The impact of state aid for restructuring on the allocation of resources

The success of an economy depends largely on how successful it is in allocating inputs and outputs across businesses efficiently with minimum disruption and frictions. Market institutions that impact this allocation potentially account for productivity differences across countries. Existing studies use quite broad measures of institutions, mostly at the country level. This paper is the first to use census micro level data on a market institution with a potentially very distortive effect – state aid for the rescue and restructuring of firms in difficulty. I investigate the impact of this aid on static and dynamic efficiency of Slovenian manufacturing by combining the aid data with firm-level accounting data, using treatment effects estimators that assume selection on observables (linear regression models) and estimators that explicitly allow for selection on unobservables (instrumental variables models). The identification strategy in the latter models involves using variables that affect the chances of getting aid before 2002, but not after. The empirical analysis reveals that state aid hindered the efficient static allocation of resources, as measured by the Olley and Pakes (1996)-inspired micro covariance measure. None of the firms that received aid exited, aid had a positive impact on the growth rate of market shares, but did not have a significant impact on the growth of total factor productivity (TFP). These results suggest that aid was distortive.