Inequality and Misallocation under Production Networks

Abstract

In this paper, I develop an aggregation theory for distorted production network economies with heterogeneous households and endogenous labor supply. I provide nonparametric decompositions that capture the impact of changes in the income and consumption distributions on the aggregate and distributional propagation of microeconomic shocks. The workers' value-added over labor income ratios (distortion centralities) are sufficient statistics for the effect of income distribution variations on TFP. Labor misallocation falls and TFP increases as labor income shifts towards workers with low distortion centralities. I define consumers' average distortion centrality as sufficient statistics for the effect of expenditure distribution variations on TFP. Labor misallocation falls and TFP increases as expenditure shifts towards households with an expenditure that, on average, faces low distortion centralities. These results prove that macroeconomic models that rely on an aggregate production function and ignore distributional variations are unbiased only under exceptional circumstances. I show that distributional allocations that do not satisfy symmetry in the distortion centralities across workers are inefficient from the perspective of a constrained social planner. Finally, I estimate the first production network model with household heterogeneity for the United States. The results show that income distribution variations fostered growth before the Great Recession by increasing TFP by 8.2% and after the Great Recession hindered growth by reducing TFP by 7.5%. Additionally, the variations in the income distribution are responsible for 20% of the business cycle volatility, and microeconomic shocks and the production network play a significant role in explaining income and real consumption inequalities.

Keywords: Misallocation, Production Networks, Heterogeneity, Secular Stagnation, Inequality

JEL Classification: C67, D24, D33, D57, D85, E25, E32