Product Dynamics and Trade Liberalization: Evidence from the Korea-US FTA

This study examines resource reallocation within firms by investigating how firms change their product portfolios in response to a fall in trade costs. Using Korean firm-product data, we show that firms experiencing large tariff reductions under the Korea-US free trade agreement are more likely to shrink their product scope. They not only decrease the number of products but also specialize their production in specific products. Furthermore, we show that those specific products are relatively more productive than others within firm by estimating a firm-product efficiency. Dropped and added products tend to be less efficient than incumbent products. However, given the sharp increase in added products’ efficiencies after they enter, the above result may not indicate the low efficiency of new products, but rather the time needed to become organized and profitable. After considering the production distributions of incumbent products within firms, this study finds that firms tend to increase the proportion of efficient products in response to tariff reductions. In other words, firms allocate resources from less efficient products to more efficient ones.