Nonhomothetic Preferences and International Trade

Abstract

This study examines whether nonhomothetic preferences underlie the “missing trade” problem associated with factor content of trade models. We first find that per capita income goes a long way in explaining differences in goods consumption across countries. We then find a striking correlation between the factor content of consumption and per capita income, and show that accounting for this is a key part of resolving the case of the missing trade. However, nonhomothetic preferences over broad categories of expenditure play only a small role in this phenomenon. Rather, we find that as income grows, spending is directed towards the relatively capital-intensive version of a given good. Since recent research shows that capital intensity is correlated with quality (Schott, 2004), our results suggest that within-product quality differences are likely important for explaining the factor content of trade, whereas nonhomothetic preferences over broad categories of expenditure are much less so.