Misallocation and Financial Market Frictions: Some Direct Evidence from the Dispersion in Borrowing Costs

21 Pages Posted: 4 May 2012  

Simon Gilchrist

Boston University - Department of Economics; National Bureau of Economic Research (NBER)

Egon Zakrajsek

Federal Reserve Board - Division of Monetary Affairs

Jae Sim

Board of Governors of the Federal Reserve System

Date Written: September 1, 2011

Abstract

Financial market frictions distort the allocation of resources among productive units-all else equal, firms whose financing choices are affected by financial frictions face higher borrowing costs than firms with ready access to capital markets. As a result, input choices may differ systematically across firms in ways that are unrelated to their productive efficiency. We propose a simple accounting framework that allows us to assess the empirical magnitude of the loss in aggregate resources due to such misallocation. To a second-order approximation, our accounting framework requires only information on the dispersion in borrowing costs across firms. We measure firm-specific borrowing costs for a subset of U.S. manufacturing firms directly from the interest rate spreads on their outstanding publicly-traded debt. Given the observed variation in borrowing costs, our approximation method implies a relatively modest loss in efficiency due to resource misallocation-on the order of 1 to 2 percent of measured total factor productivity (TFP). According to our accounting framework, the correlation between firm size and borrowing costs is irrelevant under the assumption that financial distortions and firm-level efficiency are jointly log-normally distributed. To take into account the effect of covariation between firm size and borrowing costs, we also consider a more general framework that dispenses with the assumption of log-normality and which yields somewhat higher estimates of the resource losses-about 3.5 percent of measured TFP. Counterfactual experiments indicate that dispersion in borrowing costs must be an order of magnitude higher than that observed in the U.S. financial data, in order for misallocation-arising from financial distortion-to account for a significant fraction of measured TFP differentials across countries.

Keywords: Misallocation, financial market frictions, borrowing costs, firm-level evidence, total factor productivity, financial distortions, firms-specific borrowing costs

JEL Classification: D92, O16, O40

Suggested Citation

Gilchrist, Simon and Zakrajsek, Egon and Sim, Jae, Misallocation and Financial Market Frictions: Some Direct Evidence from the Dispersion in Borrowing Costs (September 1, 2011). FEDS Working Paper No. 2012-08. Available at SSRN: https://ssrn.com/abstract=2050984 or http://dx.doi.org/10.2139/ssrn.2050984

Simon Gilchrist

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States

Egon Zakrajsek (Contact Author)

Federal Reserve Board - Division of Monetary Affairs ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-728-5864 (Phone)
202-452-3819 (Fax)

Jae W. Sim

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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