Product Differentiation, Multiproduct Firms, and Estimating the Impact of Trade Liberalization on Productivity


  • Jan De Loecker

    1. Dept. of Economics, Princeton University, Princeton, NJ 08540, U.S.A. and NBER and CEPR;
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    • An earlier version of this paper was circulated under the title “Product Differentiation, Multi-Product Firms and Structural Estimation of Productivity,” and is a revised version of Chapter 4 of my Ph.D. thesis. This paper has benefited from comments and suggestions of the editor and three anonymous referees. I am especially grateful to Dan Ackerberg, Steve Berry, Penny Goldberg, Joep Konings, Marc Melitz, Ariel Pakes, and Amil Petrin for comments and suggestions. A second special thanks to Amil Petrin for sharing his programs and code. Comments on an earlier version from David Blackburn, Mariana Colacelli, Frank Verboven, Patrick Van Cayseele, and Hylke Vandenbussche helped improve the paper. Finally, I would like to thank various seminar participants for their comments.


This paper studies whether removing barriers to trade induces efficiency gains for producers. Like almost all empirical work which relies on a production function to recover productivity measures, I do not observe physical output at the firm level. Therefore, it is imperative to control for unobserved prices and demand shocks. I develop an empirical model that combines a demand system with a production function to generate estimates of productivity. I rely on my framework to identify the productivity effects from reduced trade protection in the Belgian textile market. This trade liberalization provides me with observed demand shifters that are used to separate out the associated price, scale, and productivity effects. Using a matched plant–product level data set and detailed quota data, I find that correcting for unobserved prices leads to substantially lower productivity gains. More specifically, abolishing all quota protections increases firm-level productivity by only 2 percent as opposed to 8 percent when relying on standard measures of productivity. My results beg for a serious reevaluation of a long list of empirical studies that document productivity responses to major industry shocks and, in particular, to opening up to trade. My findings imply the need to study the impact of changes in the operating environment on productivity together with market power and prices in one integrated framework. The suggested method and identification strategy are quite general and can be applied whenever it is important to distinguish between revenue productivity and physical productivity.