Why Does Misallocation Persist?

Abhijit Banerjee and Benjamin Moll. American Economic Journal: Macroeconomics 2(1) January 2010: 189-206.

A number of papers argue that the misallocation of resources can explain large cross-country TFP differences. This argument is underpinned by empirical evidence documenting substantial dispersion in the marginal products of resources, particularly capital, in developing countries. But why does misallocation persists? That is, why don't distortions disappear on their own? This is particularly true for capital misallocation, a point this paper illustrates in a simple model of capital accumulation with credit constraints: misallocation implies high marginal products for constrained firms and therefore a strong pressure for accumulation and to eliminate the distortion. Banerjee and Moll distinguish between misallocation on the intensive and the extensive margin, and show that the former should disappear asymptotically under fairly general conditions while the latter may persist. LINK