Productivity, Welfare and Reallocation:Theory and Firm-Level Evidence

We prove that in a closed economy without distortionary taxation, the welfare of a representativeconsumer is summarized to a …rst order by the current and expected future values of the Solowproductivity residual in level and by the initial endowment of capital. The equivalence holds if therepresentative household maximizes utility while taking prices parametrically. This result justi…esTFP as the right summary measure of welfare (even in situations where it does not properly measuretechnology) and makes it possible to calculate the contributions of disaggregated units (industriesor …rms) to aggregate welfare using readily available TFP data. We show how these results mustbe modi…ed if the economy is open or if taxes are distortionary. We then compute …rm andindustry contributions to welfare for a set of European OECD countries (Belgium, France, GreatBritain, Italy, Spain), using industry-level (EU-KLEMS) and …rm-level (Amadeus) data. Afteradding further assumptions about technology and market structure (…rms minimize costs and facecommon factor prices), we show that welfare change can be decomposed into three components thatre‡ect respectively technical change, aggregate distortions and allocative e¢ ciency. Then, usingthe appropriate …rm-level data, we assess the importance of each of these components as sourcesof welfare improvement in the same set of European countries....