Source: World Bank staff analysis using Romania MoF firm-level data, 2011-2019. Exit is a dummy variable equal to 1 for the last year the firm exited the sample. Firm-level measure of allocative efficiency is computed as a cross product between two terms defined at the 4-digit NACE sector, year, and county level: (a) the deviation of a firm’s market share from the average market share at the sector-year-county level, and (b) the deviation of a firm’s (labor) productivity from the average firm-level productivity at the sector-year-county level. SOE variables are dummy variables taking the value one if national or subnational governments have ownership stake of 10-24.9%, 25-49.9%, or 50% or more, respectively, in the firm. The reference group is private-owned enterprises (POEs), defined as firms where national or subnational governments own 0-9.9%. All models include 2-digit NACE industry and year-fixed effects. Standard errors clustered at the industry level are in parentheses. ***, **, and * indicate significance at 1 percent, 5 percent, and 10 percent. Where indicated, the model includes age groups: Young (3-5), Mature (6-10), and Old (>10), with Startups (0-2) being the reference category, and size group: Small (10-49), Medium (50-99), Large (100-499), and Very large (500+). with Micro (1-9) being the reference category. For outcome variables in level form, the age and size dummies are defined using contemporaneous age and size variables, but they are defined using lagged values for outcome variables in growth (or change) form.<sup>**†**</sup> indicates values are for the state ownership model using 10-100% stake. All models include a constant term.

**Given that Romanian SOEs are less likely to exit the market, they could hold on to scarce resources, hampering allocative efficiency** . This is particularly true when they command disproportionate market shares relative to their productivity levels. In an economy with no technological and informational frictions or institutional and policy distortions, market shares must move to the most efficient and high-performing firms at the expense of the least productive ones. When policy and other distortions and frictions are present, allocative inefficiencies prevail in the economy, with less productive firms tending to have larger market shares and harming aggregate productivity. Such suboptimal allocation of resources is a common driver of slow productivity growth.

**Given that Romanian SOEs are less productive relative to their private peers, they are more likely to contribute negatively to aggregate productivity** . As is common in the literature, the paper uses the static Olley and Pakes (1996) measure of allocative efficiency, defined as the within-industry covariance between firm size and productivity. Since the analysis in this section is performed at the 2-digit NACE level, the paper uses covariance between firm size (i.e., market share) and labor productivity at the 2-digit sector, year, and county level and derive 2-digit level measures from the firm level measures using simple averages and weighted averages of revenue and employment shares as weights. The county dimension is included to account for the geographic features of markets. The paper also uses the covariance between firm size (i.e., market share) and labor productivity at the 4-digit sector, year, and county level and aggregate at the 2-digit level.

**The findings suggest that the presence of Romanian SOEs in some markets is undermining allocative efficiency** . Romanian SOEs contribute negatively to allocative efficiency: the average SOE is larger but less productive,  so they are associated with lower covariance between firm size and productivity than POEs. This is particularly true with majority owned, directly owned, and local SOEs (Table 7, column 2). This implies that these SOE ownership types command a disproportionately larger market share, given their productivity levels. This suboptimal allocation of resources is a key driver of slow aggregate productivity growth. At the market level, their larger presence or market share is also negatively correlated with allocative efficiency (Table 8).

Table 8: Conditional Correlation between SOE Market Share and Market Level Measure of Allocative Efficiency in Romania, 2011-2019

|(1)|(2)|
|---|---|
|Two-digit sector aggregation of firms’<br>revenue share and productivity|Two-digit sector aggregation of firms’<br>revenue share and productivity|
|deviations from 2-digit revenue share<br>and productivity averages, respectively|deviations from 4-digit revenue share<br>and productivity averages, respectively|
|Revenue-<br>Employment-weighted|Revenue-<br>Employment-weighted|
|weighted avg.<br>avg.|weighted<br>avg.|

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