Inverse Ramsey Problem of the Resource Misallocation Effect on Aggregate Productivity

This paper examines the extent to and the conditions under which resource misallocation negatively affects aggregate productivity in a model of heterogeneous firms to the highest degree. I analytically derive the minimum aggregate total factor productivity (TFP) under resource misallocation, when frictions are modeled as the taxes levied on a firm’s output, and the range of these taxes is provided. I find that the lower limit of the minimum aggregate TFP is the TFP under perfect substitute goods and constant returns to scale technology. Further, with the exception of particular parameter values in which the misallocation effect on aggregate TFP is small, the minimum aggregate TFP is achieved when the proportion of firms in the lowest tax level is small or when the TFP level of these firms is low.