of financial development. This suggests a mean-variance “tradeoff” in quality growth along the development path. Rapid improvements in product quality will be more likely feasible in countries with greater financial depth.

Section 3 evaluates these theoretical predictions using data on disaggregated (HS10) bilateral exports to the United States for 1990-2000. Product quality is proxied by unit values.<sup>3</sup><sup>_,_4</sup> The advantage of using international trade data is that information on exports is available at a much finer level of disaggregation than domestic production, especially for a large sample of countries. The implicit assumption is that the export basket of any country to the United States represents its technological frontier, and any domestic innovations in product quality are reflected in changes in unit values of products in the export basket to the United States. Further, given both our theoretical focus and data limitations, we focus on quality changes in existing products (i.e. the “intensive margin”), rather than the introduction of altogether new products (the “extensive margin”).

Both of the main theoretical predictions discussed above find support in the data. The mean of quality growth and the variance of quality growth are strongly correlated with each other. Countries with greater financial depth exhibit systematically higher mean and higher variance in the growth of product quality.

Our results speak to a number of interrelated issues in the literature on economic growth, technology and convergence across countries. It is well established that countries have not converged in their income levels – despite a range of theoretical mechanisms identified by the literature, such as international technology transfer and trade that could drive convergence. Our findings are consistent with the lack of income convergence across countries because they suggest that the combination of risk associated with technology upgrading and institutional weaknesses that prevent insurance against risk may be a barrier to technological adoption. The implied lack of convergence in product quality is also consistent with the well known finding by Schott (2004) that higher income countries exhibit systematically higher quality of exports.

> 3We follow a number of papers in the recent international trade literature that have used unit values as a measure of quality, such as Schott (2004). In an influential contribution, Khandelwal (2010) proposes a methodology to estimate product quality that also incorporates information on market shares. However, Feenstra and Romalis (2014) find that “much of the variation in unit values is explained by quality, so quality-adjusted prices vary much less than the raw unit values or than the quality-adjusted estimates” of Khandelwal (2010) and others. Regardless, while our analysis focuses on product unit values, in our empirical analysis we also discuss the robustness of our findings to using Khandelwal (2010)’s alternative methodology.

> 4The literature has variously explored the correlates and determinants of product quality. Schott (2004) and Hummels and Klenow (2005) show that unit values increase with level of development. Hallak and Sivadasan (2013) argue that quality improvements represent the accumulation of “caliber,” a factor of production distinct from productivity, while Sutton (2001) sees both quality and productivity as resulting from research and development.

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