Frictional Investment and the Sources of Misallocation

We study a model of investment in which a number of frictions - adjustment costs, uncertainty and institutional/policy distortions - lead to capital misallocation, i.e., static marginal products are not equalized. We devise an empirical strategy to disentangle these forces using readily observable moments in firm-level data. Applying this methodology to manufacturing firms in China reveals that adjustment costs and uncertainty have significant effects on aggregate productivity but account for a only modest share of the observed dispersion in the marginal product of capital. A substantial fraction of misallocation stems from firm-specific distortions, both productivity/size-dependent as well as permanent. For large US firms, adjustment costs are relatively more salient, though permanent firm-level factors remain important. These results are robust to the presence of liquidity/financial constraints