PRODUCT DIFFERENTIATION IN INTERNATIONAL COMMODITY TRADE*
| DOI | http://doi.org/10.1111/j.1468-0084.1989.mp51001003.x |
| Date | 01 February 1989 |
| Author | Montague J. Lord |
| Published date | 01 February 1989 |
OXFORD BULLETIN OF ECONOMICS AND STATISTICS, 51,1(1989)
0305-9049 $3.00
PRODUCT DIFFERENTIATION IN
INTERNATIONAL COMMODITY TRADE*
Montague J. Lord
In a critique of the rigid link established in the 1979 Nobel lecture by Arthur
Lewis (1980) between the export performance of primary commodities and
the prosperity of the industrialized economies, Riedel (1984) noted the dis-
regard of such studies to consider the capacity of exporters 'to engage in price
competition by which means they could conceivably expand exports despite
slowdown in developed countries by claiming a larger share of the DC
[developed country] markets'. Yet Riedel did not analyse the influence of
relative price changes on less developed country [LDC] exports because, as
he noted, 'The appropriate procedure for measuring the link between MDC
[more developed country] export growth and WC export growth... is simul-
taneous estimation of supply and demand equations for LDC exports. The
enormous complexity of demand and supply relationships, however, makes
this approach methodologically infeasible and generally restricts analysis to
highly reduced-form relationships'. This paper presents separate estimates of
parameters in the structural form of a system of equations used to charac-
terize commodity trade. The parameter estimates of the export demand
function provide a measure of the extent to which relative price changes
influence the demand for primary commodity exports of the developing
countries.
Relative price changes can influence the demand for exports when
importers differentiate among alternative supply sources. The recent growth
of interest in product differentiation has been largely due to observed
patterns of intra-industry trade which are inconsistent with the factor propor-
tions theory of trade. Grube! and Lloyd (1975) found that this pattern of
trade not only accounted for a large proportion of trade in manufactured
goods, but that it also represented 30 percent of trade in primary commodity
exports among the industrialized countries. Moreover, the developing
countries direct their primary commodity exports mainly to the industrialized
countries, which themselves produce and export many of the same goods. In
their critical survey of agricultural trade models, Thompson and Abbott
(1980) found that spatial equilibrium models, which rely on transportation
*1 am grateful to David Hendry for helpful suggestions on the dynamic specification of the
trade model, and to members of the Editorial Board for helpful comments. I am also indebted
to Greta Boye for undertaking the calculations described herein. The views expressed in this
paper do not necessarily reflect those of the institution with which the author is affiliated.
35
BULLETIN
costs, have been inadequate in explaining observed trade flows. Both
Thompson (1981) and Deardorif (1985) have noted a number of other
factors explaining levels of trade: product heterogeneity by country of origin,
diversification among supply sources, historical and political ties, and costs of
switching from one supplier to another.
The dynamic specification of the relationship used to characterize data-
generating processes of the demand for traded commodities adopts recent
works on dynamic time-series models that explain observed disequilibria
in the context of long-term, or steady-state, solutions of behavioural re-
lationships. The error correction mechanism (ECM), which has been applied
to a wide variety of economic relationships since the work of Davidson,
Hendry, Srba and Yeo (1978) and which is based on the theory of cointegral
processes of Engle and Granger (1987), is shown to provide a particularly
appropriate specification for the export demand relationship. On the one
hand, the ECM yields long-run unitary elasticity of export demand with
respect to foreign import demand and, on the other, it does not preclude non-
unitary income elasticity of foreign import demand. In the export demand
function, the application of a logit constraint to the regressand, so as to
ensure that exports to a market never exceed total imports of that market,
yields a direct estimate of the elasticity of substitution, while the price
elasticity of export demand is inversely related to the market share of a
country.
The paper is organized as follows: Section I discusses sources of product
differentiation in international commodity trade; Section II derives the
relationship used to estimate the export demand function; Section III
provides an illustrative example; and Section IV presents the empirical
results. The paper concludes with a summary of the findings.
L SOURCES OF DIFFERENTIATION
The literature dealing with product differentiation has followed Chamberlin
(1933, chap. 4) in distinguishing between two types of differentiation. The
first deals with differentiation of goods which are themselves perfectly
homogeneous but which are nonetheless differentiated because of variations
in conditions surrounding their sale. Hotelling (1929) introduced this concept
in his model of spatial competition, and Lancaster's (1979) work on market
structures, based on the characteristics approach to consumer preferences,
has focused on this type of differentiation. The second type deals with
differentiation of products based on quality distinctions that are inherent in
the goods themselves.
In the international trade context, both types of differentiation can arise.
Commodities become horizontally differentiated when importers differ in
their choice of the geographic origin of the good as a result of attributes
related to the export of a product, despite the possible absence of quality
variations from country to country. Perceived differences in commodity
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