Capital Allocation and Productivity in South Europe
Starting in the early 1990s, countries in southern Europe experienced low productivity
growth alongside declining real interest rates. We use data for manufacturing
firms in Spain between 1999 and 2012 to document a significant increase in the dispersion
of the return to capital across firms, a stable dispersion of the return to labor, and
a significant increase in productivity losses from capital misallocation over time. We
develop a model with size-dependent financial frictions that is consistent with important
aspects of firms’ behavior in production and balance sheet data. We illustrate how
the decline in the real interest rate, often attributed to the euro convergence process,
leads to a significant decline in sectoral total factor productivity as capital inflows are
misallocated toward firms that have higher net worth but are not necessarily more productive.
We show that similar trends in dispersion and productivity losses are observed
in Italy and Portugal but not in Germany, France, and Norway.