Working Paper: CEPR ID: DP16927
Authors: Tiago Cavalcanti; Angelo Mendes; Pierluca Pannella
Abstract: This paper investigates how sectoral linkages amplify or diminish misallocation at the intensive and extensive margins. Our analysis is based on a multisector general equilibrium model with input-output linkages, heterogeneous entrepreneurial abilities, and endogenous occupational choice. Distortions misallocate the intensive use of production inputs, but they also affect productivity through two additional wedges: a “labor-entrepreneurship” wedge, which misallocates agents between entrepreneurship and the labor force; and a “between- sector” wedge, which misallocates entrepreneurs among the different sectors. When the most distorted sectors are upstream (downstream), input-output linkages amplify (dimin- ish) the loss from the misallocation of entrepreneurs. We calibrate the model to the US and quantify the output losses from distortions, decomposing the role of networks and the ex- tensive margin decisions. We study an entry subsidy program, showing that it should target sectors with large profit losses, even if they are not necessarily the most distorted.
Keywords: distortions; firm entry; production network; aggregate misallocation
JEL Codes: E23; L26; O11; O41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| sectoral distortions (L52) | aggregate productivity (E23) |
| labor-entrepreneurship wedge (J39) | misallocation of individuals between entrepreneurship and labor force (J29) |
| misallocation of individuals between entrepreneurship and labor force (J29) | decrease in number of firms in sectors with low labor intensity (L16) |
| between-sector wedge (F29) | allocation of entrepreneurs among different sectors (L26) |
| allocation of entrepreneurs among different sectors (L26) | distortion of optimal scale of firms (L25) |
| distorted sectors (upstream) (F12) | amplify losses from misallocation (D61) |
| distorted sectors (downstream) (F12) | diminish losses from misallocation (D61) |
| variance of labor-entrepreneurship and between-sector wedges (J49) | output loss from distortions (H31) |
| sectoral distortions (L52) | complex interactions in production networks (L23) |
| entry subsidies targeting sectors with significant profit losses (F14) | support sectors needing support due to indirect effects of network linkages (D85) |