The Costs of Financial Crises: Resource Misallocation, Productivity and Welfare in the 2001 Argentine Crisis

Financial crises in emerging market countries appear to be very costly: output falls are often dramatic, while a host of partial welfare indicators deteriorate as well. The magnitude of the decline in output is puzzling from an accounting perspective, as factor usage does not decline as much as output, resulting in large falls in measured productivity. Furthermore, if productivity is associated with technology, we have no theory to explain why technology should deteriorate during a crisis. In this paper, we present a framework that allows us to account for observed changes in a country's productivity during a financial crises, and to measure the resulting change in the country's welfare. Specifically, we show how to decompose the change in an economy's measured productivity into changes in the efficiency with which resources are allocated across and within sectors and other factors. This framework allows us to measure the welfare costs of a financial crisis, and to decompose these welfare costs into the contributions from changes in technology, in the efficiency of the resource allocation mechanism, in the efficiency of government spending, and in the terms of trade. We apply this framework to the Argentine crisis of 2001 using a combination of national accounts and establishment level data. We find that more than half of the roughly 11% decline in measured total factor productivity can be accounted for by deteriorations in the allocation of resources both across and within sectors. We measure the decline in welfare to be on the order of 15% of one year GDP.