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

We prove that the change in welfare of a representative consumer is summarized by thecurrent and expected future values of the standard Solow productivity residual. Theequivalence holds if the representative household maximizes utility while taking pricesparametrically. This result justifies TFP as the right summary measure of welfare (even insituations where it does not properly measure technology) and makes it possible to calculatethe contributions of disaggregated units (industries or firms) to aggregate welfare usingreadily available TFP data. Based on this finding, we compute firm and industry contributionsto welfare for a set of European OECD countries (Belgium, France, Great Britain, Italy,Spain), using industry-level (EU-KLEMS) and firm-level (Amadeus) data. After adding furtherassumptions about technology and market structure (firms minimize costs and face commonfactor prices), we show that welfare change can be decomposed into three components thatreflect respectively technical change, aggregate distortions and allocative efficiency. Then,using the appropriate firm-level data, we assess the importance of each of these componentsas sources of welfare improvement in the same set of European countries....