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The labor distortion and productivity puzzle

Hugo Hopenhayn's picture

Hugo Hopenhayn is a professor of economics at the University of California, Los Angeles.

To what extent does the inefficiency of firms at the country level contribute to the vastly different levels of total factor productivity (TFP) among countries, and thus to the big income gaps among countries? Keep in mind that TFP is considered a measure of the current level of technology because it captures anything that changes the relation between measured inputs and measured outputs.

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Hugo Hopenhayn (Professor of Economics, University of California, Los Angeles) tells us that recent studies show that these distortions play a major role – in fact, it’s estimated that they account for 50% of the TFP gap between the United States and China, and 30% of the gap between the United States and India. What drives this misallocation of labor? High labor taxes and exemptions have been suggested as the culprits. But in a recent study, Hopenhayn reports that their effects on TFP in practice tend to be very small. Rather, borrowing constraints and high costs of doing business explain much of the problem.

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