Abstract:
Not all observed misallocation of factor inputs can be attributed to inefficient policies. In this paper I show how part of the dispersion in marginal products of capital is caused by fixed costs of investment. Non-convex adjustment costs cause lumpy investment behavior, which in turn give rise to large swings in marginal products over the investment cycle for individual firms. These swings in inflate the variance of marginal products in a sector, increasing observed misallocation. I present and simulate a simple model of non-convex adjustment costs to illustrate this point. I use Chinese manufacturing data to empirically evaluate the effect and show that non-convex adjustment costs can account for roughly 12% of the variation in marginal products of capital.