Misallocation and Intersectoral Linkages

Abstract

We analytically characterize the aggregate productivity loss from allocative distortions in a setting that accounts for the sectoral linkages of production. We show that the effects of distortions and the role of sectoral linkages depend crucially on how substitutable inputs are. We find that the productivity loss is smaller if input substitutability is low. Moreover, with low input substitutability, sectoral linkages do not systematically amplify the effects of distortions. In addition, the impact of the sectors that supply intermediate inputs becomes smaller. We quantify these effects in the context of the distortions caused by market power, using industry-level data for 35 countries. With our benchmark calibration, which accounts for low input substitutability, the median aggregate productivity loss from industry-level markups is 1.3%. To assume instead unit elasticities of substitution (i.e., to use a Cobb-Douglas production function) would lead to overestimating the productivity loss by a factor of 1.8. Sectoral linkages do amplify the cost of markups, but the amplification factor is considerably weaker than with unit elasticities.

Flexibility and Frictions in Multisector Models

“…Therefore, in response to tightened frictions, their prices increase relatively more than what they would increase absent of frictions, which then further increases production costs-and therefore wedges-for their many less-flexible downstream sectors. These results share the intuition in Osotimehin and Popov (2017), where eliminating markups has higher TFP gains when production flexibility is higher. Nevertheless, the analysis in Osotimehin and Popov (2017) assumes homogeneous elasticities.…”

“…These results share the intuition in Osotimehin and Popov (2017), where eliminating markups has higher TFP gains when production flexibility is higher. Nevertheless, the analysis in Osotimehin and Popov (2017) assumes homogeneous elasticities. In our case, heterogeneity in production flexibility is the key.…”

Misallocation in the Market for Inputs: Enforcement and the Organization of Production*

“…Our paper is also closely related to the literature on misallocation in developing countries (see Hopenhayn (2014) for a survey). Several papers have extended the work of Hsieh and Klenow (2009) to settings in which distortions affect the use of intermediate inputs, e.g., Jones (2013), Bartelme and Gorodnichenko (2014), Fadinger, Ghiglino and Teteryatnikova (2016), Bigio and La'O (2016), Caprettini and Ciccone (2015), Liu (2017), Caliendo, Parro and Tsyvinski (2017), Osotimehin and Popov (2017), and Baqaee and Farhi (2017). These papers typically posit industry-level production functions and use industry-level data.…”

Input-Output Networks and Misallocation

“…12 Second, in exploring the role of intersectoral linkages and the potential isomorphism between the VA and GO approaches, this paper contributes to the literature on production networks, and is thus related to the important studies of Jones (2011Jones ( , 2013 on the role of production networks in amplifying the effect of given distortions. It also relates to several other recent papers on the network propagation of distortions, which include, among others, Altinoglu (2020), Bartelme and Gorodnichenko (2015), Bigio and La'O (2020), Baqaee andFarhi (2019b, 2020a,b), Caliendo et al (2017), Liu (2019), Luo (2019), and Osotimehin and Popov (2020). 13 While these latter studies mainly focus on the aggregate effects of idiosyncratic distortions in production networks, we pay close attention to the issue of TFP gains from moving to efficiency between a model with production networks and a model without.…”