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The paper was finished while the first author was a Visiting Scholar in the Research Department of the IMF. Ralf Ruhwedel is a research and teaching assistant at Hamburg University. The comments of two anonymous referees have forced us to clarify a number of issues and have very much helped to improve the paper. We have also benefited from seminar participants at the IMF Research Department, Cambridge University, Groningen University, the University of St. Andrews, Humboldt—University of Berlin, Kiel University, and Munich University. The opinions expressed in the paper are those of the authors and should not be taken as indicative of any official position. Any remaining errors are the authors’ responsibility.
One indicator is that none of the most well-known international datasets used in the empirical growth literature (the Heston-Summers dataset, the Barro-Lee dataset, and the World Bank World Development Indicators database) contains any information on product variety over time and/or across countries. Another indicator is that the up-to-date survey of the new growth evidence by Temple (1999) does not contain any work on product variety. The reason for this state of affairs is probably that direct measures of product variety are difficult to obtain and therefore empirical work in this area seems to be a risky business.
Compare Feenstra and others (1999) with Feenstra, Yang, and Hamilton (1999). In a related paper, Weinhold and Rauch (1997) have constructed a Herfindahl specialization index for 28 different manufacturing industries to analyze the link between openness, specialization, and productivity growth. Owen and Wren-Lewis (1993) and Driver and Wren-Lewis (1999) have analyzed the impact of variety and quality upon foreign trade using rough proxies such as cumulated investment and R&D flows.
The model draws on the original theoretical analysis concerning the production of and the demand for “variety” and “quality” by Grossman and Helpman (1991).
Even with no differences across countries in the long-run growth rate, one can explain a large variation in rates of growth with transition dynamics.
In extensive sensitivity analyses of cross-country growth regressions, Levine and Renelt (1992) and Sala-i-Martin (1997) have shown that investment in physical capital is the most robust variable explaining cross-country growth differences. Explaining differences in the level of income across countries by appealing to differences in n and SK, however, obviously begs new questions. Why is it that some countries invest more in physical capital than others and why do individuals in some countries spend more time to develop new intermediate goods? This model cannot address these questions. A more complete model answering these questions has to assume utility-maximizing individuals to choose to work in either the final-goods sector or in the intermediate goods sector expanding product variety. In order to simplify the analysis, we will not develop this more complete model here.
The classification distinguishes about 6,400 commodities according to the Harmonized System (HS). Data were collected from the OECD database International Trade by Commodities Statistics—ITCS Classification, Paris 1997. All data are expressed in current US$ and start in 1989, the year that HS data were first reported. In principle it would be preferable to use national production data but they are neither available at a sufficiently disaggregated level nor are the available data consistent across countries.
In their extensive discussion of quality and variety, Grossman and Helpman (1991), Coe and Helpman (1995), and Bayoumi, Coe, and Helpman (1999) have focused on levels of investment in R&D at home and abroad. A clear problem here is that the lag between R&D expenditures and the production of new varieties could be very long. Furthermore, it is also the case that many improvements in quality and variety can be realized without any R&D expenditure being incurred. In particular, increases in variety can occur through imitation, which involves little or no R&D expenditure.
Negative (positive) values for the index indicate lower (higher) product variety than in the United States. The negative numbers are a result of the log transformation in (18).
Industrial coverage groups industries into “Primary Products” (textile products, wood products, paper and printing, rubber products, primary metal, leather products, and stone, clay and glass) and “Secondary Products” (food products, beverages and tobacco, apparel, chemicals and plastics, fabricated metal products, machinery, electrical products, transportation equipment, and instruments).
Canova and Marcet (1995) argue that such a normalization should also eliminate a significant part of the cyclical noise in the data.
The methodology followed by the vast majority of researchers up to 1995, that is, cross-sectional regression, was based on the hypothesis of a growth process characterized by a smooth path toward a steady state. As Islam (1995) and Caselli, Esquivel, and Lefort (1996) have demonstrated empirically that this underlying hypothesis is invalid, we have used panel data estimates, which are not subject to this restrictive hypothesis on the growth process and allow for heterogeneity in steady state output levels.
Since we include country dummy variables, we cannot include initial per capita GDP, which also varies across countries but not over time.
We have used lagged variables as instruments. The fact that we are chronically short of good instrument variables has led to the widespread employment of oil prices as instruments. We have not used oil prices in our work because recent research (compare Hooker, 1996) has indicated that oil prices are endogenous variables.
As the paper measures product variety in traded goods and not only capital goods, an alternative interpretation of this result, however, is the demand theory formulated by Linder (1961), where high income countries have a more advanced and differentiated consumption structure. According to Linder’s (1961) theory, the causal link runs from real income per capita to the degree of product variety. Barker (1977) acknowledges the contribution of Linder (1961) and develops a similar variety hypothesis according to which consumers love variety and therefore exports and imports tend to increase more than proportionally with real income per capita. Schott (2000) has recently also pointed out that more advanced countries have greater product variety. In other words, he interprets the causation from GDP to product variety, rather than the reverse, as done in this paper.
A11 data are from the OECD Analytical Database. Missing data do not allow us to construct TFP indices for Greece, Iceland, Portugal, or Turkey.
We have used product variety measures for “secondary products” because we would expect the hypothesis of endogenous growth to apply more to secondary than primary industries (compare Feentra and others, 1999).