Misallocation and productivity

A large portion of differences in output per capita across countries is explained by differences in total factor productivity (TFP). In this article, we summarize a recent literature — and the articles in this special issue on misallocation and productivity — that focus on the reallocation of factors across heterogeneous production units as an important source of measured TFP differences across countries.     

Aggregate productivity and aggregate technology

Aggregate productivity and aggregate technology are meaningful but distinct concepts. We show that a slightly modified Solow productivity residual measures changes in economic welfare, even when productivity and technology differ because of distortions such as imperfect competition. Our results imply that aggregate data can be used to measure changes in welfare, even when disaggregated data are needed to measure technical change. We then present a general accounting framework that identifies several new non-technological gaps between productivity and technology, gaps reflecting imperfections and frictions in output and factor markets. Empirically, we find that these gaps are important, even though we abstract from variations in factor utilization and estimate only small average sectoral markups. The evidence suggests that the usual focus on one-sector DSGE models misses a rich class of important propagation mechanisms that are present only in multi-sector models.     

Misallocation and productivity in the lead up to the Eurozone crisis

We use Portuguese firm-level data to investigate whether changes in resource misallocation may have contributed to the poor economic performance of some southern and peripheral European countries leading up to the Eurozone crisis. We extend Hsieh and Klenow’s (2009) methodology to include intermediate inputs and consider all sectors of the economy (agriculture, manufacturing, and services). We find that within-industry misallocation almost doubled between 1996 and 2011. Equalizing total factor revenue productivity across firms within an industry could have boosted valued-added 48% and 79% above actual levels in 1996 and 2011, respectively. This implies that deteriorating allocative efficiency may have shaved around 1.3 percentage points off the annual GDP growth during the 1996–2011 period. Allocative efficiency deterioration, despite being a widespread phenomenon, is significantly higher in the service sector, with 5 industries accounting for 72% of the total variation. Capital distortions are the most important source of potential value-added efficiency gains, especially in the service sector, with a relative contribution increasing over time.     

Multinational production,exports and aggregate productivity

This paper presents and estimates a dynamic model of multinational production (MP) and exports with heterogeneous firms. The model highlights the interaction between firms' location and export decisions and their effect on aggregate productivity. The model is structurally estimated using firm-level Indonesian manufacturing data. The results are broadly consistent with the pattern of productivity, exports and MP across firms. Counterfactual experiments suggest that there are substantial productivity gains due to international trade and MP. The implied changes in steady state real wages, however, are relatively small. The experiments emphasize that the nature of firm-level trade and MP interactions are crucial to determining the aggregate effects of trade and foreign direct investment policy.     

Factor market distortions across time,space and sectors in China

In this paper, we measure TFP losses in China?s non-agricultural economy associated with labour and capital misallocation across provinces and sectors between 1985 and 2007. We also decompose the overall loss into factor market distortions within provinces (between state and non-state sectors) and distortions between provinces (within sectors). Over the entire period, misallocation lowers aggregate non-agricultural TFP by an average of twenty percent. However, after initially declining, these losses increased appreciably beginning in the mid-1990s. This reversal can be attributed almost exclusively to increasing misallocation of capital between state and non-state sectors within provinces, while losses from between province misallocation remained fairly constant. We argue that the recent increase in capital market distortions is related to government policies that encourage investments in the state sector at the expense of investments in the more productive non-state sector.     

Policy distortions and aggregate productivity with heterogeneous establishments

We formulate a version of the growth model in which production is carried out by heterogeneous establishments and calibrate it to US data. In the context of this model we argue that differences in the allocation of resources across establishments that differ in productivity may be an important factor in accounting for cross-country differences in output per capita. In particular, we show that policies which create heterogeneity in the prices faced by individual producers can lead to sizeable decreases in output and measured total factor productivity (TFP) in the range of 30 to 50 percent. We show that these effects can result from policies that do not rely on aggregate capital accumulation or aggregate relative price differences. More generally, the model can be used to generate differences in capital accumulation, relative prices, and measured TFP.     

Informality,innovation, and aggregate productivity growth

This paper investigates how the costs of innovation in the formal sector temper or magnify the impacts of traditional policy levers such as taxation on sectoral choice. I embed a decision whether to operate formally or informally into a richer, general equilibrium model. Formal firms are subject to taxation, but they can improve their productivity through process innovation. Informal firms can potentially avoid taxation, and their productivity is determined by productivity growth in the formal sector. I find that changing tax rates from 50% to 60% decreases formal‐sector participation by 20.9%; however, this percentage falls by 10% when the cost of innovation is lower in the formal sector. The model also illustrates how changes in tax policy affect total factor productivity growth by limiting both the number of formal‐sector firms and the intensity of innovation. These results indicate a potential mechanism to induce firms to operate formally or mitigate harmful impacts of necessary tax changes.     

The structural transformation and aggregate productivity in Portugal

We document the substantial process of structural transformation—the reallocation of labor between agriculture, manufacturing, and services—and aggregate productivity growth undergone by Portugal between 1956 and 1995. We assess the quantitative role of sectoral labor productivity in accounting for these processes. We calibrate a model of the structural transformation to data for the United States and use the model to gain insight into the factors driving the structural transformation and aggregate productivity growth in Portugal. The model implies that Portugal features low and roughly constant relative productivity in agriculture and services (around 22%) and a modest but growing relative productivity in manufacturing (from 44 to 110%). We find that productivity growth in manufacturing accounts for most of the reduction of the aggregate productivity gap with the United States and that a further closing of this gap can only be accomplished via improvements in the relative productivity of services. This paper was written while the authors were affiliated with the Federal Reserve Bank of Richmond. We would like to thank the editor, two anonymous referees, and participants at the Third Conference on Portuguese Economic Development in the European Context organized by the Bank of Portugal for their comments. All errors are our own.     

Experimentation by firms,distortions, and aggregate productivity

Recent empirical research has documented that distortions of allocative efficiency among heterogeneous firms can have large aggregate consequences. This paper evaluates the size of these effects when distortions affect not only resource allocation but also the evolution of firm-level productivity itself. To this end, we partially endogenize the evolution of firm-level productivity in a standard heterogeneous firm model by allowing firms to engage in costly, purposeful experimentation: Firms can engage in risky experiments, which take the form of productivity shocks. Results from failed experiments can be discarded. We then show that endogenous productivity implies up to twice as large effects of productivity-dependent distortions on aggregate consumption.     

Micro-heterogeneity and aggregate productivity development in the German manufacturing sector

A decomposition of aggregate productivity growth of German manufacturing firms that pertain to 11 different industries at a roughly two-digit level observed over the period 1981–1998 is performed. Productivity is measured by a nonparametric frontier function approach. The decompositions of productivity allow for an explanation of the aggregate outcomes by the quantification of the effect of structural change and the contributions of entering and exiting firms. Our results show that these forces drive aggregate productivity to a considerable extent. Remarkably, the large productivity improvements after the German reunification are mainly driven by structural change.

Heterogeneous productivity shocks,elasticity of substitution and aggregate fluctuations

We use a Dixit-Stiglitz setting to show that aggregate productivity fluctuations can be generated through changes in the dispersion of firms’ productivity. When the elasticity of substitution among goods is larger than one, an increase in the dispersion raises aggregate productivity because firms at the top of the distribution produce most of output. When the elasticity is smaller than one, an increase in the dispersion reduces aggregate productivity because firms at the bottom of the distribution use most of inputs. We use individual firm level data from Spanish manufacturing firms to test the relationship between the dispersion of firms’ productivity and aggregate productivity. The estimated coefficients are consistent with the predictions of the model: we find that an increase in the coefficient of variation of firms productivity of 1% increases aggregate productivity by 0.16% in sectors with an elasticity of substitution larger than one while the same increase in the standard deviation reduces aggregate productivity by 0.36% in sectors with an elasticity of substitution smaller than one.     

Government subsidy and aggregate productivity dynamics: Evidence from China

Based on data for Chinese manufacturing firms from 1999 to 2007, this study explores the dynamic evolution of aggregate total factor productivity (TFP) from the perspective of firmsʼ entry and exit. It also quantifies how government subsidies influence the aggregate productivity growth. By decomposing aggregate productivity growth into components, including technological progress, reallocation, entry, and exit effects, we found that aggregate TFP growth in Chinese manufacturingfollows an upward trend during the sample period. This tendency originates from the contribution of technological progress, reallocation, and exit effects. Moreover, the effects of these four components on aggregate TFP growth of different industries, regions, and ownership types are different. Furthermore, technological progress, reallocation, and exit effects are important pathways for government subsidies to promote aggregate TFP growth in Chinese manufacturing.     

Sources of aggregate labour productivity growth in Canada and the United States

Abstract.  In this paper we propose a decomposition technique to examine the sources of industrial contribution to aggregate labour productivity growth. We show that in terms of pure labour productivity growth, the manufacturing and service sectors contributed equally to the aggregate Canada‐U.S. labour productivity growth gap during the 1987–98 period. But, in terms of total industrial contributions, which also take into account the contributions from a change in relative size, the service sector was the largest contributor. We also find that high labour productivity growth industries did not attract resources from stagnant industries – a phenomenon consistent with Baumol's cost disease of stagnant industries. JEL Classification: O47, C43     

The rise of service employment and its impact on aggregate productivity growth

This paper investigates how the employment shift from manufacturing toward service sectors affects the rate of economic growth when services play their role both in intermediate and in final demand. Our model includes as a special case both Baumol’s [Baumol, W.J., 1967. Macroeconomics of unbalanced growth: the anatomy of urban crisis. American Economic Review 57 (3), 415–426] model, in which services are produced only for final consumption, and Oulton’s [Oulton, N., 2001. Must the growth rate decline? Baumol’s unbalanced growth revisited. Oxford Economic Papers 53 (4), 605–627] model, in which services are entirely devoted to intermediate demand. We show that, given that the growth rate of productivity in the service sector is lower than that in the manufacturing sector, both the employment share in manufacturing and the rate of economic growth will decline in the long run irrespective of the size of the elasticity of substitution between labor and service input.     

Financing constraints,firm dynamics,export decisions,and aggregate productivity

We present a dynamic model in which firms accumulate wealth to avoid bankruptcy and to overcome financing constraints that affect their fixed operational costs and the costs of becoming an exporter. Financing constraints not only affect firms directly when they are binding, but also indirectly, through precautionary saving and the selection of firms via entry and exit of the domestic and export markets. We calibrate the model and test some of its predictions using a rich dataset of Italian manufacturing firms for the period 1995–2003. Financing constraints reduce the aggregate productivity gains induced by trade liberalization by 25 percent by distorting the incentives of the most productive firms to self-select into exporting.     

Trade,labour market rigidity,and aggregate productivity in OECD countries

As the economy becomes more open to trade, aggregate productivity can increase by driving out the least productive firms (the selection effect). Since the selection effect reallocates resources toward the more productive firms, this process can be hindered by rigidity in domestic labour market institutions. Based on the selection effect by Melitz (2003), this article empirically examines how rigidity in labour market institutions affects the consequence of trade on aggregate productivity. Findings from panel dynamic ordinary least square (DOLS) estimators suggest that a high degree of labour market rigidity in an open economy reduces Total Factor Productivity (TFP). In particular, in the case of extremely high labour market rigidity but low foreign R&D capital stocks, openness to trade can cause a country to experience decreasing TFP.     

Creativity over time and space

Creativity is often highly concentrated in time and space, and across different domains. What explains the formation and decay of clusters of creativity? We match data on notable individuals born in Europe between the eleventh and the nineteenth centuries with historical city data. The production and attraction of creative talent is associated with city institutions that protected economic and political freedoms and promoted local autonomy. Instead, indicators of local economic conditions such as city size and real wages, do not predict creative clusters. We also show that famous creatives are spatially concentrated and clustered across disciplines, that their spatial mobility has remained stable over the centuries, and that creative clusters are persistent but less than population.

     

Loss aversion in aggregate macroeconomic time series

Prospect theory has been the focus of increasing attention in many fields of economics. However, it has scarcely been addressed in macroeconomic growth models—neither on theoretical nor on empirical grounds. In this paper we use prospect theory in a stochastic optimal growth model. Thereafter, the focus lies on linking the Euler equation obtained from a prospect theory growth model of this kind to real macroeconomic data. We will use generalized method of moments (GMM) estimation to test the implications of such a non-linear prospect utility Euler equation. Our results indicate that loss aversion can be traced in aggregate macroeconomic time series.