Globalization and the Gains from Variety Christian Broda and David E. Weinstein NBER Working Paper No. 10314 February 2004 JEL No. F1, E3 Abstract: Since Krugman (1979), product variety has been central to trade and growth models. This paper shows that the growth in imported product variety has been a major source of welfare gains in the U.S. over the last three decades (1972-2001). Using highly disaggregated data, the number of imported product varieties increased by a factor of four. Elasticities of substitution for each category were estimated, and an exact price index was developed. The conventional import price index is biased upward by about 1.2 percent per year. This bias suggests that the welfare gains from variety growth in imports alone are 2.8 percent of GDP. The paper contributes to price measurement, showing that the creation of new goods and varieties is important for aggregate price indices. It also contributes to the measurement of elasticities of substitution, showing that they vary across time and SITC-5 industries. The results show that the increase in imported varieties has raised U.S. real income by about 3 percent. The paper also shows that the impact of increased choice on an exact price index has been enormous. Import prices have been falling 1.2 percent per year faster than official statistics suggest. This means that the aggregate price index that takes variety changes into account has fallen by 28.1 percent relative to the conventionally measured import price index. The paper also estimates the gains from new imported varieties under the same structural assumptions as Krugman (1980). The 28 percent drop in import prices due to new varieties alone implies that increases in imported varieties have raised U.S. welfare by about 3%. The results show that increases in imported varieties have had a large positive impact on U.S. welfare when measured correctly. Prior work on variety has varied in definitions, leading to inconsistent empirical comparisons. Studies have attempted to measure the impact of new varieties on welfare for individual goods and at the aggregate level. However, data requirements make it difficult to estimate aggregate gains from new products. Aggregate studies rely on calibration or simulation exercises to measure the effect of variety growth. These studies typically define a variety as the imports from a given country or the imports from a given country in a particular industry. The paper uses the Spence-Dixit-Stiglitz (SDS) framework to estimate the impact of variety growth on welfare. The SDS framework is based on the CES utility function and its close cousin, the Cobb-Douglas. The paper shows that the use of count data, rather than the changes in import volumes as suggested by Feenstra (1994), can be highly misleading as a measure of variety growth if one allows for a more general utility function.Globalization and the Gains from Variety Christian Broda and David E. Weinstein NBER Working Paper No. 10314 February 2004 JEL No. F1, E3 Abstract: Since Krugman (1979), product variety has been central to trade and growth models. This paper shows that the growth in imported product variety has been a major source of welfare gains in the U.S. over the last three decades (1972-2001). Using highly disaggregated data, the number of imported product varieties increased by a factor of four. Elasticities of substitution for each category were estimated, and an exact price index was developed. The conventional import price index is biased upward by about 1.2 percent per year. This bias suggests that the welfare gains from variety growth in imports alone are 2.8 percent of GDP. The paper contributes to price measurement, showing that the creation of new goods and varieties is important for aggregate price indices. It also contributes to the measurement of elasticities of substitution, showing that they vary across time and SITC-5 industries. The results show that the increase in imported varieties has raised U.S. real income by about 3 percent. The paper also shows that the impact of increased choice on an exact price index has been enormous. Import prices have been falling 1.2 percent per year faster than official statistics suggest. This means that the aggregate price index that takes variety changes into account has fallen by 28.1 percent relative to the conventionally measured import price index. The paper also estimates the gains from new imported varieties under the same structural assumptions as Krugman (1980). The 28 percent drop in import prices due to new varieties alone implies that increases in imported varieties have raised U.S. welfare by about 3%. The results show that increases in imported varieties have had a large positive impact on U.S. welfare when measured correctly. Prior work on variety has varied in definitions, leading to inconsistent empirical comparisons. Studies have attempted to measure the impact of new varieties on welfare for individual goods and at the aggregate level. However, data requirements make it difficult to estimate aggregate gains from new products. Aggregate studies rely on calibration or simulation exercises to measure the effect of variety growth. These studies typically define a variety as the imports from a given country or the imports from a given country in a particular industry. The paper uses the Spence-Dixit-Stiglitz (SDS) framework to estimate the impact of variety growth on welfare. The SDS framework is based on the CES utility function and its close cousin, the Cobb-Douglas. The paper shows that the use of count data, rather than the changes in import volumes as suggested by Feenstra (1994), can be highly misleading as a measure of variety growth if one allows for a more general utility function.