Misallocation, Aggregate Productivity and Policy Constraints: Cross-country Evidence in Manufacturing

Cross-country differences in GDP per capita are to a large extent driven by differences in total factor productivity (TFP). Recent studies suggest that low-income countries have low levels of aggregate TFP because of distorting policies that induce resource misallocation. This study uses a unique, international, firm-level dataset to measure the effect of misallocation on aggregate TFP, and to explain the role of policy constraints therein. The results show that hypothetically removing misallocation leads to considerably higher aggregate TFP. Misallocation is also substantially higher in countries where policy constraints such as firing costs and barriers to external competition are higher. JEL Classification: D24, O40, L60