Abstract:
This paper studies how foreign demand affects product quality specialization in international trade. In a model with non-homothetic CES preferences, firms choose quality levels based on global demand conditions, and countries with better access to high-income markets host more high-end producers. As a result, they export relatively more to rich destinations, where demand for quality is stronger. Using bilateral product-level trade data, I test this prediction by examining whether countries with higher "foreign market potential"– a trade-cost-weighted measure of access to rich consumers – export disproportionately more to higher-income destinations. A 10 percent increase in market potential raises the income elasticity of exports by 2.7 percentage points – three times the effect of domestic income. The findings highlight the role of economic integration across development levels in shaping specialization patterns.
