8 widely, even when controlling for income. This suggests that some economies could reap particularly large gains from quality upgrading, while for others diversification may be a priority. Those countries with low average quality have considerable scope to upgrade quality even within existing export sectors. Other developing countries may already enjoy relatively high export quality, but consistent with their low incomes this is in sectors with short quality ladders or low productivity. These economies could benefit from diversification into sectors with new opportunities for quality upgrading.

These broad facts hold also when focusing on two subsamples: small states, and commodity exporters (Figure 6).<sup>26</sup> Small states follow patterns similar to those in other countries: quality rises with income, and particularly sharply at income levels below $10,000. In commodity exporters, there also is potential for quality upgrading during the development process, as countries shift toward more processed products within each commodity category. However, the process may be more constrained by exogenous factors (such as the grade of available minerals) than in manufacturing.

The results indicate significant scope for quality upgrading in not just manufacturing, but also agriculture. As countries develop, the quality of agricultural products on average increases substantially. Further, the length of quality ladders varies substantially across subsectors in both agriculture and manufacturing (Figure 7).<sup>27</sup> All this suggests that early development need not be driven by the establishment of a manufacturing base. Although soil and climate may impose some limitations, the finding that sharp increases in quality can be registered in agricultural and commodity exports is particularly important since in many developing countries a large share of the labor force remains concentrated in agriculture.

# **D.   Quality Ladders: Potential for Quality Upgrading**

A country’s position on sectoral world quality ladders indicates the potential for further quality upgrading in its existing product basket. To illustrate, we analyze the position of China, Malaysia, Tanzania, and Vietnam on these quality ladders, alongside the composition of their current export baskets (Figure 8). Overall, both the length of the quality ladder, and a country’s relative position on the ladder, can vary considerably across sectors.

Tanzania and Vietnam are examples of countries with considerable quality upgrading potential within existing export sectors. Tanzania has experienced strong growth during the last decade. Yet, Tanzania’s exports are concentrated in primary and agricultural exports, and within those sectors the country is generally in the bottom half of the quality ladder, suggesting large potential for quality upgrading. Horizontal diversification, for instance towards manufactures, may create additional opportunities for quality upgrading. Vietnam’s exports, on the other hand, are already heavily tilted towards manufactures, particularly the miscellaneous manufactures sector, which includes apparel and footwear. However, as in Tanzania, there is still much potential for further quality upgrading in these sectors.

Some of the more mature Asian countries may require horizontal diversification to enable further quality upgrading. Malaysia is heavily specialized in exports of electronics, a subcategory of the machinery and transport equipment sector, but is already coming close to the world frontier in this sector. To enable further quality upgrading, it may first need to diversify. This diversification could occur across SITC 1-digit 26 Countries are classified as small states if their population is smaller than 1.5 million in either 2010 or 2011, using Penn World Tables (2010) and _World Development Indicators_ (2011) data. This classification does not include fuel exporters that are high income (as per World Bank definition), including in particular Bahrain, Brunei, and Equatorial Guinea. Countries are classified as commodity exporters, following the IMF _World Economic Outlook_ classification, if commodities on average exceed 50 percent of total exports.

27 For instance, red wine, Arabica coffee, and shrimp and prawns constitute examples of agricultural products with particularly long quality ladders (cf. Lederman and Maloney, 2012, Box. 5.1).