Misallocation, Establishment Size, and Productivityy Pedro Bento Diego Restuccia Texas A&M University∗ University of Toronto∗∗ August 2015 Abstract We construct a new dataset using census, survey, and registry data from hundreds of sources to document a clear positive relationship between development and average establishment size in manufacturing across 134 countries. We rationalize this relationship using a standard model of reallocation among production units that features endogenous entry and productivity in- vestment. The model connects small operational scales to the prevalence in poor countries of correlated distortions (the elasticity between wedges and establishment productivity). The model also rationalizes the finding in poor countries of low establishment-level productivity and low aggregate productivity investment. A calibrated version of the model implies that when correlated distortions increase from 0.09 in the U.S. to 0.5 in India, establishment size and establishment-level productivity fall by more than 82 percent and aggregate productivity falls by around 70 percent. Relative to the existing literature, these substantial size and productivity effects are more in line with cross-country data. Keywords: misallocation, establishment size, productivity, investment, idiosyncratic distor- tions. JEL codes: O1, O4. yWe thank David Atkin, Nick Bloom, Margarida Duarte, Peter Klenow, Michael Peters, Xiaodong Zhu, and several seminar and conference participants for helpful comments. All errors are our own. Restuccia gratefully acknowledges the financial support from the Social Sciences and Humanities Research Council of Canada. ∗Department of Economics, Texas A&M University, 3056 Allen Building, 4228 TAMU, College Station, TX 77843, USA. E-mail:
[email protected]. ∗∗Department of Economics, University of Toronto, 150 St.