Micro-Level Misallocation and Selection: Estimation and Aggregate Implications

How large are the aggregate productivity losses from the misallocation of resources across firms? If firm entry and exit are endogenous, micro-frictions can induce extensive-margin misallocation: inefficient firms continue to survive (Zombies) and efficient firms are forced to exit (Shadows). Furthermore, since the number of firms is endogenous, variety effects can either reinforce or offset misallocation losses. I develop and estimate a structural model with plant-level micro-data for Indonesia to quantify both types of extensive-margin effects of micro-distortions. I show that adding extensive margin effects empirically magnifies the welfare losses for a given set of measured distortions. Regarding the variety-effects, I show that sample selection issues of previous studies are likely to bias results toward finding that variety effects offset misallocation losses, when in fact, they do not. Regarding extensive-margin misallocation, my estimates show that it can increase aggregate TFP losses from micro-distortions by over 40%. Compared to existing estimates, aggregate TFP losses from micro-distortions are 50-100% higher, mostly driven by extensive-margin misallocation instead of variety effects.