Misallocation and the distribution of global volatility

Abstract

Decreasing returns at the macro level are an outcome of efficiency at the micro level. When inputs are scarce, an efficient economy carries out only the most productive projects; when inputs are abundant, the economy implements less productive projects as well. This link between decreasing returns and efficiency suggests that misallocation can reduce the extent of aggregate decreasing returns. I formalize this connection and establish two main results: (i) misallocation amplifies the volatility of output with respect to fluctuations in inputs; and (ii) financial integration amplifies shocks in relatively distorted economies, but mitigates them in less distorted economies. Garnt financial support. The author declares that she has no relevant or material financial interests that relate to the research described in this paper.