TRADE: Productivity and Quality of Multi-product Firms; Dr Shengyu Li (University of New South Wales, Sydney)

Abstract

This paper proposes a novel method to estimate productivity and quality of multi-product firms at the firm-product level, together with transformation function and demand parameters. The method relies on firm optimization conditions to obtain a one-to-one mapping between observed data and unobserved productivity and quality. It has the advantage of allowing for heterogeneous unobserved intermediate input prices and scalability to handle many products, without imputing firm-product input shares or relying on productivity evolution. We apply this method to a set of Mexican manufacturing industries. We find that multi-product firms' better-performing products have both higher productivity and higher quality, with the former emerging as a stronger predictor of within-firm performance. However, firms face a trade-off between quality and productivity, which we refer to as the cost of quality. The cost of quality is higher for more differentiated products and declines with product age. In a counterfactual exercise, we show that a reduction in the cost of quality can lead to substantial firm-level productivity gains and that, on average, about 30.3 percent of these gains are due to the within-firm reallocation of production. Notably, a larger product scope allows more room for intra-firm resource reallocation, leading to higher productivity gains. This reveals a new mechanism for enhancing the performance of multi-product firms.

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