The effects of structural reforms on productivity and profitabality enhancing reallocation: evidence from Colombia

Estimates for the U.S. suggest that in some sectors productivity enhancing reallocation is the dominant factor in accounting for productivity growth. An open question is whether reallocation is always productivity enhancing. Specifically, in developing countries, market concentration, or barriers to competition, may imply that the reallocation process is not fully efficient. Using a unique plant-level longitudinal dataset for Colombia for the period 1982-1998, we use plant-level quantities and prices to implement a novel sequential methodology to estimate productivity and demand shocks at the plant level. First, we estimate total factor productivity (TFP) with plant-level physical output data, where we use downstream demand to instrument inputs. We then turn to estimating demand shocks and mark-ups with plant-level price data, using TFP to instrument for output in the inverse-demand equation. Market reforms, introduced in the early 1990's, are associated with rising overall productivity that is largely driven by reallocation away from low- and towards high-productivity businesses. Our evidence also points to allocation of activity across businesses being less driven by demand factors after reforms.