Introduction

Resource Misallocation in Sub-Saharan Africa: Firm-Level Evidence 3

Introduction

Why are African countries considerably less productive than high-income economies? What accounts for these differences in (labor and total factor) productivity? And why is firm performance in Sub-Saharan Africa lower and more volatile than that of their counterparts in either the “aspirational development” or the “global efficiency” benchmark countries?1 This report argues that distortions in decision-making processes at the firm level have implications for a country’s aggregate output and productivity and might also help explain aggregate productivity differences across countries. It suggests that low-income countries are not as effective in allocating inputs of production to their most efficient use.

The effectiveness of resource allocation is indicated in relation to an efficiency benchmark in a model economy where firms maximize final output. It is characterized by (a) decisions about setting the number of establishments to be operating in the industry, and (b) the allocation of capital and labor across those operating establishments. Distortions in each of these two stages of decision making will reduce aggregate output and productivity. This argument lies at the heart of the literature on resource misallocation and takes center stage in the report’s analysis of low productivity in Sub-Saharan Africa. (Box 3.1 summarizes the theoretical underpinnings of the relationship between the number of operating firms and their distribution, misallocation, and aggregate productivity.)

Empirical research on resource misallocation as a source of low aggregate productivity in Sub-Saharan Africa is growing, but it is still incipient. The lack of available firm-level census data (across countries and over time) in the region is still a binding constraint. The existing evidence for the region focuses on both direct and indirect approaches to quantifying the extent of resource misallocation across Sub-Saharan African countries and its influence on aggregate total factor productivity (TFP). While some papers measure the total net effects of distortions on aggregate productivity (the indirect approach), others assess specific sources of distortions.

This report finds evidence of severe misallocation in agriculture and manufacturing across Sub-Saharan African countries. Low agricultural productivity is primarily explained by inefficiencies in the allocation