Misallocation and productivity in the lead up to the Eurozone crisis

We use Portuguese firm-level data to investigate whether changes in resource misallocation may have contributed to the poor economic performance of some southern and peripheral European countries leading up to the Eurozone crisis. We extend Hsieh and Klenow's (2009) methodology to include intermediate inputs and consider all sectors of the economy (agriculture, manufacturing, and services). We find that within-industry misallocation almost doubled between 1996 and 2011. Equalizing total factor revenue productivity across firms within an industry could have boosted valued-added 48 percent and 79 percent above actual levels in 1996 and 2011, respectively. This implies that deteriorating allocative eficiency may have shaved around 1.3 percentage points of the annual GDP growth during the 1996-2011 period. Allocative eficiency deterioration, despite being a widespread phenomenon, is significantly higher in the service sector, with 5 industries accounting for 72 percent of the total variation. Capital distortions are the most important source of potential value-added eficiency gains, especially in the service sector, with a relative contribution increasing over time.