Abstract
Resource misallocation has the potential to reduce aggregate total factor productivity and undermine industrial development. Aggregate productivity losses are found to be particularly pronounced in emerging economies where large market frictions impede efficient resource allocation. Available estimates, however, almost entirely exclude firms in the informal sector that in some countries, such as Zimbabwe, make up a high share of overall production and employment. The exclusion of informal firms can result in either an over- or under-estimate of the aggregate productivity losses from misallocation. This paper, therefore, uses firm-level survey data to analyze how market distortions contribute to the misallocation of resources within and between the formal and informal manufacturing sectors in Zimbabwe. Applying the approach developed by Hsieh and Klenow (2009) to firm-level microdata, the results reveal extensive resource misallocation in both the formal and informal manufacturing sector. Market shares of informal firms are found to be low relative to their productivity-an outcome associated with relatively large capital market distortions. Misallocation is also more pronounced among relatively productive firms, thus exacerbating aggregate losses in total factor productivity (TFP). Estimates indicate that aggregated gains in TFP of 151.4 percent can be realized through efficient resource allocation.