Capital Allocation in Developing Countries

This paper investigates the sources of capital misallocation across a group of developing and developed countries, using the empirical methodology developed in David and Venkateswaran (2019. “The Sources of Capital Misallocation.” American Economic Review 109 (7): 2531–67). The main findings are: (i) technological frictions—namely, adjustment costs and uncertainty—account for only a modest share of the observed misallocation; (ii) heterogeneity in firm-level technologies potentially explains between one-quarter and one-half, but (iii) dispersion in markups is much smaller; (iv) after accounting for these factors, on average, at least 50 percent of misallocation within each country remains unexplained, suggesting a large role for additional—potentially distortionary—factors. These factors are largely attributable to a component that is correlated with firm size/productivity and one that is essentially permanent to the firm. They exhibit strong negative correlations with income per capita and direct measures of the quality of the business environment from the World Bank Doing Business Report. The paper reports a broad set of moments describing firm-level investment dynamics and detailed parameter estimates on a country-by-country basis with an eye towards future work in this area.