The effects of structural reforms on productivity and profitability enhancing reallocation: Evidence from Colombia

Estimates for the U.S. suggest that at least in some sectors productivity enhancing reallocation is the dominant factor in accounting for producitivity growth. An open question, particularly relevant for developing countries, is whether reallocation is always productivity enhancing. It may be that imperfect competition or other barriers to competitive environments imply that the reallocation process is not fully e?cient in these countries. Using a unique plant-level longitudinal dataset for Colombia for the period 1982-1998, we explore these issues by examining the interaction between market allocation, and productivity and profitability. Moreover, given the important trade, labor and financial market reforms in Colombia during the early 1990's, we explore whether and how the contribution of reallocation changed over the period of study. Our data permit measurement of plant-level quantities and prices. Taking advantage of the rich structure of our price data, we propose a sequential mehodology 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 inversedemand equation. We examine the evolution of the distributions of TFP and demand shocks in response to the market reforms in the 1990's. We find that market reforms are associated with rising overall productivity that is largely driven by reallocation away from low- and towards highproductivity businesses. In addition, we find that the allocation of activity across businesses is less driven by demand factors after reforms. We find that the increase in aggregate productivity post-reform is entirely accounted for by the improved allocation of activity.