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# **1. INTRODUCTION**

Economic development requires the transformation of a country’s economic structure. This involves diversifying into new sectors; reallocating resources towards more productive firms; and, critically, improving the _quality_ of goods produced. Producing higher-quality varieties of existing products helps build on existing comparative advantages to boost export revenues and productivity. Yet the potential for quality upgrading varies by product (Khandelwal, 2010), and has been found to be higher in manufactures than in agriculture and natural resources. For countries at an early stage of development, diversification into new products may therefore be a precondition to reaping large gains from quality improvement.

This paper makes three contributions to the debate on quality upgrading. First, we develop new estimates, based on bilateral data, which are far more extensive than previous efforts, covering 166 countries and hundreds of products over the period 1962–2014. Second, we present a series of stylized facts about export quality and how it varies along the development path. In particular, we illustrate changes in quality over time, both for the entire sample and for selected countries of interest, and we discuss the relationship between quality and income. Throughout, we examine separately the quality of primary goods and of manufactures, and we disaggregate manufacturing into several sub-sectors. Finally, we begin the task of harvesting this data set to analyze the determinants of quality upgrading.

The paper is related to a rapidly expanding literature on diversification and quality upgrading. Schott (2004) finds significant country within-product quality differences, based on shipment-level U.S. customs data.<sup>4</sup> In particular, quality varies systematically with exporters’ relative factor endowments and production techniques. He argues that intra-industry trade is largely trade in goods of different quality. Sutton and Trefler (2011), elaborating on Hausmann et al. (2007), find that between 1980 and 2005 low-income countries moved into more “sophisticated” products<sup>5</sup> , but produced them at low quality levels. As a result, diversification has not led to a significant boost in GDP per capita. Put differently, diversification and quality upgrading should be viewed as complementary in the development process. Hwang (2007) argues that countries need to enter sectors with long “quality ladders” that they can climb.<sup>6</sup> Relatedly, Hausmann and Hidalgo (2010) demonstrate that, if production of any given good requires a combination of capabilities, then the returns to acquiring new production capabilities can increase with the number of a country’s existing capabilities. Thus, quality upgrading underpins the growth process to the extent that it implies new capabilities. In addition, the proximity in “capabilities space” between goods already being produced and higher value-added goods is also important (Hausmann and Klinger, 2006).<sup>7</sup> This literature, however, faces a key challenge: export quality cannot be directly observed and needs to be estimated. Unit values, defined as the ratio of export values to quantity for any given product category, are observable. Schott (2004) and Hummels and Klenow (2005) showed that these unit values increase with 4 For instance, unit values for cotton shirts imported from Japan are 30 times higher than those from the Philippines.

5 Defined as those products predominantly produced by high-income economies. While higher-income countries also tend to produce higher-quality varieties, the concepts of quality and sophistication are quite different. Quality refers to the relative price of a country’s varieties _within_ their respective product lines. Product sophistication, as in Hausmann et al. (2007), assesses the composition of the aggregate export basket.

6 Starting production of higher-quality varieties need not imply abandoning production of lower-quality varieties, particularly if the latter are better suited to some destination. Mukerji and Panagariya (2009) note that the United States produces goods at a large variety of quality levels. Nonetheless, the _average_ quality within 4-digit product categories, which is the focus of our study, tends to be higher in higher-income economies.

7 Regarding proximity, Bahar, Hausmann, and Hidalgo (2014) documents that the probability of a country exporting a new type of good is significantly (over 50 percent) larger if a neighboring country is a successful exporter of the same good.