Output Quality, Productivity Growth, and Resource Reallocation

Abstract

Producing high-quality products incurs higher costs but provides greater consumption benefits. This presents a challenge in measuring firms' production capability when technical efficiency and output quality evolve heterogeneously across firms in response to economic shocks. Using a unique panel dataset that contains an index of scientific output quality, this paper examines the role of quality in production capability by introducing a new, quality-adjusted productivity measure that accounts for the consumption benefits and production costs of quality in addition to the technical efficiency of production, without confounding demand shocks. We find that about three quarters of the benefit created by quality is offset by the cost of producing the quality in the Chinese steel-making industry. In contrast to the traditional quantity- and revenue-based productivity measures, growth and resource reallocation based on quality-adjusted productivity capture the net effect of differential changes in technical efficiency and output quality across firms and over time, which may reinforce or offset each other depending on the nature of the shocks.

Keywords: output quality, productivity, growth, reallocation, misallocation

JEL Classification: D24, L11, L15, O47