Misallocation and product choice

This study examines the costs of misallocation of inputs between multi-product firms that endogenously choose among heterogeneous products.

Abstract

The authors study the costs of misallocation of inputs between multi-product firms that endogenously choose among heterogeneous products. Misallocation of inputs between firms has been shown to be a significant drag on aggregate productivity: it is especially severe between farms in the agricultural sectors of low income economies. Existing estimates of its costs have relied on models of single product firms using a single aggregate production function. Using rich farm crop-level data from India, we estimate product-level production functions and find that they are meaningfully different from one another and from the aggregate one. The authors build a general equilibrium model of firm-level misallocation in which multi-product firms (or farms) are able to choose the set and mix of heterogeneous products. Misinterpreting product heterogeneity as evidence of distortions and missing the endogenous product choice response to real distortions biases single-product models to overstate misallocation, while ignoring returns to scale heterogeneity and within firm productivity dispersion biases them to understate it. On net, the single-product model understates the aggregate productivity cost of misallocation between Indian farms by 28%.

This paper is part of the Structural Transformation and Economic Growth (STEG) programme.

Citation

Gordeev P and Singh S. ‘Misallocation and product choice’ STEG Working Paper Series WP094 2024

Links

Misallocation and product choice

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Published 5 April 2024