Unit Value (Intensive)	115.3	50.3	62.7	190.7	1453

Notes

  Robust standard errors in parentheses. a p < 0.01, b p < 0.05, c p < 0.1. The dependent variable is the log difference of the quality index between 1995 and 2005, computed at the ISIC (revision 2) level for each destination country."∆ 95-05 LWC Mkt sh. America", "∆ 95-05 LWC Mkt sh. Africa", "∆ 95-05 LWC Mkt sh. Pacific", "∆ 95-05 LWC Mkt sh. Asia", "∆ 95-05 LWC Mkt sh. Europe", "∆ 95-05 LWC Market sh LWC (w/o Asia)", "∆ 95-05 LWC Market sh Asia (w/o China)" and "∆ 95-05 Chinese Market share" denote the 1995-2005 change in market shares for low wage countries in America, Africa, Pacific, Europe, Asia, low wage countries excluding Asia, Asian low wage countries excluding China and China, respectively. All market shares are computed excluding France.

			2)	(3)	(4)	(5)	(6)
			Dep. var: ∆ 95-05 ln Quality
	∆ 95-05 LWC Mkt sh. America	-5.638			-5.278
		(4.178)			(4.388)
	∆ 95-05 LWC Mkt sh. Asia	0.377 a 0.387 a		0.353 c 0.382 c
		(0.144) (0.146)		(0.196) (0.193)
	∆ 95-05 LWC Mkt sh. Europe	-0.455			-0.483
		(0.892)			(0.481)
	∆ 95-05 LWC Mkt sh. Pacific	-0.530			-1.513
		(1.995)			(1.780)
	∆ 95-05 LWC Mkt sh. Africa	0.565 c			0.531
		(0.311)			(0.381)
	∆ 95-05 LWC Mkt LWC (w/o Asia)		0.190			0.183
			(0.368)			(0.418)
	∆ 95-05 LWC Mkt sh. Asia (w/o CHN)			0.296			0.253
				(0.337)			(0.331)
	∆ 95-05 LWC Mkt sh. China			0.390 b			0.399
				(0.155)			(0.256)
	Observations	1170	1170	1170	1170	1170	1170
	R 2	0.071	0.066	0.066	0.120	0.115	0.115
	Country Dummies	Yes	Yes	Yes	Yes	Yes	Yes
	Sector Dummies	No	No	No	Yes	Yes	Yes
	Estimation Method	OLS	OLS	OLS	OLS	OLS	OLS
	Sample	Whole Whole Whole Whole Whole Whole
	Countries	All	All	All	All	All	All
	Aggregation Method	CES	CES	CES	CES	CES	CES
	Notes:

  Note: The scatter plots illustrates, for each country, the growth rate of quality over 1995-2005 (y axis) against the growth rate of its GDP per capita. GDP per capita data are taken from the World Bank's World Development Indicators.

		.3
	Change in quality 1995-2005	1 .2
		-.2	0	.2	.4	.6	.8	1	1.2
				Change in GDP per capita 1995-2005
				Eastern Europe		Eastern Asia
				Rest of the world		Fitted values

Table A

 A

		.1: Variance Decomposition
	Source	Partial SS	dof	MS	F	Prob > F
	CES
	Model	42573.5	38	1120.4	2.38	.000
	Country FE	7020.9	13	540.1	1.15	.318
	Sector FE	35552.6	25	1422.1	3.02	.000
	Residual	152917.1	325	470.5
	Total	195490.5	363	538.5
	Translog
	Model	47210.1724	38	1242.4	2.07	.000
	Country FE	10389.6	13	799.2	1.33	.191
	Sector FE	36820.5	25	1472.8	2.46	.000
	Residual	194662.4	325	599.0
	Total	241872.6	363	666.3

Table A

 A

		.2: First stage regressions
		(1)	(2)	(3)
			Dep. Var: ∆ Market Share
	∆ mks global	0.804 a	0.614 a	0.718 a
		(0.049)	(0.079)	(0.060)
	Relative distance	-0.002 a	-0.000 c	-0.065 a
		(0.000)	(0.000)	(0.009)
	Country sample	All LWCs All LWCs but China	China
	Observations	13213	12813	400
	R 2	0.475	0.191	0.391
	F-stat	102.2	22.7	94.9

Crucially, our methodology assumes that the quality produced by a given firm is time-invariant while all the variation in aggregate quality is due to reallocations of market shares across differentiated qualities. This differentiates us from[START_REF] Bloom | Trade Induced Technical Change: The Impact of Chinese Imports on Innovation, Diffusion and Productivity[END_REF],[START_REF] Mion | Trade with China and Skill Upgrading: Evidence from Belgian Firm Level Data[END_REF] and[START_REF] Mion | Import competition from and outsourcing to China: a curse or blessing for firms?, CEPR Discussion Papers[END_REF] that study how competition from low-wage countries induces within-firm technology changes that may be related to the firm upgrading the quality of its products.

The within-industry shift in demand away from unskilled and toward skilled workers is documented in a number of papers. See, among others,[START_REF] Berman | Changes in the Demand for Skilled Labor within U.S. Manufacturing: Evidence from the Annual Survey of Manufactures[END_REF] and[START_REF] Bernard | Exporters, skill upgrading, and the wage gap[END_REF] for the US, Strauss-Kahn (2004) and[START_REF] Biscourp | Employment, skill structure and international trade: Firm-level evidence for France[END_REF] for France and[START_REF] Machin | Technology And Changes In Skill Structure: Evidence From Seven Oecd Countries[END_REF] and[START_REF] Berman | Implications Of Skill-Biased Technological Change: International Evidence[END_REF] for a panel of developed countries.[START_REF] Berman | Changes in the Demand for Skilled Labor within U.S. Manufacturing: Evidence from the Annual Survey of Manufactures[END_REF],[START_REF] Machin | Technology And Changes In Skill Structure: Evidence From Seven Oecd Countries[END_REF] and[START_REF] Berman | Implications Of Skill-Biased Technological Change: International Evidence[END_REF] interpret the evidence as the result of skilled-biased technological change. Results in[START_REF] Bernard | Exporters, skill upgrading, and the wage gap[END_REF] rather suggest that the lion's share of the rise in wage premia comes from shifts from production to non-production intensive establishments within the same industry.[START_REF] Biscourp | Employment, skill structure and international trade: Firm-level evidence for France[END_REF] andStrauss-Kahn (2004) relate the phenomenon to international trade.

[START_REF] Verhoogen | Trade, Quality Upgrading, and Wage Inequality in the Mexican Manufacturing Sector[END_REF] provides evidence of a positive link between the capital intensity of a firm and the quality of its output.

[START_REF] Crozet | Quality sorting and trade: Firm-level evidence for French wine, CEPR Discussion Papers 7295[END_REF] measure the quality of exported wines using producer ratings found in wine guides.[START_REF] Verhoogen | Trade, Quality Upgrading, and Wage Inequality in the Mexican Manufacturing Sector[END_REF] uses the ISO 9000 certification as a proxy for the quality of Mexican plants.

Appendix A considers the other two possibilities, namely that the Southern firm offers an intermediate, or a high quality.

We do not seek to endogeneize quality choices since our empirical strategy assumes that, at the firm-level, quality is constant over time.

The shock has no impact on the mark-up of the southern firm: dp L dτ * = 0.

Results in Appendix A allow to refine this conclusion, by considering the possibility that the Southern firm produces a medium or even a high quality. When she produces the highest quality available in the market, the mechanism is reversed, and the mean quality of Northern exports goes down following a competitiveness loss. When the South produces the medium quality, the shock still induces a quality upgrading in the North when the low and the medium quality are close enough.

The decomposition is detailed in[START_REF] Boorstein | Quality Upgrading and its Welfare Cost in U.S. Steel Imports[END_REF]. It crucially relies on two assumptions. First, g(.) must be homogeneous of degree one. Second, the considered basket of goods has to be separable from other consumptions in the aggregate utility function. In particular, the consumption of varieties produced in France is assumed separable from the consumption of goods produced in other countries. This (strong) assumption is necessary in the absence of firm-level data on non-French export flows.

It may be that the same firm serves the same market with several cn8 varieties within the same hs6 "sector". These varieties are assumed as substitutable from each other as two varieties produced by different firms. These "multi-product" companies represent a very small share of our sample, however. More than 90% of the firms we consider produce a single product within a given hs6 category.

See Sato (1976),[START_REF] Vartia | Ideal Log-Change Index Numbers[END_REF] Feenstra (1994).

In the empirical part, we use a homogeneous calibrated value for σ k , equal to 5. We also tried using sector-specific estimates taken from[START_REF] Imbs | Elasticity Optimism, CEPR Discussion Papers 7177[END_REF]. This reduces the sample of goods under consideration, but almost all results hold both qualitatively and quantitatively.

The evolution in the number of French flows is depicted in Figure A.1.

Note that the unit value index, which the literature uses as an indicator of either price or quality competitiveness has increased by 21% over the period. This is consistent with[START_REF] Khandelwal | The Long and Short (of) Quality Ladders[END_REF] whose results suggest sectoral unit values are poor indicators of either prices or qualities.

Consistent with the empirical strategy described in Section 3, the counterfactual is measured at the lowest level of aggregation. We then aggregate across hs6 products and countries using a Sato-Vartia or a Tornqvist formula.

This number is calculated using the sub-sample of export flows that is considered in the rest of the analysis. The corresponding growth rate based on the whole universe of French exporters is very similar, equal to 69%.

We follow[START_REF] Bernard | Survival of the best fit: Exposure to low-wage countries and the (uneven) growth of U.S. manufacturing plants[END_REF] and define low-wage countries as countries which GDP per capita is less than 5% of the US one. Market shares data are averaged over France's export markets considered in the empirical exercise. They are computed using the information on bilateral trade flows of the UN-ComTrade database.

The distance variable is a population weighted mean of city-to-city bilateral distances, downloaded from the CEPII's website (http : //www.cepii.f r/anglaisgraph/bdd/distances.htm).

GDP per capita data are taken from the World Bank's World Development Indicators, and market shares are computed using ComTrade import flows declarations.