Essays on firm-level distortions and aggregate productivity

The development economics literature assigns a significant role to productivity in explaining the differences in standards of living across countries. This thesis studies the role that firm-level distortionary policies can have on productivity and revisits the empirical significance of productivity differences across countries. The first paper of this thesis (Chapter 1) develops a theory to quantify the impact of distortionary policies on aggregate productivity. I use firm-level data to measure the degrees of allocation and selection inefficiencies across countries in different levels of development. The results show that there are more severe selection distortions in developing economies where as documented in the literature, a greater level of misallocation is observed as well. Furthermore, I find that almost the entire gap in the output per-worker between rich and poor countries can be eliminated by removing the inefficiencies caused by such distortionary policies where approximately half of the effect can be attributed to the selection margin. The second paper of this thesis (Chapter 2) proposes a theoretical method to disentangle the role that different channels play in creating misallocation. Higher levels of measured misallocation can be explained by distortionary policies as well as more severe adjustment costs of capital formation in developing economies. Using data from the manufacturing firms in the US and China, I identify the role of these two channels in each country. I find that the adjustment costs play a minor role and it is the distortionary policies underlying Chapter 1 that are responsible for the most of the measured misallocation observed in both countries. The last paper of this thesis (Chapter 3) is centered around an empirical question: To what extent does productivity explain the differences in standards of living across countries? The difficulty in measurement of human and physical capital at the country level has led to drastically different answers to this question in previous work. In this paper, I use firm-level data to estimate productivity at the firm-level and use it to construct a measure of productivity at the country level. The results show that less than 55% of the income differences across countries can be explained by differences in productivity.