Misallocation, Establishment Size, and Productivity

We construct a new dataset using census, survey, and registry data from hundreds of sources to document a clear positive relationship between aggregate productivity and average establishment size for manufacturing establishments across 124 countries. We rationalize this relationship using a standard model of reallocation among production units that features endogenous entry and productivity investment. The model connects small operational scales in poor countries to the prevalence in these countries of correlated distortions (the elasticity between wedges and establishment productivity). The model also rationalizes the low establishment-level productivity and aggregate investment found in poor countries. A calibrated version of the model implies that when correlated distortions change from 0.13 in the U.S. to 0.56 in India, establishment size and productivity fall by a factor of six. These substantial size and productivity losses are large compared to the existing literature and more in line with actual data for the differences in size and productivity between India and the United States.