Next installment of the NBER growth session recap. The second paper was by Joel David (USC), Hugo Hopenhayn (USC), and Venky Venkateswaran (NYU Stern). Their jumping off point is the apparent mis-allocation of factors of production across firms. The standard of comparison here is Hsieh and Klenow (2009), who find that mis-allocation of factors is lowering output by something like 50% in China and India.

So why are factors mis-allocated? David, Hopenhayn, and Venkateswaran propose that this is partly due to informational issues. That is, firms themselves do not know ex-ante (when they are deciding on how much capital or labor to hire) exactly what their productivity will be ex-post. Hence they make mistakes, and part of what we observe in the ex-post data are these mistakes. So rather than explicit taxes, subsidies, or other frictions, poor information about future productivity drives mis-allocation.

To get some quantitative feel for how important this is, they focus on listed companies. These have the advantage of an extra source of information on future prospects, the stock price. There is a neat little information extraction problem they show solves nicely that allows them to use the observed productivity of firms and the stock prices to back out the degree of uncertainty firms have ex-ante. With this, they suggest that in the U.S. roughly 40% of variation in productivity firms is a surprise to firms. In India, about 80% of variation in productivity is a surprise. Because of the poorer information, Indian firms make bigger mistakes on average, and so there is more ex-post mis-allocation.

It's a clever explanation for mis-allocation, and is one of those stories that in some sense has to be true to some extent. There is no way firms have perfect information on future productivity (or demand, which is essentially the same thing in these models). The question is how big of an effect it is, and they suggest it's pretty sizable.

One question that came up in my head afterwards was whether the degree of uncertainty is related to the level of returns. That is, Indian firms have a lot of uncertainty (risk) in their productivity draws, apparently. Is that high risk associated with higher rewards? If it is, then we can't really say that this is mis-allocation, per se. Firms are making optimal decisions ex-ante, and there happens to be a willingness to tolerate risk in the economy. If, on the other hand, high risk is associated with low rewards, then there really is a mis-allocation in the sense that they are making uninformed decisions.