Policy Distortions and Aggregate Productivity: The Role of Idiosyncratic Shocks

Jose Maria Da Rocha, Pau Salvador Pujolas
2011 The B.E. Journal of Macroeconomics  
We study the implications of idiosyncratic shocks on the effects of resource misallocation across heterogeneous plants. We consider that plant productivity follows a Brownian process and we use the forward Kolmogorov equation to analytically characterize the endogenous distribution of entering plants. We show that when plant's operational profits are non constant, exit decision is equivalent to asking whether the plant option value is non-negative. The model reproduces the fact that
more » ... ct that cross-sectional dispersion in productivity is positively correlated with time-series volatility of productivity. Our main contribution is to show that if one is calibrating/estimating a model without shocks and endogenous entry, to fit data generated from a model with shocks and endogenous entry, one will underestimate fixed cost of production and overestimate TFP distortions. JEL classification: O1
doi:10.2202/1935-1690.2297 fatcat:y4cytz6hx5hzfobrvz4b7laemu