Session 4: Causes and Consequences of Misallocation: Theory and Empirics

How does growing international financial diversification affect firm-level and aggregate labor shares? We study this question using a novel framework of firm labor choice in the face of aggregate risk. The theory implies a cross-section of labor risk premia and labor shares that appear as markups in firm-level data. International risk sharing leads to a reallocation of labor towards riskier/low labor share firms alongside a rise in within-firm labor shares, matching key micro-level facts. We use cross-country firm-level data to document a number of empirical patterns consistent with the theory, namely: (i) riskier firms have lower labor shares and (ii) international financial diversification is associated with a reallocation towards risky/low labor share firms. Our estimates suggest the reallocation effect has dominated the within effect in recent decades; on net, increased financial integration has reduced the corporate labor share in the US by about 2.5 percentage points, roughly one-third of the total decline since the 1970s.

We study the local and aggregate welfare effects of foreign multinational enterprises (MNEs) in an economy with wedge-like distortions. We start with a guiding general equilibrium (GE) framework that highlights the ex-ante ambiguous role distortions can play in amplifying or attenuating the welfare effects of foreign MNEs, and the primitives needed to take the theory to the data. For our empirical application in Mexico, we track the size of four sectors of the economy -- domestically-owned establishments (split into formal or informal) and foreign MNEs (split into maquila and non-maquila) -- across time (1994 to 2019) and commuting zones (CZs). We also construct direct measures of initial wedges and distortions such as crime, labor taxes, subsidies, and credit constraints (varying across establishment types and CZs). We show that Mexico faces substantial distortions that can generate resource misallocation within and across CZs. Then, using an instrumental variable strategy, we find that increases in foreign MNE employment lead to expansions of the local domestic economy. This effect is mainly driven by formal domestic sector growth. Moreover, foreign MNEs in the maquila program have weaker positive effects on the domestic economy than non-maquila MNEs. Finally, we use the reduced-form estimates and the microdata to calibrate the model and quantify the GE effects. We simulate a 10% MNE productivity shock and find that the expansion of MNEs in Mexico between 1994 and 2019 led to an aggregate 6% welfare gain. A quarter of this gain comes from reallocation effects in the presence of distortions, while a fifth comes from productivity spillovers from foreign MNEs to the local domestic sector. (With Jose P. Vasquez (LSE) and Roman David Zarate (World Bank))

We study the role of Export Credit Agencies—the predominant tool of industrial policy—on firm behavior by using the effective shutdown of the Export-Import Bank of the United States (EXIM) from 2015–2019 as a natural experiment. We document sizable real effects of the shutdown: a $1 reduction in EXIM trade financing reduces exports by approximately $4.50. EXIM-dependent firms also experience a contraction in total revenues, investment, and employment. EXIM’s shutdown has the largest effects for exporters facing financing frictions and selling to markets with high contractual frictions, indicating that even in well-developed financial markets, trade financing can be under-supplied by private banks. Consistent with the idea that EXIM support can help to address market frictions, we find that the shutdown increased capital misallocation, as firms with a higher ex-ante marginal revenue product of capital contracted more. These results provide a framework for the conditions under which Export Credit Agencies can boost exports and firm growth, and can act as a tool of industrial policy without necessarily leading to a misallocation of resources.

We leverage a comprehensive dataset of electronic invoices from Chilean firms to document new facts on price dispersion across buyers of manufactured intermediate goods. Over half of firm-to-firm manufacturing sales are accounted for by products that are purchased by more than one buyer in the same month. Price dispersion across buyers is pervasive, with a price range across buyers of 46 percentage points for the average product. Price gaps are highly persistent over time and strongly correlated across different products purchased by the same buyer. While price disparities comove with observable characteristics of buyer-seller pairs—such as size of the buyer and the transaction—these factors account for a small portion of the overall variation in price gaps. We use a workhorse model of production networks to quantify the productivity gains from eliminating observed dispersion in prices across buyers of the same product, under the assumption that this dispersion is driven by buyer-product specific markups. The increase in aggregate productivity (normalized by the sales share of treated multi-buyer firms) ranges from 2 to 7 percent, depending on the calibration of elasticities of substitution. The gains from eliminating markup dispersion across buyers are as large as those of eliminating markup dispersion across products.

Using administrative data from Germany, we document that high-wage locations have substantially lower labor shares and higher wage dispersion. We show that a parsimonious model, in which firm monopsony power stems from search frictions in local labor markets, can explain these facts as long as “superstar” firms sort into productive locations. This positive sorting, which emerges as the unique equilibrium if firm and location productivity are sufficient complements or labor market frictions are sufficiently large, steepens the local wage ladder in productive locations and leads to not only higher wages, but also greater wage inequality. At the same time, positive firm sorting reduces local labor shares in prosperous places because more productive firms have more monopsony power. Our estimated model indicates that firm sorting can rationalize the lower local labor shares in regions with endogenously higher wages and can account for 40% of their increased wage dispersion. In spatial firm sorting, we thus highlight a new source of disparities in local labor market outcomes.

This paper offers a novel perspective on the general equilibrium effects of labour market power. By developing a tractable model of entrepreneurship with monopso- nistic labour markets and endogenous technology adoption, I show that labour market power diminishes aggregate productivity through three distinct channels: (i) misallocation of workers towards small firms, (ii) excess entry of low-ability entre-preneurs, and (iii) limited diffusion of productivity-enhancing technologies. Theproposed theory generates testable predictions, which I validate with novel evidence from Italian microdata: at the province-level, weaker competition in labour markets is associated with greater misallocation, more entrepreneurship, reduced firm size, inferior use of intangibles, and lower productivity. To quantify aggregate losses, I calibrate the model with measures of market power from financial statements, information on IT adoption from survey data, and expenditure shares from national accounts. My results reveal a significant impact of labour market power: aggregate productivity in a typical province is 21% lower than in a competitive benchmark, with excess entry and limited technology diffusion being the dominant factors.

We analyze the adoption of clean technology by heterogeneous firms subject to financing constraints. In the model, capital goods differ in terms of their energy needs and age. In equilibrium, cleaner and newer capital requires more financial resources. Therefore, financial constraints induce an endogenous pattern in clean technology adoption: Financially constrained, smaller firms optimally invest in dirtier and older capital than unconstrained, larger firms. The model is consistent with the empirical patterns of technology adoption we document using data on commercial shipping fleets. We use a calibrated version of our model to simulate the aggregate transition dynamics to cleaner technology.

We develop and quantify a growth theory where consumers preferences are de ned over products with varying environmental impacts. Preferences are nonhomothetic: Necessities are intensive in material inputs whose production leads to high emissions, while luxury goods, being more reliant on service labor, exhibit a comparatively lower environmental footprint. Directed innovation is the focal point of the study: it can be aimed at either enhancing the productivity of material production or re ning the quality of luxury goods. Over time, innovation increasingly prioritizes quality improvement, consequently reducing the environmental impact of economic growth. The pace of structural transformation and the composition of GDP are both endogenous and susceptible to policy interventions. The shift towards quality-oriented growth may result in a decline in measured GDP growth without a decrease in welfare. Extending the model to a two-country trade scenario reveals that trade barriers could have a detrimental e ect on environmental sustainability.

We use firm-level data to identify financial frictions in China and explore the extent to which they can explain firms' saving and capital misallocation. We first document the features of the data in terms of firm dynamics and debt financing. State-owned firms have higher leverage and pay much lower interest rates than non-SOEs. Among privately owned firms, smaller firms have lower leverage, face higher interest rates, and operate with a higher marginal product of capital. We then develop a heterogeneous-firm model with two types of financial frictions, default risk, and a fixed cost of issuing loans. Our model generates endogenous borrowing constraints as banks consider the firm's productivity, asset, and debt when providing a loan. Using evidence on the firm size distribution and financing patterns, we estimate the model and find it can explain aggregate firms' saving and investment and around 50 percent of the dispersion in the marginal product of capital within private firms, which translates into a TFP loss as high as 12%.

We show how to use credit registry microdata to estimate the cost of capital, and how this affects capital allocation efficiency in the United States. Our measure of the cost of capital accounts for the interest rate, expected default probability, recovery rates, and, for floating-rate loans, the expectation of future rates. We find that, on average, the lender’s cost of capital closely tracks the five-year Treasury rate, with a spread of 1.5%. Misallocation depends on dispersion in the social cost of capital, which equals the lender’s cost of capital plus an agency friction. We find that in normal periods, the implied misallocation is small, resulting in an output loss of only 0.5%. However, the dispersion in the cost of capital rose dramatically during the COVID19 pandemic, driven by agency frictions. By integrating microdata with a corporate f inance framework, this study highlights the resilience of U.S. credit markets under typical conditions, and underscores the inefficiencies that can arise during a crisis.

Risk is an important factor that affects investment decisions, especially for undiversified entrepreneurs in less developed economies. Yet standard macro models of f inancial frictions do not incorporate risk: short-term returns are known in advance, and investment is fully reversible. Thus, even if entrepreneurs are risk averse and credit constrained, they will invest all of their assets in the firm, until the marginal product of capital equals the interest rate. As a result, standard models often find that productive entrepreneurs quickly save their way out of credit constraints, limiting the effect of financial frictions on output and aggregate productivity. We incorporate risk into a model of financial frictions, by making investment partially irreversible. Productive entrepreneurs accumulate capital substantially more slowly than in the first-best, leading to a reduction in aggregate productivity. Credit can play a role in undoing these frictions if firms have an option to default. Default creates a state-contingent contract, in which the entrepreneur repays if productivity stays high and defaults if productivity falls; this encourages investment and improves welfare through risk-sharing with the bank.