Growing Like Spain: 1995-2007: JEL Codes: D24, O11, O47. Keywords: TFP, Misallocation, Spain

Growing like Spain: 1995-2007
Manuel Garca-Santana
Universite Libre de Bruxelles (ECARES)
Josep Pijoan-Mas
CEMFI and CEPR
Enrique Moral-Benito
Banco de Espa
na
Roberto Ramos
Banco de Espa
na
April 9, 2015
Abstract
Spanish GDP grew at an average rate of 3.5% per year during the expansion of 1995-2007,
above the EU average of 2.2%. However, this growth was based on factor accumulation rather
than productivity gains. In particular, TFP fell at an annual rate of 0.7%, while it increased
at 0.4% in the EU and 0.7% in the US. Why did Spain fail to benefit from the growth of the
technological frontier? We argue that deterioration in the allocative efficiency of productive
factors across firms is at the root of the low TFP growth in Spain. Using administrative data of
firms we show that within-sector misallocation of production factors increased substantially over
the period in all industries, with most of the effects coming from inefficient capital and labor
mix rather than inefficient size. We find that absent such deterioration, average TFP growth
would have been around 0.8% per year, in line with the growth of the technological frontier.
Finally, we provide empirical evidence that differences in the influence of the public sector
across industries is a potential source of this deterioration. In contrast, sectoral differences in
skill intensity, innovative content, or financial dependence are unrelated to changes in allocative
efficiency. We also document that young and small firms were the most affected.
JEL Codes: D24, O11, O47.

Keywords: TFP, Misallocation, Spain.
We thank John Fernald for sharing the financial intensity data with us, and Eric Bartelsman for helpful discussion.
We also thank seminar participants at Banco de Espa
na for useful comments.
1 Introduction
The 1994-2007 expansion was the longest in Spanish history (see Berge and Jorda (2013)). GDP grew
at an average 3.5% per year, which compares very favourably to the EU average of 2.2% over the same
period.1 However, Spanish growth during this expansion was based on factor accumulation rather
than productivity gains. In particular, annual TFP growth was -0.7%, which is low in comparison to
other developed economies such as the US or EU. Such a dismal performance of productivity growth
is surprising for a country that is so well integrated in a trade and monetary union with some of the
World technology leaders. Did Spain fail to keep up with the technological frontier?
In this paper, we argue that the source of negative TFP growth has been the increase in the
within-sector misallocation of production factors across firms. We use a large administrative data
set of Spanish firms to compute several measures of allocative efficiency for every year between 1995
and 2007. In particular, we compute the potential TFP gains due to factor reallocation as Hsieh and
Klenow (2009) and the Olley and Pakes (1996) covariances. All measures show a severe deterioration
of allocative efficiency over the period. Furthermore, we find the phenomenon to be present in all
sectors of activity, which casts doubt on the widespread view that specialization in low productivity
sectors such as construction was the main force behind Spanish low TFP growth. We thus argue
that allocative efficiency of resources across firms is at the root of the low rates of TFP growth
observed in Spain. Our results are very stark: had the level of within-sector allocative efficiency
remained constant, TFP growth would have been around 0.8% per year. Therefore, our conclusion is
that Spain did not fail to keep up with the technological frontier. Aggregate productivity stagnated
because the economy increasingly allocated capital and labor in the wrong place across firms within
each industry.2
The deterioration of factor allocation across firms during an economic expansion is arguably a
singular experience in Spain. Bartelsman, Haltiwanger, and Scarpetta (2013) find that misallocation remained roughly constant over the nineties and early 2000s in several developed countries
such as US, UK, Germany or the Netherlands, while it clearly fell for the transitional economies
of Central and Eastern Europe. Lewrick, Mohler, and Weder (2014) find that improvements in the
within-industry allocation of resources is one of the main drivers of aggregate TFP growth in Swiss
manufacturing. Using the Hsieh and Klenow (2009) framework, Bellone and Mallen-Pisano (2013)
find that misallocation remained constant between 1998 and 2005 in France, while Dias, Robalo, and
1
EU average refers to the EU15 group, which includes Austria, Belgium, Denmark, Finland, France, Germany,
Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden and the United Kingdom. We take
this reference group of developed countries similar to Spain because we have comparable growth accounting data from
EU-KLEMS.
2
The prominent role of within industry misallocation as a hindrance to TFP growth has relevant policy implications. For instance, reallocation of workers across industries is generally more costly than reallocation within industries
(see e.g. Shin (1997)).
Richmond (2014) show that misallocation increased in Portugal between 1996 and 2011, but this
was a period of stagnation in Portugal. Finally, Chen and Irarrazabal (forthcoming) find that the
Chilean economy experienced a substantial decline in misallocation over its 1983-1996 expansion.
In order to shed some light on the potential sources of this phenomenon in Spain, we evaluate the
relationship between several sector-specific characteristics and the changes in allocative efficiency. In
particular, we find that industries in which the influence of the public sector is larger (e.g. through
licensing or regulations) experienced significantly larger increases in misallocation. In contrast, other
sectoral characteristics such as skill intensity, innovative content or financial dependence are unrelated
to changes in allocative efficiency. Turning to firm-specific distortions, we find that small and young
firms in Spain might have faced higher market distortions than large and mature firms. As a result,
these firms grew less than optimal and operated with capital-labor ratios smaller than optimal (i.e.
those observed in the same industries in the US). Finally, we show that the increase in misallocation
across firms is present in all Spanish regions, and that regional differences in average wage growth
are uncorrelated with the increase in distortions.
It remains to be understood why the Spanish economy accumulated capital and labor at such
a fast pace despite the negative increase in aggregate productivity. Our view is that this was due
to exogenous supply factors. The convergence process leading to the entry to the EMU reduced
interest rates dramatically and created an unprecedented credit boom. As shown by FernandezVillaverde, Garicano, and Santos (2013), the total credit to GDP ratio tripled between 1994 to
2007.3 Along these lines, Gopinath, Kalemli-Ozcan, Karabarbounis, and Villegas-Sanchez (2015)
rationalize low rates of TFP growth in South Europe by developing a model of heterogeneous firms
that can generate misallocation of capital across firms as a result of financial frictions and investment
adjustment costs. An alternative view of this supply side explanation is given by Daz and Franjo
(2014). These authors show that the large increase in capital accumulation over the period was
largely due to capital structures, which they interpret as the result of government subsidies. The
process of capital accumulation triggered by cheap credit could by itself increase the employment
rate. However, there were also clear labor supply factors at play: the working-age population ratio
increased over the period and females of new cohorts participated in the labor market at a much
larger rate than females of the older cohorts.
The rest of the article is organized as follows. Section 2 briefly shows the growth accounting
results for Spain as well as some micro-based evidence motivating the paper. Section 3 describes the
data. Then, Section 4 presents the main results regarding the increase in misallocation and Section 5
explores the potential sources of misallocation. Some concluding remarks are provided in Section 6.
3
These authors also argue that the credit boom might be the very reason behind an increase in misallocation
of productive factors across firms. Banks face a signal-extraction problem to identify good firms. In bubble times
the signal becomes more noisy and hence credit may be allocated less efficiently. This would be consistent with our
finding that the increase in distortions was larger among young firms. However, we should also expect the increase in
misallocation to be larger in sectors with higher financial dependence, a pattern that is absent in the firm-level data.
Finally, Appendix A reviews the theoretical framework of Hsieh and Klenow (2009) and Appendix
B contains additional results.
2 The 1995-2007 growth experience

The Spanish economy grew by around 3.5% per year between 1995 and 2007. This expansion, the
longest in the twentieth century, helped Spanish income per capita surpass the EU average in the
early 2000s. Growth accounting exercises show that the boom was driven by factor accumulation
(labor and capital) rather than increases in productivity. Using data from EU-KLEMS, Figure 1
clearly illustrates this pattern.
100
120
140
160
180
Figure 1: The Spanish growth experience Macro evidence
1995
1998
Production
2001
Labor
2004
Capital
2007
TFP
The labor contribution to output (total hours worked) expanded 3.8 percent a year in 1995-2007.
This was the result of three main factors: a fast growing working age population, mainly due to
migration flows, and an increasing labor force participation rate, mainly reflecting the incorporation
of women into the labor market, and a decline of the unemployment rate since the high values
achieved in 1993. The capital stock also grew at an unprecedented pace of 5.2 percent a year. The
rise of the construction sector together with easy borrowing conditions played an important role
in the expansion of the capital stock in Spain. Since both labor and capital grew more than final
production, total factor productivity (TFP) was reduced by 0.7% per year.
These Spanish figures are in sharp contrast to other developed economies. In the average EU
country, output growth was 2.2% per year with growth rates of 1.1% and 3.3% for labor and capital
respectively. As a result, TFP growth in the EU was on average 0.4% per year in contrast to the
Spanish annual rate of -0.7%. This difference is even more pronounced with respect to the US
economy, which experienced TFP growth rates around 0.7% per year over the 1995-2007 period.4
Figure 2: The Spanish growth experience Micro evidence
Joinery installation
Change in share 20012007
0
Manufacture of toys

0

0
Manufacture of butter
0
Relative TFP in 2001
Sale of textiles
Retail sale of bread
Retail sale of telecom

0

0
0

0
0
0
0
0
.15
tstatistics for industryspecific regressions

1.96
.05
.1
1.96
30
20
10
10
Notes: Relative TFP refers to the logarithm of firm-specific TFP relative to the industry average, ln(TFPi /TFP).
Change in share refers to the difference in firm-specific market share measured in terms of sales.
Turning to the micro-based evidence, a first glimpse at the data cleary illustrates the deterioration
in the within-industry allocation of resources across firms. In the upper panel of Figure 2 we plot
the change in market shares over the 2001-2007 period against the level of TFP in 2001 for six
selected 4-digit industries.5 In all the six cases the relationship is negative, which means that firms
with initial TFP below the industry average gained market share at the expense of firms with larger
4
See EU-KLEMS dataset at www.euklems.net.

For illustrative purposes we focus on the 2001-2007 period to maximize the number of observations in the scatter
plots. This is so because we use a balanced version of our panel dataset in order to compute changes in shares.
5
TFP. This negative relationship is negative and statistically significant for 80 per cent of the 356
industries considered as we can see in the bottom panel of Figure 2, which plots the distribution of
the t-statistics resulting from the 356 sector-specific regressions. We interpret this evidence as an
intuitive illustration of how more productive firms lost market share at the expense of less productive
firms, which, in our view, is a clear indication of a deterioration in the allocation of resources across
firms within each industry. However, in the remainder of the paper we focus on well-known indicators
of allocative efficiency that facilitate the mapping between the micro and the macro evidence.
3 Data
We use a firm-level dataset containing information of a representative sample of non-financial companies in Spain from 1995 to 2007. The sample contains an average number of 497,782 firms per
year. This database is named Central Balance Sheet Data (Central de Balances) and is provided by
the Banco de Espa
na.
The database is comprised of two complementary datasets. The first one is based on a standardized voluntary survey handled to companies at the time of requesting compulsory accounting
information. Each year around 9,000 companies fill this survey. The information gathered is very detailed, but the sample size is low and big firms are over represented. The second dataset contains the
balance sheets of a much larger number of companies. It originates from the firms legal obligation
to deposit their balance sheets on the Mercantile Registry. Therefore, coverage is much wider.
The Bank of Spain Central Balance Sheet Office is in charge of collecting and cleaning these
datasets. All of the variables contained in the second database are also included in the first one. For
each firm, we observe its value added, total wage bill, employment, book value of the capital stock
(both physical and intangible) and sector of activity at the 4-digit level (according to NACE rev. 2
classification). Since most of the variables are recorded in nominal terms, we employ sector-specific
deflators for capital and value added, to compute real values with 2000 as base year.6
Panel A of Table 1 illustrates the size distribution of firms in our raw sample for the year 2001.
The table also compares this distribution with that obtained from the Central Business Register
available from the National Statistics Institute. There are two important aspects to highlight. First,
the coverage of our raw sample is remarkably large in terms of both the number of firms (56% of
the operating firms in Spain) and the level of employment (54% of total employment). Second, our
sample provides an excellent representation of the firm size distribution in Spain. In particular, small
firms (less than 10 employees) account for 83.90% of the total number of firms and 20.47% of the
employment in our sample versus 83.07% and 20.23% in the population. At the other extreme, large
firms (more than 200 employees) represent less than 0.5% of the total number of firms both in our
6
The capital deflator is collected from Mas, Perez, and Uriel (2013) and the value added deflator is taken from
the National Accounts. Both deflators are constructed at the 2-digit NACE classification.
sample and in the population, while they account for 33.47% of the employment in our sample and
32.13% in the population.
Table 1: Size distribution of firms in our sample and in the census.
Central Balance Sheet Dataset
Firms
Number of employees
Total (#)
Central Business Register
Labor
Share (%)
Total (#)
Firms
Share (%)
Total (#)
Labor
Share (%)
Total (#)
Share (%)
83.07
8.98
5.42
2.06
0.47
100.00
1,718,600
1,050,038
1,400,422
1,596,481
2,728,958
8,494,499
20.23
12.36
16.49
18.79
32.13
100.00
78.46
11.42
6.89
2.63
0.60
100.00
1,718,600
1,050,038
1,400,422
1,596,481
2,728,958
8,494,499
20.23
12.36
16.49
18.79
32.13
100.00
PANEL A: Raw Sample

0-9
10-19
20-49
50-199
+200
All
406,924
41,664
27,125
8,064
1,245
485,022
83.90
8.59
5.59
1.66
0.26
100.00
941,897
583,312
828,714
707,535
1,540,260
4,601,718
20.47
12.68
18.01
15.38
33.47
100.00
715,795
77,372
46,683
17,781
4,082
861,713
PANEL B: Final Sample

1-9
10-19
20-49
50-199
+200
All
249,770
41,272
26,919
7,984
1,219
327,164
76.34
12.62
8.23
2.44
0.37
100.00
907,098
577,844
822,699
700,565
1,528,178
4,536,384
20.00
12.74
18.14
15.44
33.69
100.00
531,399
77,372
46,683
17,781
4,082
677,317
Notes: Figures refer to the year 2001. Self-employed persons are not included.
From this original sample we drop observations with missing or non-positive values for the number
of employees, value added, or capital stock. We also eliminate observations at the top and bottom 1%
of these variables. Since our misallocation measures are computed within each 4-digit industry, we
also drop firms belonging to industries with less than 10 firms per year. Therefore, we are left with
around 350,000 firms per year distributed in 518 4-digit industries. Turning to this final sample in
Panel B of Table 1, our screening strategy slightly over-samples larger firms because small firms with
less than 10 employees are more prone to misreport their information in the Mercantile Registries.
Note also that our final sample does not include firms with 0 employees because these firms represent
mostly firms with no production, created merely for tax purposes. In any event, since those firms
account for a small fraction of employment, the representativeness of our final sample in terms of
employment remains noticeably good.7 It is our view that the availability of information on small
firms is crucial for measuring within industry misallocation at the 4-digit level as opposed to typical
7
The Amadeus database, commercialised by Bureau Van Dyck, also provides firm-level information extracted from
firms balance-sheets on a set of variables for all European OECD members including Spain. For instance, Hsieh and
Klenow (2014) exploited this dataset. However, Amadeus presents some well-known drawbacks. First, information
on employment (typically a non-mandatory item in balance sheets) is only available for 40-50% of the firms in the
sample (this implies that although listed in terms of identifier in the Amadeus data, 50-60% of the firms do not provide
information about employment). Second, the large attrition bias generates a the lack of representativeness in terms
of size, European Central Bank (2014). Third, the readily usable version of the Amadeus data currently starts in the
year 2004.
datasets used in the literature that are restricted to samples of larger firms (e.g. with more than 10 or
20 employees). Indeed, using only large firms in our sample, the estimated increase in misallocation
is two times smaller than that obtained from our full sample.
4 Misallocation and productivity in the Spanish boom

Our main finding is illustrated in Figure 3. Applying the methodology of Hsieh and Klenow (2009)
to our sample of Spanish firms, we find that potential TFP gains from reallocation steadily increased
over the 1995-2007 period. While TFP could have been around 24% higher in 1995, this figure doubled
by 2007.8 Between 1995 and 2007, the allocative efficiency decreased by 20 percent (1.49/1.24 - 1),
or a reduction of about 1.7 percent per year.
These hypothetical increases in the level of aggregate TFP would result from fully equalizing
TFPR across firms in each 4-digit sector, i.e., from reallocating resources from firms with low physical
TFP towards firms with high TFP. As acknowledged by Hsieh and Klenow (2009), these counterfactuals do not allow for measurement error or model misspecification, which may cast doubt on the
usefulness of these numbers without a reference point to compare. However, we do not focus on the
level but on the change of potential TFP gains relative to the year 1995. Our implicit assumption is
that neither measurement error nor model misspecification have changed over time.
In any event, changes in dispersion of TFPR might arise from other frictions apart from idiosyncratic distortions of the type embedded in the Hsieh and Klenow (2009) theoretical framework.
For instance, overhead labor or quasi-fixed capital (see Bartelsman, Haltiwanger, and Scarpetta
(2013)). Based on Olley and Pakes (1996), we thus explore two covariances as alternative measures
of misallocation. First, we compute a covariance term between firm-specific labor shares and labor
productivity; and second we compute the covariance between firm-specific production shares and
total factor productivity. Under an efficient allocation of resources, more productive firms should
produce more and hire more workers.9
Table 2 summarizes the different measures of misallocation for two sub-periods, namely, 19952000 and 2001-2007. In particular, we use the Hsieh and Klenow (2009) measure of potential TFP
gains (labeled as HK) together with the standard deviation of log TFP (labeled as STD), which
8
Crespo and Segura-Cayuela (2014) consider a sample of French, Italian, German, and Spaninsh firms in order
to compare TFP gains resulting from the HK methodology in selected years. According to their results, TFP gains
in Spain are larger than those in France but smaller than those in Germany and Italy. Moreover, they also find an
increase in Spanish TFP gains between the years 2002 and 2008.
9
To be more precise, for industry j and year t, the covariance statistic for labor productivity (LPR) is given by:
X
OPj,t =
(ij,t j,t )(ij,t
j,t )
i
where i is the firm index, ij,t refers to the firm-specific labor share, ij,t is the firm-specific labor productivity, and j,t
and
j,t are the unweighted averages of industry j. The same covariance can be computed for TFP using firm-specific
production shares as originally considered by Olley and Pakes (1996).
.25
.3
.35
.4
.45
.5
Figure 3: Potential TFP gains from reallocation
1995
1997
1999
2001
2003
2005
2007
measures the dispersion of (log) TFPR at the firm level as an alternative measure of misallocation in
the HK framework.10 We also report the two covariance terms as used by Bartelsman, Haltiwanger,
and Scarpetta (2013) labeled as OP, one based on labor productivity (LPR) and labor shares,
and the other based on total factor productivity (TFP) and production shares.
All the statistics in Panel A of Table 2 clearly point to an increase in the degree of misallocation
in the Spanish economy over the last expansion as documented in Figure 3. While the dispersion
in TFP increased from 0.42 to 0.47, the OP covariance of LPR and labor shares was reduced from
0.30 to 0.21, and the covariance between TFP and production shares moved from 1.59 to 1.35. This
finding is present not only for the aggregate economy but also for the main four the sectors of the
economy as shown in Panel B of Table 2.11 Depending on the misallocation measure considered, the
sector with the largest misallocation deterioration is either construction or services. However, the
four measures of misallocation point to a deterioration in allocative efficiency in the four sectors.
Moreover, Table A1 in Appendix B reports the corresponding results for disaggregated sectors at
NACE rev 2 - 2 digits showing that this deterioration is prevalent among virtually all of the 58 2-digit
sectors considered.
This fall in the allocative efficiency of production factors is distinctive of the Spanish growth
experience. In particular, Bartelsman, Haltiwanger, and Scarpetta (2013) find that misallocation
10
Under joint log normality of Asi , 1 Ysi , and 1 + Ksi , both measures are equivalent.
Note that the sector-specific results are based on misallocation within 4-digit industries aggregated using industry
weights.
11
remained roughly constant over the nineties and early 2000s in several developed countries such as
US, UK, Germany or the Netherlands, while it clearly fell for the transitional economies of Central
and Eastern Europe.
Table 2: Misallocation in Spain over the period 1995-2007.
PANEL A: Total Economy
1995-2000
2001-2007
HK
STD TFP
OP LPR
OP TFP
0.29
0.43
0.42
0.47
0.30
0.21
1.59
1.35
PANEL B: By sector
HK
STD TFP
OP LPR
OP TFP
1995-2000
2001-2007
Manufacturing
0.23
0.32
0.42
0.45
0.32
0.27
1.43
1.13
1995-2000
2001-2007
Construction
0.36
0.62
0.38
0.42
0.15
0.10
1.61
1.28
1995-2000
2001-2007
Trade
0.38
0.48
0.43
0.48
0.31
0.25
1.73
1.39
1995-2000
Services
0.40
0.44
0.37
1.72
2001-2007
0.54
0.50
0.19
1.58
Notes: HK refers to the potential TFP gains if resources were allocated efficiently as proposed
by Hsieh and Klenow (2009). OP refers to the Olley and Pakes (1996) covariance term. STD
refers to standard deviation as a measure of dispersion. LPR refers to log labor productivity
and TFP to log total factor productivity.
We argue that the stark increase in within-sector misallocation over the Spanish boom is at the
root of the bad performance of aggregate TFP. We next compute potential TFP growth under the
assumption that the level of misallocation remains constant at its 1995 level. This counterfactual
exercise provides the aggregate TFP that we would have observed during the expansion without
increases in misallocation. To be more precise, we simply multiply the observed aggregate TFP by
the year-specific percentage of TFP gains given by the HK exercise above (see Figure 3). Then, we
plot the resulting potential TFP growth rates together with the observed ones in Figure 4. Annual
growth rates of potential TFP growth would have been between 0.6% and 1.1% with an average
of 0.8% under the assumption of constant within-sector misallocation. In contrast, observed TFP
growth was -0.7% on average, ranging from -0.8% to -0.5%. We can also use the OP methodology to
compute the potential TFP growth. Had the OP covariance term remained constant for the period,
TFP would have grown at a 1.1% annual rate12 which is similar to the counterfactual TFP growth
computed using HK methodology.
12
This number can be computed by calculating the percentage change in the OP covariance term between 1995-2000
and 2001-2007 as reported in Panel A of table 2, which is 24%, and obtaining the corresponding average annual rate
over the 12-year span.
Finally, we also compute an alternative counterfactual TFP growth based on aggregating sectorspecific TFP growth rates with weights given by the sector shares in 1995. This exercise aims to
illustrate the role of between sector misallocation in the evolution of aggregate TFP. While we see
that this counterfactual TFP growth is higher than the observed one, it is substantially smaller than
the counterfactual based on constant within-sector misallocation. More specifically, it ranges from
-0.8% to -0.1% with an average annual growth of -0.4%
All in all, these counterfactual exercises speak in favor of the crucial role of within-sector misallocation in the evolution of aggregate TFP in Spain over the last expansion. This finding casts doubt
on the traditional view that between-sector misallocation (i.e. specialization in low productivity
sectors such as construction) was behind low TFP growth in Spain.
.5
.5
Figure 4: Potential TFP growth under 1995 misallocation level
1995
1997
1999
2001
2003
2005
2007
Observed TFP growth

Potential TFP growth constant misallocation
Potential TFP growth constant sector shares
4.1 Robustness analysis

In this Section we perform three robustness exercises related to the level of industry disaggregation,
to the distinction between intensive and extensive margin only, and to the elasticity of substitution.
4.1.1 Industry classification
Our baseline results are based on misallocation within 4-digit industries because the HK theoretical
framework relies on the assumption that each industry represents a monopolistic competitive market
10
in which firms produce different varieties of the same intermediate good. Therefore, the greater
the level of disaggregation the more plausible this assumption is when taken to the data. However,
since the 4-digit level of disaggregation requires very large samples of firms to obtain meaningful
figures for more than five hundred industries, we investigate if the deterioration in allocative efficiency
documented for Spain at the 4-digit level is also present when considering 2- and 3-digit classifications.
Table 3 shows the evolution of allocative inefficiency in Spain in terms of potential TFP gains
from reallocation to an efficient allocation of resources across firms within each 4-, 3-, and 2-digit
sectors in columns (1), (2) and (3). The increase in TFP gains, or the deterioration in allocative
efficiency, is prevalent among all the three industry classifications. Moreover, the increases over the
whole period are of the same magnitude, around 20% or 1.7% per year, in all the cases. In particular,
the average increases are 1.7, 1.6, and 1.8 percent per year for the exercises at 4-, 3-, and 2-digit
industries, respectively.
4.1.2 Balanced versus unbalanced panel
Our baseline sample is an unbalanced panel including firms that might enter or exit at any time. The
extensive margin may also play a role in shaping the evolution of allocative efficiency depicted above.
However, the potential sources of misallocation might be different depending on the importance of
this extensive margin relative to the intensive margin of misallocation of resources within established
firms. In order to quantify the importance of the extensive margin in terms of efficient TFP and the
evolution of allocative efficiency over time, we consider a balanced panel restricted to firms that were
in the sample for the whole period (1995-2007). In the balanced version of the panel we have only
5,419 firms per year, which precludes us from considering misallocation within 4-digit industries.
Column (4) in Table 3 shows the resulting TFP gains from the balanced panel under the 2-digit
disaggregation. We find that the deterioration in allocative efficiency over time still holds, although
smaller in size: while the increase in misallocation is around 20% (1.49/1.24 - 1) or 1.7% per year
when considering the unbalanced panel, the corresponding figures are 7% (1.28/1.20 - 1) and 0.6%
under the balanced panel. These numbers suggest that about two thirds of the deterioration in
allocative efficiency is due to the extensive margin.
4.1.3 Elasticity of substitution
As as final robustness test we repeat the exercise with a higher elasticity of substitution: =5. This
figure is also used by Dias, Robalo, and Richmond (2014) for Portugal and comes from the estimates
for the Eurozone in Christopoulou and Vermeulen (2012). In column (5) of Table 3 we report the
results. As expected, TFP gains increase for all years when =5. Moreover, the magnitude of the
increase in misallocation over the 1995-2007 period is similar to that of the case =3, a decrease of
21% (1.69/1.39 - 1) or 1.8 percent per year.
11
4.1.4 Measurement error

Our estimated increases in TFP gains from reallocation might be driven by an increase in measurement error in our data as a result of the year-to-year increases in our sample size. While this concern
is partially addressed in the balanced panel exercise, we also consider an alternative robustness check
based on recording errors created by extreme outliers. In particular, following Hsieh and Klenow
(2009) we trim the 2% tails of TFPR and TFPQ in order to avoid the potentially increasing influence
of outliers in our sample. Column (6) of Table 3 shows the resulting TFP gains, which clearly point
to a large deterioration in allocative efficiency of around 14% (1.42/1.25 - 1) or 1.1 percent per year.
4.1.5 Sample of large firms
We now check the sensitivity of our findings to the size distribution of firms in our sample. In
particular, we computed TFP gains resulting from removing idiosyncratic distortions in a subsample
of large firms (more than 50 employees). We report the results in Column (7) of Table 3. While the
deterioration in allocative efficiency still arises, its magnitude is substantially smaller, 0.6% percent
per year against the baseline of 1.7% per year. Moreover, the levels of TFP gains are substantially
smaller than those of the full sample in the baseline case. Our interpretation of this result is that
datasets of large firms typically used in the literature might under-estimate the magnitude of withinindustry misallocation.
12
Table 3: Misallocation in Spain over the period 1995-2007 Robustness analysis

TFP gain from reallocation
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Baseline
(1)
3-digit
(2)
2-digit
(3)
Balanced
(4)
=5
(5)
M. error
(6)
Large firms
(7)
0.24
0.26
0.27
0.28
0.34
0.36
0.38
0.40
0.41
0.44
0.45
0.47
0.49
0.27
0.28
0.31
0.32
0.39
0.39
0.40
0.42
0.44
0.46
0.48
0.51
0.52
0.33
0.37
0.38
0.41
0.45
0.46
0.46
0.48
0.51
0.54
0.58
0.62
0.62
0.20
0.20
0.22
0.20
0.23
0.23
0.23
0.23
0.24
0.25
0.27
0.29
0.28
0.39
0.45
0.42
0.45
0.52
0.52
0.53
0.53
0.54
0.61
0.61
0.72
0.69
0.25
0.26
0.27
0.29
0.32
0.32
0.33
0.35
0.36
0.38
0.39
0.40
0.42
0.14
0.14
0.16
0.16
0.18
0.17
0.21
0.23
0.20
0.20
0.23
0.21
0.22
Notes: Baseline in column (1) refers to our benchmark results based on misallocation within 4-digit
industries, =3, and the unbalanced panel. Columns (2) and (3) report the results when considering
indutries at 3- and 2-digit classifications (NACE 2 rev. 2). Column (4) is based on the balanced version
of our panel. Column (5) reports the TFP gains when considering =5 instead of =3. Column (6) refers
to the trimming of the 2% tails of TFPR and TFPQ in order to alleviate the influence of measurement
error. Finally, column (7) is based on a sample of large firms (more than 50 employees).
5 Sources of misallocations evolution

In the previous sections we have uncovered a large decrease in within-industry allocative efficiency,
which we have shown to be the main source of low TFP growth observed over the 1995-2007 period in
Spain. Given this finding, the challenge is to identify the economic forces that led to the increase in
the misallocation of production factors across firms. In this section, we make a first step by providing
some descriptive evidence together with some tentative interpretations regarding the potential sources
of the Spanish increase in misallocation over the last expansion. In particular, we estimate the
relationship between different sector- and firm-specific characteristics with the observed sector and
firm-specific changes in allocative efficiency.
5.1 Size versus capital distortions
In this section we explore the firm-specific measures of distortions implied by the Hsieh and Klenow
(2009) exercise of Appendix A. In particular, we have two measures of distortions, one labeled as
K that distorts the capital-labor ratio, and one labeled as Y that distorts the size of the firm.
Intuitively, a firm faces a high distortion in the capital-labor ratio (i.e. K is high) when the ratio of
13
labor to capital compensation is high relative to what one would expect in the absence of distortions
(i.e. when there is no within-industry variation on the ratio of labor to capital compensation). On
the other hand, a firm faces a high distortion in its size (i.e. a high Y ) when it is smaller than it
should be, in other words, when the labor compensation of the firm is low compared to what one
would expect given the industry elasticity of output with respect to labor.
Potential TFP gains increased from around 0.25 in 1995 to around 0.50 in 2007 (see Figure 3).
Figure 5 plots the resulting TFP gains when eliminating variation in one distortion at a time. By
switching down the capital-labor distortion, i.e., fixing Ki = 0 i, TFP gains increased from around
0.01 in 1995 to around 0.03 in 2007. Therefore the level of TFP gains due to size distortions is very
low. In contrast, the level of TFP gains remain relatively high with an increase from 0.11 in 1995 to
0.20 in 2007 when the size distortion is switched off (i.e. Yi = 0 i) and the K distortion is present.
All in all, the K distortion to the capital-labor ratio seems to be the most important distortion in
explaining the evolution of aggregate misallocation in Figure 3. Moreover, the interaction between
both distortions also explains a significant part of the misallocation level and increase. A possible
rationale for this finding is that firms operating with bad input mixes (large capital distortion) also
tend to be larger than optimal (large size distortion), worsening the misallocation problem. For
instance, Smagghue (2015) shows that size-dependent regulations might also generate an inefficient
reallocation of resources from capital intensive to labor intensive firms. Indeed, the within industryyear correlation between both distortions is 0.40 in levels and 0.24 in growth rates.
.1
.2
.3
.4
.5
Figure 5: Potential TFP gains from reallocation by type of firm-specific distortion
1995
1997
1999
2001
2003
2005
Overall TFP Gain
Due to interaction
Due to capital distortion
Due to size distortion
14
2007
5.2 Sector-level analysis

We first analyze the type of sectors in which the deterioration in allocative efficiency between 1995
and 2007 was more pronounced. We have information on several characteristics of 58 sectors at
the 2-digit NACE rev. 2 classification (see Table B1 in the Appendix). In order to exploit this
information we consider here changes in allocative efficiency at the 2-digit level.13 Figure 6 plots
the level of potential TFP gain from reallocation in 1995 against its change between 1995 and 2007.
Most of the sectors (51 out of 58) experienced increases in such TFP gains, i.e. deterioration in
allocative efficiency, which explains the overall deterioration in Figure 3. In particular, the industries
Warehousing and support activities for transportation, Electricity, gas, steam and air conditioning
supply, and Activities of head offices; management consultancy activities worsened the most while
Manufacture of furniture, Manufacture of beverages, and Motion picture, video and television
programme production, sound recording experienced slight improvements in allocative efficiency.
Moreover, there is no relationship between the initial level of allocative efficiency and the change
over the 1995-2007 period. Therefore, we next investigate to what extent observable sector-specific
characteristics can generate such differences in allocative efficiency between sectors. In particular,
we consider four different dimensions that might be related to the evolution of allocative efficiency.
Figure 6: TFP gain and its change by 2-digit sector

70
35
52
Change in TFP gain (19952007)

0
.5
38
41
61
60
26
50
37
53
71
1739
74
49
56 55 7915
271820 10
7563
73
58 80
46 69
78
43 32 47
77
25 82
81
62
23
28 16 14
22
13
33 21
30 24
72
42
11 31
29
45
68
.5
59
.5
1
TFP gain in 1995 by sector (NACE 2digits)
1.5
First, we explore the role of skill intensity differences across sectors. There are several reasons
13
Note that the results are based on misallocation within 4-digit sectors that is aggregated to the 2-digit level using
production-based weights as oppossed to computing misallocation within each 2-digit sector.
15
why this may matter. For instance, firing costs have been long blamed as a possible source of
misallocation of workers across firms (see Dolado, Ortigueira, and Stucchi (2011)). Firing costs on
open ended contracts are high in Spain. However, the share of employment under flexible fixedterm contracts was large and stable over the period.14 It has been argued that fixed-term contracts,
because they preclude human capital accumulation on the job, are more prevalent among low skilled
occupations. Hence, if firing costs are a source of misallocation, we should expect a larger increase
in misallocation in high-skill industries. Skill intensity in US sectors is taken as our baseline proxy
because it is expected to be exogenous to the evolution of allocative efficiency in Spanish sectors of
activity. As a robustness check, we also consider the share of skilled workers in Spain taken from
PITEC (Panel de Innovacion Tecnologica), which is based on a survey of innovative firms conducted
by the National Statistics Institute.15
Second, differences in external financial dependence across sectors may affect the resource allocation process. The sharp expansion in bank lending during the period 1995-2007 originated a stock of
loans from credit institutions to non-financial corporations of 90% of GDP in 2007 while it was 38%
in 1995. The increasing abundance of new credit to firms together with a loose screening process by
banks can generate a deterioration in allocative efficiency if bad firms are able to survive hampering
the reallocation process towards better firms. In order to check this potential channel, we consider
a sector-specific finance intensity variable constructed by Fernald (2014) for the US. Exploiting I-O
tables, this finance intensity variable is given by nominal purchases of intermediate financial services
as a share of industry gross output. Again, using US sector characteristics ensures exogeneity with
respect to the evolution of allocative efficiency in Spanish industries. As an alternative measure of
sector-specific financial dependence, we consider the ratio of sectors total liabilities as a percentage
of its total assets computed using firm-level data from the Central Balance Sheet Data.
Third, more dynamic industries can be expected to produce better allocations of resources. For
instance, more innovative sectors have usually larger shares of innovative and young firms that
can easily adapt to shifts in demand or actions taken by competitors. Cecchetti and Kharroubi
(2012) argue that credit booms (such as the one witnessed in Spain over 1995-2007) undermine R&D
intensive sectors, which might be related to the deterioration in TFP growth. Along these lines, we
consider Fernald (2014) IT intensity variable at the sector level in the US, which consists on the
payments for IT as a share of income (taken from the Bureau of Labor Statistics). As an alternative
measure of sector-specific IT content, we exploit the Spanish PITEC to construct shares of R&D
investment over total investment.
Finally, some sectors may be less competitive because business success is related to state licensing
or regulation. If this is the case, we could expect some firms in such sectors to operate with size or
14
The share of fixed-term contract was around 35% of employment in those years, but it witnessed a large increase
before 1995.
15
See www.icono.fecyt.es/PITEC for more details.
16
input mix far from optimal and still survive. To explore this hypothesis, we define a dummy variable
taking value 1 for those sectors considered to be crony sectors, which we define as those sectors
susceptible to monopoly or requiring licensing or highly dependent on government regulation.16
As an alternative measure, we also consider the Bribe Payers Index constructed by Transparency
International with information at the sector level. The 2011 Bribe Payers Survey, on which the index
is based, asked business executives how common bribery was in the sectors with which they have
business relations.17
Table 4 shows some correlations between the sector characteristics just described and the changes
in allocative efficiency. In particular, we regress the change in sector-specific potential TFP gains on
the different characteristics measured as the average over the 1995-2007 period. Columns (1)-(5) are
based on linear regressions with different covariates. Column (6) is based on weighted-average least
squares (WALS), a model averaging approach that provides standard errors incorporating not only
parameter uncertainty but also model uncertainty.18
16
These sectors are, casinos, coal, palm oil and timber, defense, deposit-taking banking and investment banking,
infrastructure and pipelines, ports, airports, real estate and construction, steel, other metals, mining and commodities,
utilities and telecoms services. In our dataset, we label as crony the following 2-digit sectors: 24, 35, 37, 38, 39, 41,
42, 50, 51, 61, and 68 (see Table B1 in the Appendix).
17
The survey asked how often three different types of bribery were perceived to occur in each sector: firstly, bribery
of low-ranking public officials; secondly, improper contributions to high-ranking politicians to achieve influence; and
thirdly, bribery between private companies. Answers were given on a 5-point scale. This was then converted to a
10-point scale where 0 indicates that companies in that sector are perceived to always pay bribes and 10 to never pay
bribes.
18
Model uncertainty results from the lack of theoretical guidance on the particular regressors to include in the
empirical model. When model uncertainty is present, traditional standard errors would under-estimate the real
uncertainty associated to the estimate of interest because variation across models is ignored. In order to account for
both levels of uncertainty, model averaging techniques (e.g. WALS) estimate all possible combinations of regressors
and constructs a single estimate by averaging all model-specific estimates (see Moral-Benito (2015) for an in-depth
analysis of model averaging).
17
Table 4: Misallocation and sector-specific characteristics.

Dep. Variable: TFP Gain
(1)
OLS
High-skill intensity (US share)
(2)
OLS
(3)
OLS
(6)
WALS
0.226***
(0.081)
0.197***
(0.034)
58
0.12
-0.008
(0.271)
0.333
(0.501)
0.033
(0.032)
0.209**
(0.086)
0.112
(0.078)
58
0.15
-0.008
(0.210)
0.188
(0.408)
0.025
(0.027)
0.150**
(0.077)
0.149**
(0.068)
58
-
0.284
(0.445)
Financial dependence (US financial intensity)
0.044
(0.029)
Public sector influence (crony dummy)
Observations
R-squared
(5)
OLS
0.064
(0.219)
Innovative content (US IT intensity)
Constant
(4)
OLS
0.219***
(0.069)
58
0.00
0.216***
(0.046)
58
0.01
0.148**
(0.066)
58
0.04
Notes: TFP Gain refers to the change over the 1995-2007 period in the ratio of optimal TFP in the absence
of misallocation to observed TFP.
We fail to find any statistically significant relationships between skill intensity, innovative content,
or financial dependence with the change in allocative efficiency (see Column (1)-(3) in Table 4).
Furhtermore, the R-squared indicates that variation in these characteristics can only account for less
than 0.5% of the variation in misallocation changes. In contrast, Column (4) in Table 4 indicates that
the deterioration in allocative efficiency was 22.6 points larger in crony than in non-crony sectors.
This statistically significant difference implies that the eleven industries in which success in business
depends more on relationships between firm managers and public sector officials were the industries
experiencing the largest increases in misallocation over the 1995-2007 period. In addition, the crony
dummy is able to account for 11% of this variation. When all the variables are jointly included in
the regression in column (5), the magnitude and significance of the crony dummy remains virtually
unaltered; however, partial correlations of skill intensity, innovative content, and financial dependence
are statistically indistinguishable from zero. Finally, column (6) reports WALS estimates confirming
the conclusion from column (5) even when we also account model uncertainty.
18
Table 5: Misallocation and sector-specific characteristics Alternative proxy regressors.

Dep. Variable: TFP Gain
(1)
OLS
High-skill intensity (Spain share)
(2)
OLS
(3)
OLS
(6)
WALS
-0.264***
(0.086)
2.015***
(0.058)
58
0.14
0.149
(0.157)
-0.475*
(0.249)
-0.025
(0.092)
-0.266***
(0.090)
2.033***
(0.623)
58
0.21
0.083
(0.131)
-0.339
(0.215)
-0.022
(0.086)
-0.194**
(0.084)
1.553***
(0.585)
58
-
-0.303
(0.249)
Financial dependence (Spain debt burden)
0.021
(0.097)
Public sector influence (BPI index)
Observations
R-squared
(5)
OLS
0.163
(0.155)
Innovative content (Spain R&D share)
Constant
(4)
OLS
0.187***
(0.053)
58
0.02
0.257***
(0.040)
58
0.03
0.228***
(0.051)
58
0.00
Notes: See notes to Table 4.
Table 5 shows the same set of results but considering alternative proxy variables for each sectorspecific characteristic. For the influence of public sector we consider the BPI index described above
and for the other three dimensions we evaluate the Spanish counterparts of the US indicators. Again,
public sector influence is significantly related to changes in misallocation; in particular, sectors in
which the incidence of bribery is larger experienced large increases in misallocation over the 19952007 period (note that the lower the BPI index the higher the bribery incidence). Turning to skill
intensity, innovative content, and financial dependence in columns (1), (2), and (3), respectively, we
again fail to find statistically significant correlations in all the three cases. Using these alternative
proxies, columns (5) and (6) of Table 5 also confirm the results in the corresponding columns of
Table 4.
5.3 Firm-level analysis
We now turn to exploit firm-level data on distortions. Formally, the two measures of firm-specific
distortions provided by the theoretical model, Ki and Yi , are given by equations (17) and (18),
respectively. We aim to investigate the characteristics of firms behind the increases in misallocation
over the period; hence, we define the firm-specific growth rates of Ki and Yi to facilitate the
interpretation of our estimates.19 We then regress the firm-specific changes in distortions on two
firm characteristics (size and age) including a set of 4-digit industry dummy variables as well as a
set of year dummy variables to ensure that identification is based on across firms variation within
each industry-year.
19
More specifically, ln(1 + Ki,t ) = ln(1 + Ki,t ) ln(1 + Ki,t1 ) and ln(1 Yi,t ) = ln(1 Yi,t ) ln(1 Yi,t1 ).
We do not use the firm-specific growth rate over the entire period because it would drastically reduce the number of
observations available for estimation.
19
We focus on size and age of the firm because these are natural candidate characteristics to explain
the within industry-year variation in firm-specific distortions. There are some size-dependant policies
in Spain favoring smaller firms (e.g. by reducing the cost of labor through labor regulations or less
strict enforcement activity of tax collection for smaller firms), but other economic mechanisms such
as access to credit may be hindering the growth of smaller firms. The credit channel may as well
hamper the access to credit of young firms without credit reputation while other firm-age contingent
policies favor younger firms (e.g. special lines of credit or labor regulations for start-ups). Given
our interest in changes in distortions, our hypothesis is that these channels may have been amplified
during the 1995-2007 period; for instance, the increasing abundance of public revenues and bank
credit due to the housing boom allowed the proliferation of public subsidies and loose bank lending
policies that may have evolved differently for different types of firms.
Table 6 reports some estimation results. Regarding distortions to the capital-labor ratio, columns
(1) and (2) show that smaller firms faced on average larger increases in their capital distortions. In
particular, the average yearly growth rate of the capital distortion was 8.5 log points larger for
firms with less than 50 employees according to column (2). Also, a size increase of 100 employees
is associated to an average reduction of 0.7 log points in the capital distortion each year according
to column (1). One possible interpretation of this finding is that larger firms enjoyed increasing
subsidies to capital, for instance through cheaper access to credit.20 Columns (3) and (4) indicate
that younger firms experienced higher capital distortions than older firms. For instance, firms with
less than 10 years old experienced an average capital distortion growth 1.7 log points larger than
mature firms (10 years and above).21 Moreover, according to column (3) a 10-year increase in firm
age is associated to a yearly reduction of 1.3 log points in the capital distortion. This result would
confirm the hypothesis that younger firms faced more difficulties in the access to credit relative to
mature firms, and that this has worsened over the 1995-2007 period.
20
Note that the dependent variable can be written as ln(1 + Ki,t ) = ln(wLi,t ) ln(RKi,t ) under the
assumption that s does not vary over time. Thefore, this result implies that, in small firms the difference between
labor compensation growth and capital compensation growth was larger than in large firms within each industry.
21
We take the definition of young firms from Haltiwanger, Jarmin, and Miranda (2013). However, this result is
robust to alternative thresholds.
20
Table 6: Changes in firm-level distortions and firm size and age

Dep. Variable: ln(1 Yi,t )
Dep. Variable: ln(1 + Ki,t )

(1)
OLS
Size
(2)
OLS
(3)
OLS
-0.00007***
(0.00002)
Small dummy
0.085***
(0.004)
(6)
OLS
-0.0013***
(0.0001)
0.072***
(0.002)
NO
YES
YES
YES
0.02
1,682,056
(7)
OLS
(8)
OLS
-0.113***
(0.004)
Young dummy
Size dummies
Age dummies
Industry dummies
Time dummies
R-squared
Observations
(5)
OLS
0.00009***
(0.00002)
Age
Productivity
(4)
OLS
0.074***
(0.002)
NO
YES
YES
YES
0.02
1,682,056
0.083***
(0.003)
YES
NO
YES
YES
0.02
1,682,056
0.0017***
(0.0001)
0.017***
(0.003)
0.083***
(0.003)
YES
NO
YES
YES
0.02
1,682,056
-0.082***
(0.002)
NO
YES
YES
YES
0.05
1,682,056
-0.085***
(0.002)
NO
YES
YES
YES
0.05
1,682,056
-0.097***
(0.003)
YES
NO
YES
YES
0.06
1,682,056
-0.025***
(0.001)
-0.097***
(0.003)
YES
NO
YES
YES
0.06
1,682,056
Notes: Standard errors are clustered at NACE rev. 2 4-digit level. Firms with less than 50 employees are labeled
as small. Young firms are less than 10 years old, see Haltiwanger, Jarmin, and Miranda (2013). Four groups are
considered for the size dummies, 1-10 employees, 10-50 employees, 50-250 employees, and more than 250 employees.
Age dummies are based on age groups divided by year-specific quartiles. Estimation sample covers the period
1995-2007.
Turning to the size distortion in columns (5)-(8), we find that smaller and younger firms faced
larger increases in size distortions.22 To be more precise, our results could imply that the growth
of small and young firms over the 1995-2007 period was hampered by increasing distortions faced
by those firms. For instance, column (5) implies that a size increase of 100 employees is associated
to an average increase of 0.9 log points in the size distortion each year, while according to column
(7) a 10-year increase in firm age is associated to an annual increase of 1.7 log points in the size
distortion.23 Finally, note that the estimates in Table 6 are robust to the inclusion of industry-year
dummy variables, region dummy variables, and region-year dummy variables, as well as to outliers
(i.e. excluding the top and bottom 1% of the dependent variables).
5.4 Regional misallocation
Spanish regions (Comunidades Autonomas) have the political power to enact laws and establish regulations. Indeed, Marcos, Santalo, and Sanchez-Graells (2010) document the existence of substantial
22
Note that the dependent variable is defined as the change in ln(1 Yi,t ). According to equation (18), smaller
values of 1 Yi,t correspond to firms smaller than optimal given s , , and their production.
23
Under the assumption of constant industry elasticities, the growth of the size distortion can be decomposed as
ln(1 Yi,t ) = ln(wLi,t ) ln(Pi,t Yi,t ). Thus, our results imply that in small and young firms the difference
between labor compensation growth and sales growth was smaller than in large firms within each industry, i.e., given
their sales those firms should have hired more workers.
21
heterogeneity in region-specific regulations. In addition, the Spanish labor market is characterized

by large regional differences in employment and wages, see Bentolila and Jimeno (1998). Under these
circumstances, a natural concern is whether the overall deterioration in allocative efficiency across
firms might be just reflecting heterogeneity in the change of the relative cost of capital and labor
in different regions. We argue that this does not seem to be the case. First, Figure 7 shows that
the increase in misallocation was present in all the seventeen Spanish regions.24 Second, using data
from the Encuesta de Estructura Salarial for the years 2002 and 2006,25 we regress the region-specific
average wage growth on the change in missallocation. The estimated coefficient renders this relationship statistically insignificant, and has a point estimate of 0.047 (t-stat = 0.79). We thus conclude
that the deterioration in allocative efficiency uncovered in this paper is caused by nationwide forces.
Figure 7: Evolution of TFP gains in Spanish regions
2007
2001
2005
2007
2007
2005
2007
2007
2003
2005
2007
2005
2007
200
150
200
100
2003
2005
2007
200
150
2005
2007
2001
2003
2005
2007
200
PAIS VASCO
150
200
2003
2007
100
2003
100
2001
2005
GALICIA
150
150
2007
2001
NAVARRA
100
2005
2001
COMUNIDAD MURCIANA
200
200
150
100
2003
2007
100
2001
COMUNIDAD DE MADRID
2001
2005
150
200
100
2005
2003
EXTREMADURA
150
200
150
2003
2001
COMUNIDAD VALENCIANA
100
2001
2003
150
200
2003
2001
CASTILLA Y LEON
150
2001
CATALUNYA
2007
200
2005
2005
100
100
2003
2003
CASTILLA LA MANCHA
150
200
150
100
2001
2001
CANTABRIA
200
CANARIAS
2003
100
2005
100
150
100
2003
100
150
150
100
2001
BALEARES
200
ASTURIAS
200
ARAGON
200
ANDALUCIA
2001
2003
2005
2007
2001
2003
2005
2007
100
150
200
LA RIOJA
2001
2003
2005
2007
24
We compute potential TFP gains from within-industry reallocation for each region-year pair over the 2001-2007
period. The number of firms steadily increased over the sample period in Spain so that for certain small regions there
are not enough firms in each 4-digit sector in the first years to estimate meaningful TFP gains. Focusing on 2-digit
sectors we can compute those measures and the increases are also generalized for these intial years.
25
Available at http://goo.gl/tbYiOp.
22
6 Concluding Remarks
Spanish growth during the 1994-2007 expansion was based on factor accumulation rather than productivity gains. In particular, annual TFP growth was -0.7%, which is low in comparison to other
developed economies such as the US or EU. In this paper, we argue that the source of negative TFP
growth has been the increase in the within-sector misallocation of production factors across firms.
Furthermore, we find the phenomenon to be present in all sectors of activity, which casts doubt on
the widespread view that specialization in low productivity sectors such as construction was the main
force behind Spanish low TFP growth.
In order to shed some light on the potential sources of this phenomenon in Spain, we find that
industries in which the influence of the public sector is larger (e.g. through licensing or regulations)
experienced significantly larger increases in misallocation. In contrast, other characteristics such
as skill intensity, innovative content or financial dependence are unrelated to changes in allocative
efficiency. Turning to firm-specific distortions, we find that small and young firms in Spain might
have faced higher market distortions than large and mature firms.
In light of these findings, the next challenge is to develop a framework for understanding the
major forces and policies behind these patterns of allocative efficiency and firm-specific distortions.
For instance, Garcia-Santana, Moral-Benito, Pijoan-Mas, and Ramos (2015) explore the role of public
procurements on the allocation of resources in the private sector.
23
A Theoretical framework
This section presents the model of monopolistic competition with firm heterogeneity a` la Melitz
(2003) introduced by Hsieh and Klenow (2009) (HK) to measure within industry misallocation as a
source of differences in aggregate TFP. The crucial characteristic of this model is that firms differ
not only in their efficiency levels but also in the capital and output distortions they may face when
taking their production decisions.
The HK model is characterized by a closed economy with two primary inputs (capital and labor)
and S industries producing differentiated intermediate goods that are combined by a pure assembly sector to produce an homogeneous final good. Firms producing the intermediate differentiated
goods operate under monopolistic competition and sell their products to the final good producers. In
the absence of distortions, the allocation of resources across firms producing the intermediate goods
depends only on physical levels of firm-specific TFP, which yields to the optimal level of aggregate
TFP. However, the model features firm-specific distortions that preclude firms from optimally choosing their levels of output and capital-labor mix. This implies within industry misallocation, which
deviates aggregate measured TFP from its optimal level.
HK assume that there are S different industries in the economy. The output of each of the
industries s S is the outcome of aggregating Ms differentiated intermediate goods:
Ys =
Ms
X
! 1
Ysi
(1)
i=1
where is the elasticity of substitution between goods. Each of these goods is produced by a firm
that operates in a monopolistic competitive market and has access to a Cobb-Douglas production
function that combines labor and capital:
s
Ysi = Asi Ksis L1
si
(2)
Firms choose labor and capital to maximize profits:

si = max {(1 Ysi )Psi Ysi wLsi (1 + Ksi )RKsi }
Lsi ,Ksi
(3)
where Ysi and Ksi are firm-specific distortions. Notice that Ysi distorts the size of the firm, whereas
Ksi distorts the optimal capital-labor ratio decission. This problem yields the following first order
conditions:
24
(1 Ysi )Psi Asi (1
)L
si Ksi
1
Psi Asi L1
si Ksi

W =0
(4)
R(1 + Ksi ) = 0
(5)
These two first order conditions imply that the price of firms output equals a mark-up over the
marginal cost:
1s
W
1 (1 + Ksi )s
(6)
1 s
Asi 1 ysi
1s
s
s
W
1 (1Ksi )
is the mark-up charged by the firm and Rs

is its marginal
where 1
1s
Asi (1Ysi )
cost. This optimal pricing rule yields labor demand and output that are proportional to the firms
physical TFP and the idiosyncratic distortions:
Psi =
1
R
s
s
A1
si (1 ysi )
(1 Ksi )s (1)
Asi (1 ysi )
(1 Ksi )s
Lsi
Ysi
and a capital-labor ratio that depends only on the firms idiosyncratic distortions and relative prices:
s w
Ksi
1
=
Lsi
1 s R 1 + Ksi
(7)
In the absence of distortions, the allocation of resources across firms depends only on physical levels
of firms TFP, yielding to a equalization of capital-labor ratios and marginal revenue products of
labor and capital. In the presence of distortions, both capital-labor ratios and total outputs become
distorted, generating variation on the marginal revenue products and hence misallocation.
A.1 Within-industry Misallocation
Total factor productivity revenue of firm i is defined as:
TFPRsi Psi Asi
(8)
Therefore, substituting equation (6) into equation (8):
TFPRsi =
1
R
s
s
25
W
1 s
1s
(1 + Ksi )s
1 ysi
(9)
Note that, in the absence of idiosyncratic distortions the TFPRsi would equalize across firms operating in the same industry. Suppose, for example, that there is a firm with a relatively high level
of physical TFP (Asi ). This firm would want to attract labor and capital until reaching the point
where its lower price makes its TFPRsi the same as the one of less productive firms. In this situation,
revenue marginal products of labor and capital are equalized across firms and the first best allocation
is achieved.
Observed TFP in a given industry is defined as:
1
"M
1 # 1
s
X
TFPRs
TFPs =
Asi
TFPRsi
i=1
(10)
where TFPRsi is the total factor productivity revenue of firm i in industry s defined and TFPRs is the
weighted average total factor productivity revenue in industry s. Equation (10) clearly suggests that,
conditional on the distribution of firms physical productivity Asi , the industry TFPs is maximized
when there is no variation in TFPRsi across firms. Then, the higher the variation in the firms
idiosyncratic distortions, the higher the variation in the within-industry TFPRsi , and hence the
higher the amount of misallocation.
A.2 Aggregate TFP
In the model, there is a single final consumption good produced by a representative firm in a perfectly
competitive final good market. This firm combines intermediate goods Ys produced in a finite number
of different industries s S. These intermediates are aggregated to produce the final good using a
Cobb-Douglas technology:
Y =
S
Y
Yss
(11)
s=1
where
PS
s=1 s
= 1. The optimization problem of the representative firm implies:

Ps Ys = s Y
(12)
Q s
is set equal to 1.
where Ps refers to the price of industry output Ys . The price index P Ss=1 Pss
It is important to emphasize that, due to the Cobb-Douglas assumption, the only source of inefficiency
in this model is the within-industry misallocation: the increase in an industrys productivity is fully
compensated by a the decrease in its price index, so firms idiosyncratic distortions do not affect the
sectoral composition of the economy. GDP can be expressed as a function of industries amounts of
labor, capital, and TFPs :
26
Y =
S
Y
(T F Ps Kss Ls s )s
(13)
s=1
Then, by using equations (10) and (13) the aggregate observed TFP becomes:
TFP =
S
Y
TFPss =
s=1
S
Y
Ms
X
s=1
i=1
Asi
TFPRs
TFPRsi
1
1 ! 1
(14)
This expression clearly shows how within-industry misallocation of labor and capital yields a lower
measured aggregate TFP. To understand how costly are the idiosyncratic distortions one can define
the optimal level of TFP (i.e. the TFP level in the absence of firm-specific distortions):
TFP =
S
Y
s=1
TFPs =
S
Y
Ms
X
s=1
1 s
! 1
(Asi )1
(15)
i=1
The ratio of optimal TFP to observed TFP (i.e. TFP

1) is the potential TFP gain from
TFP
reallocation that we will use throughout the paper. In particular, we analyze its evolution over time
as an indication of the relevance of changes in within sector misallocation to explain the evolution
of aggregate TFP growth in Spain.
A.3 Identification of firm-specific distortions
Using the firms optimality conditions we can infer the level of idiosyncratic distortions by picking
the values of Ksi and Ysi that, through the lens of the model, rationalize the combinations of labor,
capital, and production that we observe in the data.
Aggregate parameters: we follow Hsieh and Klenow (2009) by setting R to 10% (5% interest
rate and 5% depreciation rate) and the elasticity of substitution to 3.26 The industry-specific
capital shares s are set to 1 minus the labor share in industry s in the US.
Pinning-down firms physical TFP: For every firm in the data we infer its physical TFP
using the expression:
(Psi Ysi ) 1
Asi = s s 1s
Ksi Lsi
26
(16)
Note that the gains from reallocation increase in , and this is a conservative value given that industries are
defined at the 4-digit level. Moreover, we later conduct some robustness checks evaluating the importance of this
assumption.
27
1
1
w1s (Ps Ys )
Ps
where s =
is a industry-specific constant. Since it does not affect relative productivities within industry, we set s = 1 for all industries. Note that we do not observe firms real output
Ysi but rather its total revenue Psi Ysi . We hence use revenue data and the elasticity of substitution
to infer real output.
Pinning-down capital accumulation distortions: Equation (7) pins-down the distortion
associated to capital accumulation:
1 + Ksi =
s wLsi
1 s RKsi
(17)
The model identifies a high Ksi when the ratio of labor to capital compensation is high, relative to
what one would expect in the absence of distortions. In a situation in which no firm faces distortions
on capital accumulation, we should observe that there is no within-industry variation on the ratio
of labor to capital compensation. Through the lens of the model, a relatively high level of labor
to capital compensation is associated to the firm facing an idiosyncratic tax distorting its optimal
capital-labor ratio. For instance, labor market regulations that result in a high cost of labor only for
some firms would be reflected in low Ksi for those firms. Conversely, financial markets frictions that
raise financial costs for some firms would be reflected in high Ksi for those firms.
Pinning-down size distortions: After some straightforward manipulation, we can express
equation (4) as:
(1 Ysi ) =
wLsi
1 (1 s )Psi Ysi
(18)
This equation pins-down a high Ysi when the labor compensation of the firm is low compared to what
one would expect given the industry elasticity of output with respect to labor (adjusted for markups). In the presence of distortions, the before-taxes marginal revenue products are not equalized
across firms, and hence misallocation arises. Any policy that penalizes firms growth would appear
in the form of a high inferred Ysi s.
28
B Misallocation Results for All Sectors NACE rev.2
Table A1: Misallocation in Spain over the period 1995-2007. Sectors 10-23.
Sector
HK
STD TFP
OP LPR
OP TFP
1995 - 2000
2001 - 2007
10
0.24
0.32
0.45
0.48
0.33
0.26
1.26
1.11
1995 - 2000
2001 - 2007
11
0.32
0.32
0.53
0.52
0.57
0.50
1.70
1.39
1995 - 2000
2001 - 2007
12
0.16
0.16
0.62
0.64
0.43
1.17
1.42
1.99
1995 - 2000
2001 - 2007
13
0.27
0.28
0.39
0.42
0.14
0.13
1.17
0.90
1995 - 2000
2001 - 2007
14
0.29
0.36
0.38
0.45
0.18
0.17
1.15
1.09
1995 - 2000
2001 - 2007
15
0.40
0.53
0.46
0.53
0.05
0.04
0.82
0.72
1995 - 2000
2001 - 2007
16
0.25
0.27
0.34
0.39
0.19
0.14
1.15
0.89
1995 - 2000
2001 - 2007
17
0.24
0.32
0.39
0.48
0.44
0.41
1.38
1.11
1995 - 2000
2001 - 2007
18
0.21
0.24
0.36
0.39
0.26
0.22
1.42
1.13
1995 - 2000
2001 - 2007
20
0.29
0.44
0.50
0.58
0.57
0.49
1.61
1.26
1995 - 2000
2001 - 2007
21
0.35
0.26
0.54
0.59
0.31
0.42
1.29
1.42
1995 - 2000
2001 - 2007
22
0.17
0.21
0.35
0.38
0.42
0.31
1.41
1.15
1995 - 2000
2001 - 2007
23
0.19
0.26
0.38
0.44
0.38
0.31
1.28
1.04
29
Sector
HK
STD TFP
OP LPR
OP TFP
1995 - 2000
2001 - 2007
24
0.21
0.32
0.37
0.44
0.60
0.58
2.01
2.05
1995 - 2000
2001 - 2007
25
0.27
0.35
0.41
0.44
0.16
0.11
0.97
0.83
1995 - 2000
2001 - 2007
26
0.31
0.54
0.53
0.58
0.54
0.42
1.74
1.19
1995 - 2000
2001 - 2007
27
0.17
0.28
0.36
0.38
0.34
0.40
1.74
1.23
1995 - 2000
2001 - 2007
28
0.16
0.19
0.29
0.33
0.26
0.20
1.08
0.94
1995 - 2000
2001 - 2007
29
0.13
0.27
0.41
0.48
0.38
0.46
2.02
2.17
1995 - 2000
2001 - 2007
30
0.10
0.12
0.25
0.33
-0.08
0.18
1.09
1.03
1995 - 2000
2001 - 2007
31
0.16
0.25
0.36
0.40
0.20
0.15
1.00
0.92
1995 - 2000
2001 - 2007
32
0.21
0.31
0.36
0.44
0.23
0.19
1.16
0.95
1995 - 2000
2001 - 2007
33
0.20
0.24
0.30
0.36
0.30
0.12
0.99
0.92
1995 - 2000
2001 - 2007
35
0.24
0.36
0.59
0.70
0.69
1.11
1.84
1.98
1995 - 2000
2001 - 2007
37
0.43
0.79
0.63
0.62
-0.02
0.15
0.87
0.57
1995 - 2000
2001 - 2007
38
0.57
0.60
0.61
0.63
0.13
0.12
1.01
1.12
1995 - 2000
2001 - 2007
39
0.64
0.83
0.69
0.67
-0.06
-0.09
1.82
1.18
30
Sector
HK
STD TFP
OP LPR
OP TFP
1995 - 2000
2001 - 2007
41
0.32
0.82
0.37
0.44
0.20
0.10
1.66
1.43
1995 - 2000
2001 - 2007
42
0.17
0.20
0.31
0.34
0.12
0.28
1.61
1.37
1995 - 2000
2001 - 2007
43
0.22
0.25
0.35
0.35
0.11
0.07
1.55
1.10
1995 - 2000
2001 - 2007
45
0.55
0.65
0.56
0.62
0.21
0.23
1.20
1.15
1995 - 2000
2001 - 2007
46
0.41
0.50
0.45
0.48
0.17
0.13
1.43
1.28
1995 - 2000
2001 - 2007
47
0.31
0.33
0.42
0.43
0.45
0.35
2.57
1.86
1995 - 2000
2001 - 2007
49
0.20
0.38
0.36
0.43
0.14
0.13
1.41
1.10
1995 - 2000
2001 - 2007
50
0.36
0.43
0.50
0.49
0.44
0.52
1.32
1.10
1995 - 2000
2001 - 2007
51
0.12
0.16
0.46
0.51
0.43
0.52
2.04
2.66
1995 - 2000
2001 - 2007
52
0.68
1.01
0.56
0.60
0.54
0.43
1.60
1.30
1995 - 2000
2001 - 2007
53
0.75
1.12
0.64
0.71
-0.03
0.13
1.04
0.88
1995 - 2000
2001 - 2007
55
0.22
0.38
0.41
0.49
0.21
0.19
1.74
1.56
1995 - 2000
2001 - 2007
56
0.23
0.44
0.37
0.46
0.08
0.01
1.22
1.00
1995 - 2000
2001 - 2007
58
0.28
0.41
0.41
0.46
0.58
0.55
1.98
1.82
31
Sector
HK
STD TFP
OP LPR
OP TFP
1995 - 2000
2001 - 2007
59
0.57
0.69
0.52
0.56
0.16
0.09
1.40
1.30
1995 - 2000
2001 - 2007
60
0.33
0.79
0.50
0.54
1.29
0.90
2.00
1.63
1995 - 2000
2001 - 2007
61
1.22
1.12
0.68
0.79
1.86
2.03
2.05
2.75
1995 - 2000
2001 - 2007
62
0.15
0.20
0.38
0.41
0.33
0.43
2.16
2.29
1995 - 2000
2001 - 2007
63
0.05
0.23
0.25
0.42
0.43
0.37
1.91
1.97
1995 - 2000
2001 - 2007
68
1.67
2.02
0.90
0.96
-0.15
-0.14
1.31
1.32
1995 - 2000
2001 - 2007
69
0.57
0.64
0.49
0.47
0.21
0.09
1.61
1.29
1995 - 2000
2001 - 2007
70
0.38
0.62
0.39
0.53
0.36
0.06
1.57
1.43
1995 - 2000
2001 - 2007
71
0.19
0.49
0.42
0.51
0.21
0.07
2.21
1.63
1995 - 2000
2001 - 2007
72
0.25
0.15
0.51
0.50
0.18
0.18
1.12
1.26
1995 - 2000
2001 - 2007
73
0.37
0.57
0.46
0.49
-0.20
-0.24
1.69
1.55
1995 - 2000
2001 - 2007
74
0.30
0.35
0.41
0.45
-0.11
-0.15
1.53
1.44
1995 - 2000
2001 - 2007
75
0.19
0.26
0.35
0.38
0.10
0.15
0.94
0.86
1995 - 2000
2001 - 2007
77
0.42
0.55
0.50
0.58
0.09
0.10
1.27
1.28
32
Sector
HK
STD TFP
OP LPR
OP TFP
1995 - 2000
2001 - 2007
78
0.19
0.26
0.33
0.35
-0.34
-0.33
1.68
1.69
1995 - 2000
2001 - 2007
79
0.36
0.47
0.47
0.52
0.25
0.29
1.70
1.43
1995 - 2000
2001 - 2007
80
0.17
0.19
0.31
0.35
0.15
0.17
1.80
1.90
1995 - 2000
2001 - 2007
81
0.20
0.27
0.31
0.38
0.01
-0.04
1.48
1.44
1995 - 2000
2001 - 2007
82
0.31
0.33
0.41
0.43
-0.10
-0.15
1.40
1.49
Notes: See notes to Table 2.
33
C Two Digit NACE rev.2 Classification
Table B1: Description of sectors

Code
10
11
12
13
14
15
16
17
18
20
21
22
23
24
25
26
27
28
29
30
31
32
33
35
37
38
39
41
42
43
Description
Manufacture of food products
Manufacture of beverages
Manufacture of tobacco products
Manufacture of textiles
Manufacture of wearing apparel
Manufacture of leather and related products
Manufacture of wood and of products of wood and cork, except furniture
Manufacture of paper and paper products
Printing and reproduction of recorded media
Manufacture of chemicals and chemical products
Manufacture of basic pharmaceutical products and pharmaceutical preparations
Manufacture of rubber and plastic products
Manufacture of other non-metallic mineral products
Manufacture of basic metals
Manufacture of fabricated metal products, except machinery and equipment
Manufacture of computer, electronic and optical products
Manufacture of electrical equipment
Manufacture of machinery and equipment n.e.c.
Manufacture of motor vehicles, trailers and semi-trailers
Manufacture of other transport equipment
Manufacture of furniture
Other manufacturing
Repair and installation of machinery and equipment
Electricity, gas, steam and air conditioning supply
Sewerage
Waste collection, treatment and disposal activities; materials recovery
Remediation activities and other waste management services
Construction of buildings
Civil engineering
Specialised construction activities
34
Table B2: Description of sectors (cont.)
Code
45
46
47
49
50
51
52
53
55
56
58
59
60
61
62
63
68
69
70
71
72
73
74
75
77
78
79
80
81
82
Description
Wholesale and retail trade and repair of motor vehicles and motorcycles
Wholesale trade, except of motor vehicles and motorcycles
Retail trade, except of motor vehicles and motorcycles
Land transport and transport via pipelines
Water transport
Air transport
Warehousing and support activities for transportation
Postal and courier activities
Accommodation
Food and beverage service activities
Publishing activities
Motion picture, video and television programme production, sound recording
Programming and broadcasting activities
Telecommunications
Computer programming, consultancy and related activities
Information service activities
Real estate activities
Legal and accounting activities
Activities of head offices; management consultancy activities
Architectural and engineering activities; technical testing and analysis
Scientific research and development
Advertising and market research
Other professional, scientific and technical activities
Veterinary activities
Rental and leasing activities
Employment activities
Travel agency, tour operator reservation service and related activities
Security and investigation activities
Services to buildings and landscape activities
Office administrative, office support and other business support activities
35
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Growing Like Spain: 1995-2007: JEL Codes: D24, O11, O47. Keywords: TFP, Misallocation, Spain

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Growing like Spain: 1995-2007

JEL Codes: D24, O11, O47.

2 The 1995-2007 growth experience

Figure 1: The Spanish growth experience Macro evidence

Change in share 20012007

Change in share 20012007

Retail sale of bread

Retail sale of telecom

Change in share 20012007

Change in share 20012007

Change in share 20012007

tstatistics for industryspecific regressions

See EU-KLEMS dataset at www.euklems.net.

Central Business Register

PANEL A: Raw Sample

PANEL B: Final Sample

4 Misallocation and productivity in the Spanish boom

Figure 3: Potential TFP gains from reallocation

Figure 4: Potential TFP growth under 1995 misallocation level

Observed TFP growth

4.1 Robustness analysis

4.1.4 Measurement error

Table 3: Misallocation in Spain over the period 1995-2007 Robustness analysis

5 Sources of misallocations evolution

Figure 5: Potential TFP gains from reallocation by type of firm-specific distortion

Overall TFP Gain

Due to capital distortion

Due to size distortion

5.2 Sector-level analysis

Figure 6: TFP gain and its change by 2-digit sector

Change in TFP gain (19952007)

Table 4: Misallocation and sector-specific characteristics.

Financial dependence (US financial intensity)

Public sector influence (crony dummy)

Innovative content (US IT intensity)

Table 5: Misallocation and sector-specific characteristics Alternative proxy regressors.

Financial dependence (Spain debt burden)

Public sector influence (BPI index)

Innovative content (Spain R&D share)

Notes: See notes to Table 4.

Table 6: Changes in firm-level distortions and firm size and age

Dep. Variable: ln(1 + Ki,t )

heterogeneity in region-specific regulations. In addition, the Spanish labor market is characterized

Firms choose labor and capital to maximize profits:

(1 Ysi )Psi Asi (1

is the mark-up charged by the firm and Rs

Therefore, substituting equation (6) into equation (8):

= 1. The optimization problem of the representative firm implies:

The ratio of optimal TFP to observed TFP (i.e. TFP

B Misallocation Results for All Sectors NACE rev.2

Notes: See notes to Table 2.

C Two Digit NACE rev.2 Classification

Table B1: Description of sectors

Table B2: Description of sectors (cont.)

Fernandez-Villaverde, J., L. Garicano, and T. Santos (2013): Political Credit Cycles:

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