Mohler, Lukas und Seitz, Michael:
The Gains from Variety in the European Union
Munich Discussion Paper No. 2010-24
Department of Economics
University of Munich
Online at http://epub.ub.uni-muenchen.de/11477/
The Gains from Variety in the European Union
Faculty of Business and Economics, University of Basel, Peter Merian-Weg 6, 4002 Basel, Switzerland
Department of Economics, Ludwig-Maximilians-University of Munich, Ludwigsstrasse 28, 80539 Munich, Germany
Over the last decade, European Union members have experienced a dramatic increase in im-
ports. This increase was accompanied by a strong growth in the number of imported goods and
trading partners, indicating positive welfare gains for consumers via an extended set of consumption
possibilities, as pointed out in the "New Trade Theory". In this paper, we apply the methodology
developed by Feenstra (1994) and Broda and Weinstein (2006) to estimate structurally the gains
from imported variety for the 27 countries of the European Union using highly disaggregated trade
data at the HTS-8 level from Eurostat for the period of 1999 to 2008. Our results show that, within
the European Union, especially “newer” and smaller member states exhibit high gains from newly
imported varieties. Furthermore, we find that the vast majority of the gains from variety for con-
sumers stem from intra-European Union trade.
JEL classification: F12, F14;
Keywords: European Union, Welfare Gains from Trade, Trade in Variety;
∗Tel.: +41 61 267 0770; fax +41 61 267 1316; Email address: Lukas.Mohler@unibas.ch
†Corresponding author. Tel.: +49 89 2180 6286; fax +49 89 2180 6227; Email address: Michael.Seitz@lrz.uni-
The European Union with its 27 member states today constitutes the largest single market in the
world. Over the past decade, several historical events have deepened the economic integration of the
economies within the European Union but also of the member states into the world economy, resulting
in a strong increase in trade flows. First, the euro was introduced as book money in 1999 and today
is the official currency of 16 European Union member states. Second, the transition of the Eastern
European economies from planned economies to market economies after the fall of the Iron Curtain was
accompanied by a surge and redirection of trade flows towards the "old" member states as well as a surge
of trade between Eastern European countries. This transition finally led to the eastern enlargement in
2004, when ten new member states joined the European Union, followed by Romania and Bulgaria
in 2007. Finally, the European Union and its member states were confronted with the integration of
fast-growing emerging markets into the world trading system over the last decade, with China and other
East Asian economies at the forefront. This dynamic process of economic integration on the one hand
caused more competition and new challenges for the European member states and European firms. On
the other hand the integration process was accompanied by a dramatic increase in internal and external
trade flows for all the member states. One important aspect of this phenomenon is the positive effect on
consumer welfare via increased imports and an extended choice set of available varieties for consumers.
From 1999 to 2008 the total value of imports for all countries has more than doubled. At the same time,
the mean number of supplying countries within an average product category has increased by about
15%, while the number of imported product categories has stayed roughly constant. In sum, about 60%
in the increase of total imports can be attributed to the establishment of new trade linkages with new
goods and/or new trading partners, indicating high gains for consumers as a result of newly available
Since the pioneering work of Krugman (1979, 1980, 1981) the "love for variety" motive and its
implications for consumer welfare have been a key element of the "New Trade Theory". Based on a
monopolistic competition model, first outlined by Spence (1976) and Dixit and Stiglitz (1977), where
a single good is available in different varieties, these models predict that trade leads to an increased
number of varieties available for consumers. In combination with a constant elasticity of substitution
(CES) utility function, trade generates positive effects for consumer welfare via the availability of more
varieties of one good. Since then, economists have tried to quantify empirically the gains for consumers
from newly imported varieties. In his seminal contribution, Feenstra (1994) was the first to assess
empirically the impact of new and disappearing varieties for a single imported good. Based on the
theoretical framework of the New Trade Theory, Feenstra (1994) developed an artificial price index
to measure the impact of traded varieties on consumer welfare. The idea is that new varieties lower
the price index, while disappearing varieties increase the index, where the magnitude depends on the
substitutability between the varieties and their expenditure share. Broda and Weinstein (2006) extend
the approach of Feenstra (1994) and construct an aggregate price index using the full set of imported
products to compute the import price index bias resulting from the omission of new and disappearing
varieties. This approach allows them to quantify the overall impact of imported varieties on consumer
welfare for the United States for the period from 1972 to 2001. Using highly disaggregated trade data,
and the assumption that goods are differentiated across countries, they show that the unmeasured
growth in product variety has been an important source of welfare gains.1Their results indicate an
upward bias of the conventional price index of the magnitude of 1.2% per year which translates into
an overall effect of 2.6% of GDP for the overall period or put differently, consumers are willing to pay
roughly 0.1% of their annual income to have access to a larger set of goods and varieties.
In this contribution we adopt the methodology of Broda and Weinstein (2006) to estimate struc-
turally the gains from imported variety for all 27 European Union member states for the period from
1999 to 2008 by exploring a rich dataset of highly disaggregated trade data at the HS-8 level which allows
us to identify over 10,000 different product categories: to our best knowledge this has not been used
before in another study. The effects on consumer welfare of newly available products are in particular
interesting for European economies, since the European Union consists of many small and medium-sized
economies with high import shares and a high degree of political and economic integration within the
European Union as well as in the world economy. In addition, our study of a set of countries allows us
1The definition that goods are differentiated across countries is based on the theoretical framework of Armington
(1969). Here, a variety is simply a particular good produced by a particular country, e.g., French wine.
to analyse and interpret results across countries, adding another dimension to this approach. We follow
Broda and Weinstein (2006), and construct an artificial import price index for each country. In a first
step we estimate a total of approximately 170,000 elasticities of substitution, one for each imported good
of each country. In a second step we use these elasticities to compute a correction term for each product.
This term captures the effect on the price index that is due to the change in the variety set. Based
on the structural assumption of a Krugman (1980) style economy, we finally calculate the gains from
variety for each single member state. Furthermore, we extend the approach of Broda and Weinstein
(2006) which allows us to calculate the import price index for European Union internal and external
imports. This enables us to identify which trade flows contribute most to the gains from variety for
each member state. Using our highly disaggregated trade data, we also provide extensive descriptive
statistics about the number of trading partners and traded products for the European member states,
which allows us to gain new insights into the trade integration process of all the member states. Finally,
we provide some new robustness measures to build further confidence in our results. Our results can
be summarized as follows: for most countries the biases and hence the gains from variety are positive.
However, the results differ across countries and three different groups can be identified. First, for the
largest four economies in the European Union in terms of GDP, the impact of traded variety is small for
the considered period. This can be explained by smaller import shares and the fact that these economies
have already been strongly integrated into the European Union and the world market in 1999, which is
our base year. Secondly, for all the smaller "old" member states we find modestly positive gains from
imported variety. Finally, for the "newer" member states of the European Union, with the exception of
Malta, the gains are strongly positive, mostly larger than 1% of GDP. This result reflects the effects of
the ongoing integration of these countries into the European single market and into the world trading
system as well as their higher growth rates and higher import shares. For example, variety gains for
Estonia sum up to 2.8% of GDP, which is of the same magnitude as Broda and Weinstein (2006) find
for the United States for their much longer period from 1972 to 2001. Our results show that especially
for fast-growing, less-developed and smaller countries, the establishment of new trade linkages and the
importing of new varieties are an important source of welfare gains via trade. We also find that for
most countries about 70% of the gains stem from intra-European trade, emphasizing the positive effects
and importance of European integration. Third, descriptive statistics of the estimated elasticities of
substitution indicate that they do not differ systematically across countries, which is interesting, given
the different sizes of the economies.
Our paper contributes to two strands of the empirical trade literature. First, beside the approaches
of Feenstra (1994) and Broda and Weinstein (2006) several other studies have tried to evaluate the
effects of new varieties on consumer welfare and the role of trade.2
Feenstra (1992). He shows in a numerical example how trade barriers can affect the number of available
products and reduce consumer welfare. Following the idea of Feenstra (1992), Romer (1994) calibrates
a model with fixed export costs and finds that a substantial reduction in trade barriers will lead to more
exported varieties, resulting in an increase of GDP of up to 20%. Using a similar approach Klenow
and Rodríguez-Clare (1997) construct and calibrate a general equilibrium model with detailed Costa
Rican trade data to quantify the impact of trade restrictions on welfare. Their results suggest that
the gains from trade liberalization can be higher compared with traditional models if the effects of
traded variety are taken into account. In an extension, Arkolakis et al. (2008) provide a more detailed
analysis of the Costa Rican trade liberalization and find that the effect of trade liberalization on product
variety is relatively small, since new products are imported in small quantities. Furthermore, Broda
and Weinstein (2004) document the rapid growth in product variety over the last decade in world trade
and point to the important effects on consumer welfare.3 4Although these studies made important first
steps in analysing and understanding the impact of new traded varieties, their methodologies and data
rest on strict assumptions and provide an unprecise measure compared with the more sophisticated
approach of Broda and Weinstein (2006). Therefore, more recent papers rely on the methodology first
proposed by Feenstra (1994) and extended by Broda and Weinstein (2006). Using detailed market data
A first attempt was made by
2For a more microeconomic perspective on the effects of new varieties on consumer gains see Hausman (1981), Hausman
(1994), and Trajtenberg (1989).
3For a theoretical explanation of the increase in traded varieties also see Yi (2003), Melitz (2003), and Bernard et al.
4The increase of product variety over the last decades can also be observed at the national level. Bils and Klenow
(2001) find a strong increase in 106 product categories for the U.S especially over the last 20 years.
about the U.S. automobile market Blonigen and Soderbery (2009) are able to estimate a more precise
measure of welfare gains and show that the Armington assumption, that goods are only differentiated
across countries, hides significant welfare gains. They find that the estimated impact of new net varieties
on consumer welfare is doubled in magnitude when compared with conventional import data. Using
similar methodologies and data another strand of literature emphasizes the positive effect of increased
import variety on productivity, including Feenstra and Markusen (1994), Broda et al. (2006), and
Feenstra and Kee (2008). Considering the European case, Funke and Ruhwedel (2005) provide an
empirical analysis of disaggregated trade data on export variety and economic growth in the Eastern
European countries. Their analysis shows a high correlation between increased imported variety and
economic growth. Second, while the European integration process has received substantial interest in
the literature, the analysis of European Union trade flows and their positive effects on consumer has
been scarce. Smith and Venables (1988) made an important first step in evaluating the positive effects
of a single market in the European Union. Based on a Krugman (1979) model, they show in a numerical
experiment that the creation of a single market has a strong pro-competitive effect at the industry level,
generating large welfare gains for its member states of up to 4% of GDP. In the European trade literature
three prominent lines can be identified. First, several studies have tried to quantify the positive effect
of the introduction of the euro on trade: see Baldwin (2006) for a survey. Second, researchers have
studied the effect of European integration and the role of national borders in intra-European trade
flows, including Nitsch (2000) and Chen (2004). Finally, Buch and Piazolo (2001) and Manchin and
Pinna (2009) study the implications of the Eastern European enlargement in 2004 on the growth and
redirection of trade flows towards the European Union. All these studies rather build on aggregated
trade data and evaluate the extent to which the composition and volume of trade flows are changing,
but do not analyse highly disaggregated trade data which is also a novelty of our approach. Finally,
all these papers neglect the potential positive effect on consumer welfare, which is at the heart of our
The rest of the paper is organized in the following sections. In section 2 we describe the dataset and
provide detailed descriptive statistics of disaggregated trade data and the number of imported varieties
for all the member states. Section 3 briefly reviews the methodology developed by Feenstra (1994) and
Broda and Weinstein (2006) to account for variety changes in price indices before turning to section 4
which presents the results and interpretation for each member state. Section 5 concludes.
2 Descriptive Statistics
To quantify empirically the positive effects on consumer welfare from the availability of new imported
products, our analysis requires highly detailed product information on the quantity and prices of im-
ported goods. Therefore our empirical analysis uses the database from Eurostat which consists of highly
disaggregated trade data defined at the HS-8 level for all EU-27 member states for the period from 1999
to 2008. In this data set about 10,000 products are classified, for which data on the value and tons
of imports are available, which allows us to calculate unit prices for each product. From this database
we collect information on the imports for each single member state from all the trading partners in the
world. We use quarterly data from the first quarter of 1999 to the first quarter of 2008 to rule out
potential seasonality effects. The richness of this data set allows us to provide a precise estimate of the
gains from variety, which is robust to several extensions as discussed in the following sections. Table
1 provides some detailed information on the development of the product categories available from this
data set over time. For the period from 1999 to 2008 the total number of classified products amount
to 13,234. At the same time the number of classified products decreased from 10,428 to 9,699. In
total, 2,950 new products were introduced and 3,838 were deleted, resulting in a total net change of
6,788 classified, products for the overall period. It is also obvious that for each year the numbers new
and excluded products are roughly equal, while the absolute value of reclassification varies over time.
Especially for the years 2002, 2006, and 2007 large product category changes can be observed.5
5This is due to reclassifications that appear regularly. The empirical approach presented below is robust towards such
reclassifications of products, as explained by Feenstra (1991).
Our results show that for most countries the import price index is biased upwards due to the
omission of newly imported varieties. This gives rise to positive welfare gains to consumers stemming
from an increased product variety. However, our analysis also reveals substantial differences across
countries. Based on the assumption of a Krugman type economy, we can hardly identify any gains from
newly imported varieties over the last decade for the largest four countries of the European Union. On
the other hand, these gains are more significant for the smaller and especially younger member states
of the European Union. Here, our results suggest positive welfare gains of up to 2.8% of GDP, as in
the case of Estonia. This fact demonstrates that especially for smaller and fast-growing economies the
creation and extension of trade linkages can be an important source of welfare, a fact often neglected in
the discussion about the positive effects of globalization and economic integration.
To shed further light on the source of these gains, we develop an empirical strategy that allows us
to identify the extent to which intra-EU and non-EU imports contribute to the gains from variety. Our
analysis shows that between 70% and 100% can be attributed to increased variety imports from other
European Union members. Imports from other countries did not contribute much to these gains; on
the contrary, according to our results these imports often even contributed negatively, thus mitigating
the positive effects of variety growth in the total imports. Thus, the ongoing integration of countries
within the European Union positively benefits consumers with availability of an increased consumption
set. Specifically, these predominantly stem from European varieties accentuating the economic benefits
of the European integration process. Consequently, our empirical study is also interesting for future
European Union accession candidates.
Finally, we provide a sensitivity analysis and conclude that our results are reasonably robust to
other specifications. We show that the estimation of different elasticities of substitution for different
product categories is a central issue. Additionally, using aggregated data may hide significant growth
along the extensive margin leading to an underestimation of the gains from variety. While our study
solely focuses on the consumption side, the methodology and data can also be easily implemented to
analyse the positive effects of variety growth on production and productivity and may be an interesting
field for future research.
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