The whole is greater than the sum of its parts: complementary reforms to address microeconomic distortions

This paper links microeconomic rigidities and technological adoption to propose a partial explanation for the observed differences in income per capita across countries. The paper first presents a neoclassical general equilibrium model with heterogeneous production units. It assumes that developing countries do not generate frontier technologies but can adopt them by investing in new capital, which requires firm renewal. The model analyzes how this process can be hindered by barriers to the entry of new investment projects and the exit of obsolete ones. It finds that there are nonlinearities in the way entry and exit barriers operate: Barriers have increasing costs, and they reinforce each other's negative impact. The paper then calibrates and simulates the model to measure the impact of these barriers on the GDP per capita gap between the United States and a large sample of developing countries. It accounts for a range of 26 to 60% of the income gap between the United States and 107 developing countries. Most importantly, the model implies that, for the median developing economy, about 50% of the simulated gap is explained by the interaction of entry and exit barriers (and the rest by their individual effects). The paper's main policy implication is that only comprehensive reforms can have substantial effects, especially when initial distortions are large. If they are too narrow (focusing on only one barrier) or too mild (leaving in place a large distortion), microeconomic reforms are unlikely to have significant effects on aggregate productivity and output growth.The research from this article was financed by the World Bank's Knowledge for Change Program, the World Bank's Japan Consultant Trust Fund, and Chile's Fondecyt #1070805. The authors thank Diego Comin, Roberto Fattal, Markus Poschke, Claudio Raddatz, Andrea Repetto, Diego Restuccia, Luis Serven, seminar participants at the Federal Reserve Bank of Minneapolis, the World Bank, IHS Vienna, Universidad de Chile, Universidad Catolica de Chile, the 2010 Econometric Society World Congress, the 2011 Meetings of the SED, and the EEA-ESEM meetings 2011 and WBER editor Andrew Foster and the three anonymous referees for insightful comments and Naotaka Sugawara, Rei Odawara, Marc Teignier-Baque, Tomoko Wada, and Claudia Meza-Cuadra for excellent research assistance. A supplemental appendix to this article is available at http://wber.oxfordjournals.org