generation of knowledge, its destination and its ultimate economic impact are inclusive, responsive to the broad needs of the local economy – across households, geography, and industries.

# **_III.2 Impact on people_**

Efficient reallocation and innovation by enterprises can also, supported by appropriate policies, positively affect the risk management of all people, including: lowering the volatility to firms of returns from production and to people of consumption expenditures by providing a diversified mix of products; helping people absorb shocks and provide a steadier stream of income and employment; alleviating the resource constraints that limit people’s own risk management possibilities through higher incomes afforded by enhanced productivity; and directly addressing health and safety risks.

# **_III.2a. Impact on people as consumers_**

To what extent do reallocation and innovation decisions by enterprises in response to short-term shocks and longer-term changes in demand and supply trends allow the enterprise sector to make the best use of available resources to meet consumer needs, both in aggregate terms and across different income groups? Bartelsman, Haltiwanger and Scarpetta (2013) examine this question in aggregate terms through a model calibrated to developed and developing country enterprise-level data with permanent and transitory enterprise-specific productivity and distortion shocks.<sup>32</sup> Their analytical framework allows for two different channels through which distortions affect aggregate output and consumption, namely both resource reallocation within industries across enterprises of different productivity levels as well differing paces of firm selection (entry and exit of enterprises of differing levels of productivity). In the presence of distortions, the enterprises with the highest productivity no longer have the highest market shares, outputs and inputs, and some highly productive enterprises with a “bad distortion draw” will exit while some low productivity enterprises will be able to operate, leading to a further misallocation of inputs. A higher dispersion in distortions worsens selection based on productivity and lowers the overall efficiency of resource allocation across operating enterprises, reducing enterprise sector output and consumption by households. They show how the improved selection and size-productivity relationship in Central and Eastern European economies as their transition to a less distorted market economy progressed in the 1990s is associated with a substantial increase in consumption.<sup>33</sup>

> 32 The inclusion of idiosyncratic, enterprise-specific distortion shocks –interpreted broadly to include any distortion that impacts the scale of a business– is consistent with evidence that certain regulations apply _de jure_ differently to enterprises of different sizes (such as rules affecting the hiring and firing of workers applying only to enterprises above a certain size threshold in a number of countries), whereas other regulations are _de facto_ enforced unevenly across enterprises of different sizes, industries, and rent-seeking propensities.

33 Holding the distribution of plant productivity fixed, Hsieh and Klenow (2009) provide suggestive evidence that resource misallocation between existing plants can account for about one-third of the gaps in aggregate manufacturing TFP between the US and countries such as China and India. In Hsieh and Klenow (2013), they show that another type of misallocation that punishes large plants lowers the productivity of the average plant in India and Mexico. Both types of distortions are important in reducing aggregate output and consumption by households. Based on a panel of enterprises in Ghana, Kenya and Tanzania, Soderblom, Teal and Harding (2006) find that TFP does not impact on survival of small firms, suggesting that there is no process of sorting or selection by which the more efficient firms survive and grow, again reducing aggregate output and consumption (see also Teal 2013).

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