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TFP Differences and Capital Misallocation in Developing Countries: Hsieh and Klenow (2009) and Virgiliu and Xu (2014)

Cross-country income differences for the most part reflect differences in total factor productivity (TFP) across countries. But what could explain the differences in TFP in different countries?

Hsieh and Klenow (2009, QJE, citation 3021), use establishment level data in manufacturing to measure TFP gaps between China and India and the U.S. They find that misallocation in labor and capital could explain 30%-60% of the TFP differences between developing and developed countries, which means that  China and India have low TFP mainly because that resources are not allocated in the most efficient way.

Virgiliu and Xu (2014, AER, citation 571) extend the framework to study the role of financial frictions in determining TFP. They focus on one specific type of misallocation, distortion in capital allocation generated by financial frictions. However, they find that this type of misallocation explains only a small part, 5%- 10%, of the TFP differences. However, financial frictions reduces new entries and adoption of new technologies and this explains up to 35% of the TFP differences. Their evidence is from South Korea  as well as China and Colombia. This evidence is in line with Buera, Kaboski and Shin (2011, AER) where they find that financial frictions distort the allocation of capital and entrepreneurial talent across production

Buera, Francisco J., Joseph P. Kaboski, and Yongseok Shin. "Finance and development: A tale of two sectors." American Economic Review 101.5 (2011): 1964-2002.
Hsieh, Chang-Tai, and Peter J. Klenow. "Misallocation and manufacturing TFP in China and India." The Quarterly journal of economics 124.4 (2009): 1403-1448.
Midrigan, Virgiliu, and Daniel Yi Xu. "Finance and misallocation: Evidence from plant-level data." American economic review 104.2 (2014): 422-58.


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