Input misallocation and productivity dynamics

This paper builds on Hsieh and Klenow’s (2009) model to offer a refined analysis of how input misallocations impact aggregate total factor productivity (TFP). We enhance the original model by relaxing the assumption of uniform input prices and adopting an econometric approach to estimate parameters using firm-level data. Estimation of model parameters and allocation efficiency is based on the system of input demand and the production function. We use an indirect inference approach to estimate the system to avoid maximum likelihood estimation, which often faces convergence issues, when there are numerous constraints. We demonstrate our model using the US firm-level manufacturing panel data from 1975 to 2010. Our final sample contains 55,518 observations. We divide the manufacturing industry into seven major categories. Our findings indicate that between 1975 and 2010, the average productivity growth rate was 2.8% but could have reached 3.2% without misallocation, highlighting the substantial gains possible through better resource allocation.