Asymmetric information, quality, and regulations

The author presents a model of international trade that features heterogeneous firms and asymmetric information on the quality of products, which is known to producers but unknown to consumers. The presence of asymmetric information leads to adverse selection whereby high-quality firms exit and only low-quality firms survive. The model shows that adverse selection also affects export participation as only firms with the lowest quality are able to export. For this reason, trade can lead to a reduction in welfare if it causes an average product quality reduction that is too substantial. The author studies the effects of two instruments: minimum quality standards, which force out firms with the lowest quality, and quality certifications, which allow firms to signal to consumers that their quality is higher than a certain threshold, upon payment of a fixed cost. Both instruments can improve welfare if the increase in prices associated with the higher-quality goods is small enough. Furthermore, the author studied how the two instruments interact with countries' openness.