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Productivity, welfare, and reallocation: theory and firm-level evidence

  • Susanto Basu
  • Luigi Pascali
  • Fabio Schiantarelli
  • Luis Serven

We prove that the change in welfare of a representative consumer is summarized by the current and expected future values of the standard Solow productivity residual. The equivalence holds if the representative household maximizes utility while taking prices parametrically. This result justifies total factor productivity (TFP) as the right summary measure of welfare (even in situations where it does not properly measure technology) and makes it possible to calculate the contributions of disaggregated units (industries or firms) to aggregate welfare using readily available TFP data. Based on this finding, we compute firm and industry contributions to welfare for a set of European OECD countries (Belgium, France, Great Britain, Italy, and Spain), using industry-level (EU-KLEMS) and firm-level (Amadeus) data. After adding further assumptions about technology and market structure (firms minimize costs and face common factor prices), we show that changes in welfare can be decomposed into three components that reflect, respectively, technological change, aggregate distortions, and allocative efficiency. Then, using appropriate firm-level data, we assess the importance of each of these components as sources of welfare improvement in the same set of European countries.

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Paper provided by Federal Reserve Bank of Boston in its series Working Papers with number 09-19.

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Date of creation: 2009
Date of revision:
Handle: RePEc:fip:fedbwp:09-19
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  1. Martin L. Weitzman, 1976. "On the Welfare Significance of National Product in a Dynamic Economy," The Quarterly Journal of Economics, Oxford University Press, vol. 90(1), pages 156-162.
  2. Amil Petrin & Jerome Reiter & Kirk White, 2011. "The Impact of Plant-level Resource Reallocations and Technical Progress on U.S. Macroeconomic Growth," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(1), pages 3-26, January.
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