The Causes and Costs of Misallocation

TLDR: In this paper, the authors provide a perspective on three key questions: how important is misallocation, what are the causes of misallocating, and beyond the direct cost of lower contemporaneous output, are there additional costs associated with misallocations.

Abstract: Why do living standards differ so much across countries? A consensus in the development literature is that differences in productivity are a dominant source of these differences. But what accounts for productivity differences across countries? One explanation is that frontier technologies and best practice methods are slow to diffuse to low-income countries. The recent literature on misallocation offers a distinct but complementary explanation: low-income countries are not as effective in allocating their factors of production to their most efficient use. We provide our perspective on three key questions. First, how important is misallocation? Second, what are the causes of misallocation? And third, beyond the direct cost of lower contemporaneous output, are there additional costs associated with misallocation? A summary of our answers is as follows: Misallocation appears to be a substantial channel in accounting for productivity differences across countries, but the measured magnitude of the eff...