Misallocation in Firm Production: A Nonparametric Test Using Procurement Lotteries” with Paul Carrillo (GWU), Dina Pomeranz (U Zurich) and Monica Singhal (UC Davis)

Abstract:

Is there misallocation in firm production, as we might expect to result from market power, contracting constraints, taxes, regulations, corruption, or other potential distortions? And where there is misallocation, how severe are its resulting welfare consequences? In this paper we propose a new test for allocative efficiency of production (AEP) that proceeds without restrictions on firms' production technologies, demand, market structure, or optimizing behavior. We also develop a new procedure to quantify losses from misallocation via a nonparametric instrumental variable random coefficient model. Both procedures exploit exogenous shocks that induce some firms to alter their input use and then measure the average level of, and cross-firm dispersion in, the rate at which firms’ output value increases, on the margin, for a given increase in inputs. We apply these results to a setting in which thousands of firms experience exogenous demand shocks due to lottery-based assignment of public procurement contracts for construction services in Ecuador. Using administrative data on these firms, a randomization inference version of our test rejects the null of AEP but the welfare losses resulting from this misallocation are only 1% relative to the first-best. Standard parametric assumptions applied to the same setting would suggest losses that are an order of magnitude larger.