International Finance Discussion Papers (IFDP)

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May 2018

A Tale of Two Sectors: Why is Misallocation Higher in Services than in Manufacturing?

Daniel A. Dias, Carlos Robalo Marques, and Christine Richmond

Abstract:

Recent empirical studies document that the level of resource misallocation in the service sector is significantly higher than in the manufacturing sector. We quantify the importance of this difference and study its sources. Conservative estimates for Portugal (2008) show that closing this gap, by reducing misallocation in the service sector to manufacturing levels, would boost aggregate gross output by around 12 percent and aggregate value added by around 31 percent. Differences in the effect and size of productivity shocks explain most of the gap in misallocation between manufacturing and services, while the remainder is explained by differences in firm productivity and age distribution. We interpret these results as stemming mainly from higher output-price rigidity, higher labor adjustment costs, and higher informality in the service sector.

Accessible materials (.zip)

Keywords: Misallocation, productivity, firm-level data, structural transformation, Gelbach decomposition.

DOI: https://doi.org/10.17016/IFDP.2018.1229

PDF: Full Paper

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Last Update: January 09, 2020