DP11144-2 | Growing like Spain: 1995-2007

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Measured TFP fell at an annual rate of 0.7% in Spain during the boom years of 1995 to 2007. Using administrative data from the quasi-universe of firms for all sectors we show that deterioration in the allocative efficiency of productive factors across firms was at the root of the low TFP growth in Spain. Cross-industry variation reveals that the increase in misallocation was more severe in those sectors where connections with public officials are more important for business success, which represents novel evidence on the potential macroeconomic costs of crony capitalism. We write and estimate a simple model of cronyism in which heterogeneous firms invest in political connections. The model is consistent with the facts that (a) there is more dispersion in firm productivity in those sectors more prone to cronyism and (b) a general decline in the quality of institutions generates a larger increase in the dispersion of firm productivities in those sectors more prone to cronyism. Our quantitative exercise concludes that the institutional decline over this period costed 1.9% growth in TFP per year.