Capital Reallocation and Aggregate Productivity

Abstract: This paper studies the productivity implications of the cyclical reallocation of capital. Frictions in the reallocation process are a source of factor misallocation. Cyclical movements in these frictions lead to variations in the pace of reallocation and thus in productivity. These frictions also impact the capital accumulation decision. The effects are quantitatively important in the presence of fluctuations in the cross sectional dispersion of profitability shocks. The cyclicality of the output loss due to costly reallocation depends on the joint distribution of capital and plant-level productivity. Instead of relying on approximative solution techniques we show analytically that a higher-order moment is needed to solve the model accurately. Even without aggregate productivity shocks, the model has quantitative properties that resemble those of a standard stochastic growth model: (i) persistent shocks to the Solow residual, (ii) positive co-movement of output, investment and consumption and (iii) consumption smoothing and can mimic the dynamics of reallocation and the cross sectional dispersion in average capital productivity. A model with both aggregate productivity and dispersion shocks matches the moments best.