# **1 Introduction**

One of the most enduring challenges in the field of economic growth and development is to understand the sources of the large variation in economic well-being across countries. The current consensus in the literature is that even though cross-country differences in physical and human capital stocks are important factors explaining development gaps, aggregate productivity remains the predominant source. In this paper, we provide a systematic study of one of the most promising avenues for accounting for total factor productivity (TFP) gaps, those stemming from an inefficient allocation of resources across firms in one of the poorest yet least explored regions in the world: Sub-Saharan Africa (SSA). Combining novel census-based firm-level manufacturing databases with a structural theory of misallocation, the paper provides a characterization of the degree and nature of resource misallocation as well as a quantification of the productivity losses associated with these inefficiencies in Cˆote d’Ivoire, Ethiopia, Ghana, and Kenya.

Following the work of Hsieh and Klenow (2009), we measure allocative distortions in the data as deviations from the output-maximizing prescription of equalizing marginal returns across comparable production units. We summarize the information about the degree of misallocation by reporting statistics about the joint distribution of productivity and distortions that we back-out from the data. In particular, we report measures of dispersion in the deviation from the efficient allocation and investigate the correlation between these deviations with idiosyncratic characteristics of the firms, such us their physical productivity and their age. We then undertake a counterfactual exercise to quantify the aggregate manufacturing TFP gains that would result from a reversal of these distortions and a reallocation of resources in accordance with the output maximizing rule.

We find evidence of large within-industry misallocation of resources in the four countries that we study, with Kenya exhibiting the largest idiosyncratic distortions, followed by Ghana, Ethiopia, and Cˆote d’Ivoire. As points of reference, the degree of misallocation measured by the dispersion in revenue total factor productivity (TFPR) is on average larger than in India and China, and is similar to those of the worst performing countries in Latin America in terms of allocative efficiency, such as the Rep ́ublica Bolivariana de Venezuela and Colombia.<sup>1</sup> Besides significant dispersion, we find a tight correlation between the distribution of distortions, TFPR, and the distribution of physical productivities across firms, TFPQ. Controlling for other firm characteristics, we estimate a regression coefficient for the relationship between the logarithm of TFPR and the logarithm of TFPQ to be between 0.42 and 0.53. This statistic is an important determinant of the extent to which the estimated distribution of distortions creates a decline in aggregate productivity in the economy. As shown in Restuccia and Rogerson (2008), when resources are diverted away from high productivity firms to relatively unproductive ones, distortions carry a larger drag on TFP. Our estimate shows that such perverse misallocation, the one “taxing the good”, is evident in the four economies that we study.

Taken together, these findings imply that, the distortion and productivity-dependence of the distribution of distortions create a substantial decline in manufacturing productivity in the four countries. Had resources been allocated according to the output-maximizing rule, productivity would have been

> 1The magnitudes of TFPR dispersion in India are our own calculations based on the Prowess database. These values, in turn, are very close to those reported by Hsieh and Klenow (2009) from which we take the dispersion in TFPR in China. For Latin America, our reference is Busso et al. (2013).

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