Misallocation and Intersectoral Linkages

We study the effects of distortions in the use of primary and intermediate inputs on aggregate productivity. We show analytically how the aggregate productivity loss from distortions depends on the input-output structure of the economy and the degree of complementarity between inputs. We find that the production network does not systematically amplify the aggregate productivity loss, and that higher complementarity between inputs reduce the effects of distortions. Then, we apply our framework to quantify the effects of distortions caused by market power. Calibrated on Mexican industry-level data, the model suggests that reducing industry-level markups in Mexico to the US levels could raise aggregate TFP by as much as 15 percent. The TFP gain is as much as 5 times larger than without input-output linkages.