Wedges: A Microeconomic Perspective on Misallocation

Lauren Bergquist, Danial Lashkari and Eric Verhoogen

No 26021, RFBerlin Discussion Paper Series from ROCKWOOL Foundation Berlin (RFBerlin)

Abstract: This chapter takes stock of what has been learned from the recent micro-development literature about wedges - mechanisms generating dispersion in marginal revenue products of factors across firms, which are commonly interpreted as indicators of misallocation. We present a general theoretical framework that allows us to consider several different types of wedges simultaneously. We argue that it is important to distinguish between between technological wedges, which are present even in the efficient allocation that would be chosen by the social planner, and distortionary wedges, which are present in market equilibrium but not the social planner's allocation. Not all wedges, as we have defined them, are distortionary. We also argue that interactions among wedges are pervasive. We review empirical findings about different types of wedges - taxes, regulations, political connections, corruption, market power, contracting frictions, upgrading investments, and search - focusing on studies that present direct evidence on particular wedges and how they generate dispersion in marginal returns to factors. Throughout, we pay special attention to how wedges vary with firm size and whether the evidence supports the "large firms are constrained'" view of development. We conclude with thoughts about promising directions for the misallocation literature.

Keywords: wedges; misallocation; distortions; direct approach; development (search for similar items in EconPapers)
JEL-codes: D21 H25 L11 L51 O11 O12 O14 (search for similar items in EconPapers)
Date: 2026-01
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