Abstract: Empirical evidence indicates that resource misallocation has a substantial negative effect on aggregate productivity in developing countries. I show that the same underlying institutions that create misallocation are also important for explaining cross-country technology differences. I study a model of heterogeneous firms that choose both labour and technology inputs. Distortions are modeled as idiosyncratic wedges on firm revenues and delay adoption by disincentivizing firms from investing in newer technologies. At the aggregate level, distortions targeting high productivity firms delay the initial adoption of new technologies. In the calibrated model, distortions account for a large portion of the observed cross-country technology differences. Moving from the distortions of the bottom decile economy to the United States' level explains just under half of the observed adoption lag and increases productivity by 89%. Over half of the productivity increase is from firms adjusting technology.
Keywords: Productivity, Misallocation, Technology Diffusion.
JEL Classification: O11, O14, O33, O41, O43.