Globalization and the gains from variety

Since the seminal work of Krugman, product variety has played a central role in models of trade and growth. In spite of the general use of love-of-variety models, there has been no systematic study of how the import of new varieties has contributed to national welfare gains in the United States. In this paper we show that the unmeasured growth in product variety from U. S. imports has been an important source of gains from trade over the last three decades (1972-2001). Using extremely disaggregated data, we show that the number of imported product varieties has increased by a factor of three. We also estimate the elasticities of substitution for each available category at the same level of aggregation, and describe their behavior across time and SITC industries. Using these estimates, we develop an exact aggregate price index and find that the upward bias in the conventional import price index over this time period was 28 percent or 1.2 percentage points per year. We estimate the value to U. S. consumers of the expanded import varieties between 1972 and 2001 to be 2.6 percent of GDP.