The Aggregate and Complementary Impact of Micro Distortions

We explore how regulatory or institutional distortions to resource reallocation limit the ability of developing countries to adopt new technologies. An efficient economy innovates quickly; but when the economy is unable to redeploy resources away from inefficient uses, technological adoption becomes sluggish, growth is reduced, and income lags further behind the leading economy. We use a firm dynamics model to analyze income gaps between the U.S. and several developing countries. For the median country, the model accounts for one-third of the income gap with respect to the U.S., with 60% of the simulated gap explained by firm renewal distortions taken individually and 40% by their interaction.