TFP Declines: Misallocation or Mismeasurement?

Abstract This paper documents the sectoral growth paths of measured total factor productivity (TFP) in southern Europe during the boom that proceeded the great contraction (1996 to 2007). Using both aggregate and firm-level panel data, I show that TFP in sectors that displayed fast expansion, such as construction, dropped significantly, while in non-expanding sectors, such as manufacturing, it stayed stable. I evaluate the relevance of two alternative explanations of this phenomenon: capital misallocation (the increase in capital was directed to less productive firms) and labor quality mismeasurement (lower quality of incoming labor was not fully captured in the TFP calculation). I find that the misallocation channel is almost negligible. Moreover, worker-firm matched data shows that labor quality did deteriorate in the expanding sectors but not in the others, giving credence to the labor-quality mismeasurement hypothesis. A model featuring both the misallocation and the mismeasurement channels and calibrated to match the micro-level productivity distribution and labor quality distribution predicts that the drop in true TFP was small if labor quality is measured properly.