Do Financial Frictions Matter as a Source of Misallocation? Evidence from Japan

We evaluate the role of borrowing constraints in misallocation overall using a rich plant-level dataset of manufacturers in Japan. We first measure plant-level distortions and estimate the hypothetical TFP gains and plantsize distributions that would be achieved if all plant-level distortions were removed. Then we develop a dynamic general equilibrium model incorporating borrowing constraints, parameterize it using plant-level information, and estimate the hypothetical TFP gains and plant-size distributions that would be realized if borrowing constraints were removed. Comparing the modelbased counterfactual experiments with the measured misallocation overall, we find that borrowing constraints are a significant, but not a major source of misallocation overall in the manufacturing sector in Japan.