Capital Misallocation, Agricultural Subsidies and Productivity: A European Perspective

Resource misallocation has been identified as an important source of aggregate productivity loss, yet to date there is a notable dearth of studies exploring the nature and extent of misallocation in the agricultural sector, despite the fact that it continues to receive significant government supports. In this paper, we analyse resource misallocation in the agricultural sector of the European Union with the aim of quantifying the impact of capital misallocation on aggregate productivity and disentangling its sources. We find that misallocation contributed to a 30 percent loss in productivity in the sector between 2001 and 2010. We can attribute about one third of this loss to distortionary government subsidies which disproportionately benefit relatively less productive farms. We find no evidence that the decoupling reform of the CAP in the mid-2000s reduced the distortionary effect of CAP subsidies on the allocation of capital. Our results provide an important benchmark for understanding misallocation in the context of a modern developed agricultural sector and other industries that benefit from potentially distortionary government supports.