Micro-Level Misallocation and Selection†

American Economic Journal: Macroeconomics 2021, 13(4): 341–368 https://doi.org/10.1257/mac.20160253 By Mu-Jeung Yang* How large are the aggregate productivity losses from the misallocation of resources across firms? With endogenous selection, microfrictions can induce extensive margin misallocation among firms: too many unproductive firms are active (Zombies), and too many productive firms are inactive (Shadows). Therefore, the same set of measured distortions potentially induces much larger aggregate productiv- ity losses, as the composition of firms is shifted toward unproduc- tive active firms. I develop and calibrate a model with plant-level microdata for Indonesia to quantify aggregate welfare in the pres- ence of extensive margin misallocation. My estimates show that selection can magnify aggregate TFP losses from microdistortions by over 40 percent compared to existing estimates. Realistic values of measurement error even increase the relative importance of exten- sive margin misallocation. (JEL D22, D24, E23, J24, J31, O14, O15) icrodistortions that prevent optimal resource allocation across firms have been shown to contribute significantly to observed differences in total factor produc- tivity (TFP) across countries; see Hsieh and Kleno 2009 w (). The current empirical literature has focused on intensi ve margin misallocation: among active firms, some are too big and some too small relative to an equilibrium without frictions. At the same time, a parallel literature has emphasized the potential importance of selection for aggregate TFP, as in Lucas 1978 ( ); Melitz 2003 ( ); and Guner, Ventura, and Xu 2008 (). This paper contributes to both literatures by quantitatively showing that even without direct selection barriers, the presence of producer-level frictions can distort selection indirectly and reduce aggregate productivity by shifting the composition of firms toward lower-efficiency firms: too many lo w-efficiency firms are...