Cross Country Differences in Productivity: The Role of Allocative Efficiency

There is a growing body of evidence suggesting that healthy, market economies exhibit both static and dynamic allocative efficiency, whereby more productive businesses have a larger market share and reallocation of outputs and inputs within sectors shifts resources from less to more productive businesses (e.g. Baily, Hulten, and Campbell (1992), Bartelsman, Haltiwanger, and Scarpetta (2004), Foster, Haltiwanger, and Krizan (2006), Olley and Pakes (1996)). Because there are no welfare or productivity gains to be obtained from resource reallocation in a frictionless economy (e.g. Hulten (1978); Levinsohn and Petrin (2006)), theoretical and empirical research is needed to model and quantify the frictions that yield a connection between reallocation and productivity. In this paper, we consider models that feature taste and technology differences so that a market with free entry sustains firms operating within a wide range of productivity (e.g, Restuccia and Rogerson (2004), and Hsieh and Klenow (2006)). We then investigate to what extent distortions in signals to decision makers generate model outcomes that track patterns of resource allocation and productivity observed across countries, sectors and over time.