The Misallocation of Finance

We estimate real losses arising from the cross-sectional misallocation of financial liabilities. Extending the framework of Hsieh and Klenow (2009) to the liabilities side of the balance sheet, and using manufacturing firm data from the United States and China, we find significant misallocation of debt and equity in China but not the United States. Reallocating liabilities to firms in China to mimic U.S. efficiency would produce gains of 50%-68% in terms of real value-added, with only 15%-20% stemming from inefficient debt-equity combinations. For Chinese firms that are large or in developed cities, we estimate lower distortionary costs of equity and debt