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Using micro-data on firm-specific borrowing costs and wages, we demonstrate that distortions in firms’ employment and investment policies can be empirically measured using firm-level gaps between marginal revenue products and user costs (MRP-cost gaps). We estimate MRP-cost gaps for 4 million firm-year observations in Italy between 1997 and 2013, showing that the variation in these measures is closely related to the extent of credit market frictions and to the degree of labor market rigidities individual firms face. Using the estimated MRP-cost gaps, we propose a reallocation algorithm that helps us assess the scope of capital and labor misallocation in Italy, and its impact on aggregate output and total factor productivity (TFP). We calculate that, holding constant the aggregate capital and labor endowments in the economy, the Italian corporate sector could produce between 3% to 4% more output by reallocating resources from over-endowed producers toward higher-value users. The output losses from misallocation are larger during episodes of macro-financial instability, in non-manufacturing industries, and in geographical regions with less developed socio-economic institutions. † University of Chicago, Department of Economics; ‡ Bank of Italy, Labour Market Division. This paper previously circulated as “Rigid Factor Prices and Output Losses: Evidence from Italian Firms”. Simone Lenzu is indebted to Michael Greenstone, Amir Sufi, Chad Syverson, and Alessandra Voena for their guidance and thoughtful advice. We thank Stéphane Bonhomme, Jan De Loecker, Luigi Guiso, Lars Peter Hansen, Erik Hurst, Pete Klenow, Francesca Lotti, Neale Mahoney, Gregor Matvos, Magne Mogstad, Jack Mountjoy, Jacopo Ponticelli, David Rivers, Enrico Sette, Pietro Tebaldi, Luigi Zingales, and the seminar participants at the Bank of Italy and the University of Chicago for their comments. A special thanks goes to Simcha Barkai, Filippo Mezzanotti, Jung Sakong, and Nicola Pierri for insightful discussions in di erent stages of this research project. Simone Lenzu thanks the University of Chicago, the Macro Financial Modeling Group, the Stigler Center at the University of Chicago, and the Stevanovich Center at the University of Chicago for generous financial support. Francesco Manaresi developed part of this project while visiting the Bank for International Settlement under the Central Bank Research Fellowship program. The results in this paper represent the views of the authors only, and not those of the Bank of Italy, the Eurosystem, the Cerved Group S.p.A., or the Italian National Social Security Institute. The paper has been screened to make sure that no confidential information has been released. All errors are our own. Email: lenzus@uchicago.edu; francesco.manaresi@bancaditalia.it. The Appendix of the paper is available at www.simonelenzu.com or here

Do Marginal Products Differ from User Costs? Micro-Level Evidence from Italian Firms