Capital Account Liberalization and Aggregate Productivity: The Role of Firm Capital Allocation

Abstract

We study the effects of capital account liberalization on firm capital allocation and aggregate productivity in ten Eastern European countries. Using a large firm-level dataset, we show that capital account liberalization decreases the dispersion of the return to capital across firms, particularly in sectors more dependent on external finance. We provide evidence that capital account liberalization improves capital allocation by allowing financially-constrained firms to demand more capital and produce at a more efficient level. Finally, we use a model of misallocation and document that capital account liberalization increases aggregate productivity through a more efficient firm capital allocation by 10% to 16%.