Techniques Choice, Misallocation and Total Factor Productivity

We develop a generalized production framework with endogenous production techniques that serve to organize raw factor inputs in an efficient manner. We establish a positive relationship between production flexibility and cost efficiency. By allowing firms to differ in technology scales, capital constraints and technique limitations, we illustrate an amplification of the detrimental effects of technique limitations by production flexibility. We apply the structure to studying, both theoretically and quantitatively, the consequences of capital and technique misallocation across firms for the TFP and the interplay of their TFP effects with production flexibility. Using firm-level data from U.S. manufacturing industries, we find that, due to the amplification effect of production flexibility, technique misallocation generates more TFP losses than capital misallocation. Our quantitative results suggest that the relative importance of technique misallocation on TFP is substantial for a broad range of manufacturing industries with larger TFP gains from removing technique misallocation in industries using more flexible production technologies