Public policy and resource allocation: evidence from firms in OECD countries

The relationship between a firm's size and its productivity level varies considerably across OECD countries, suggesting that some countries are more successful at channelling resources to high productivity firms than others. In this paper, we examine the extent to which these differences depend on regulations affecting product, labour and credit markets, and assess their relevance for aggregate productivity. To this purpose, we exploit a decomposition of industry productivity into a moment of the firm productivity distribution (the unweighted mean), and a moment of the joint distribution with firm size (the covariance between productivity and market shares – allocative efficiency). We apply such decomposition to a cross section of more than 800 country-industry cells and estimate the relevance of regulation policies for each of the two terms exploiting cross-industry differences in exposure to the policy. Our results suggest that there is an economically and statistically robust negative relationship between policy-induced frictions and productivity, though the specific channel depends on the policy considered. In the case of employment protection legislation, product market regulations (including barriers to entry and bankruptcy legislation) and restrictions on foreign direct investment, this is largely traceable to the worsening of allocative efficiency (i.e. a lower correspondence between a firm's size and its productivity level). By contrast, the adverse impact of financial market under-development on aggregate productivity tends to arise through shifts in the firm productivity distribution (i.e. a lower unweighted mean). Furthermore, stringent regulations are more disruptive to resource allocation in more innovative sectors. — Dan Andrews and Federico Cingano