Misallocation, Establishment Size, and Productivity

We consider a model of heterogeneous production units with endogenous entry and productivity investment to assess the quantitative impact of policy distortions: when the productivity elasticity of distortions increases from 0.09 in the United States to 0.5 in India, aggregate output and average establishment size fall by 53 and 86 percent (37 and 0 percent in the standard factor misallocation model). Entry productivity and factor misallocation contribute equally to the reduction in output, whereas lower life-cycle productivity growth is fully offset by increased entry and reduced productivity dispersion. Establishment size differences are consistent with evidence from a new comprehensive cross-country dataset.