Productivity loss and misallocation of resources in Southeast Asia

Abstract

AbstractThis article examines within-sector resource misallocation in three Southeast Asian countries—Indonesia, Malaysia, and Vietnam. The methodology accounts for measurement error in revenues and costs. The firm-level evidence suggests that measurement error is substantial, resulting in an overestimation of misallocation by as much as 30%. Nevertheless, resource misallocation across firms within a sector remains large, albeit declining. The findings imply that there are considerable potential gains from efficient reallocation—above 80% for Indonesia and around 20% to 30% for Malaysia and Vietnam. Private domestic firms and firms with higher productivity appear to face larger distortions that prevent them from expanding.Keywords: Productivitydistortionsresource misallocationJEL classification: D24L11O30O47 Disclosure statementNo potential conflict of interest was reported by the authors.Notes1 There is a large literature on each of these potential sources of misallocation; the suggested references rely on data from Southeast Asia, the region at the center of this paper. Interestingly, although not surprisingly, none of the individual channels by itself is able to explain the magnitude of misallocation estimated using the indirect approach discussed later. A given economy may suffer from multiple sources of misallocation at once.2 HK measures misallocation without precisely identifying the sources of misallocation. They broadly classified the sources of distortions as capital and output market related distortions. The essence of their findings is that resource misallocation affects productive firms’ access to sufficient resources (in terms of capital and labor) needed for expansion, and this results in lower aggregate productivity. Therefore, reallocation of resources through the elimination of distortions in the markets is productivity enhancing as this allows productive firms to grow larger, and the less productive ones to either contract their operations or exit from the sector.3 As acknowledged by HK, their approach relies on restrictive assumptions such as CES aggregation of differentiated products within a narrowly defined sector (allowing to derive TFPQ from revenue data in the absence of information on input and output quantities), and hence constant mark-ups within the same sectors. Under these conditions, any variation in TFPR is attributable to resource misallocation.4 Assuming additive rather than multiplicative measurement error yields more conservative estimates.5 Elasticity of substitution between products is related to the mark-ups σsσs−1=1+μs, where μs is the markup. An elasticity of substitution of 3 corresponds to a markup of 50%.6 The subscript t for time is omitted, to simplify the notation.7 The circumflex sign indicates measured values.8 To understand how the results in Table 5 and Table 4 are related, it is useful to recall that in BKR sectoral TFP can be decomposed into the product of four terms: allocative efficiency, a productivity dispersion term, average productivity, and a variety term.9 While the BKR approach is mute about the source of additive measurement error, it is interesting to note that measurement error increased in Malaysia while it declined in Indonesia during the two time periods considered. Indonesia is well-known for the quality of its data, at its income level, which is possibly due to the open data policy that the country recently enacted.10 Because of data availability, we only focus on key firm characteristics in explaining firm-specific distortions and do not include other potential explanatory factors such as firms’ technology (for example Nakatani (Citation2021) reports that intangible assets, a proxy for firm technology, are positively associated with firms’ TFP growth in the ICT sector).Additional informationFundingThe authors have no relevant financial or non-financial interests to disclose.