Multi-product firms and misallocation

This paper studies how distortions alter firms’ product decisions. Using two firm-level datasets in China, we find (i) that multi-product (MP) firms are fewer and smaller in China than in the United States and (ii) that the MP probability of a firm is negatively associated with the level of distortion. We build discrete product choices into a heterogeneous firm model à la Melitz (2003) with entry and exit. Firms are subject to a size-dependent distortion that increases in firm-level productivities and product-level tastes. Calibrated to firm-level data moments in the United States and China, the model generates a welfare loss of 30% compared to the distortion-free economy. 24% of the overall loss is from the distorted product margin, while most of the rest is from the static misallocation as in Hsieh and Klenow (2009).