General Methods for Measuring Factor Misallocation

The paper develops novel methods to measure the extend of factor misallocation. These rely on production functions being homogeneous, but not on specific parameterizations and partly not even on specific functional forms. This reduces the risk to incorrectly reject an efficient allocation. In an empirical application these general methods strongly reject an efficient capital and labor allocation across 473 six-digit U.S. manufacturing industries. Potential output gains of efficiently reallocating factors are between 22 and 64% of observed output. There is also evidence that misallocation increased substantially during the Great Recession with a sizeable contribution to the observed fall in manufacturing output.