Misallocation and the Credit Cycle: Evidence from Europe

Abstract

Using a large firm level dataset, that covers 18 European countries in the 2006-2014 period, I develop an empirical approach in the spirit of Rajan and Zingales (1998) in order to study whether and to what extent the credit cycle influences the efficient allocation of resources across firms. I document that a higher availability of credit leads to a decline in both capital and labor misallocation, suggesting that, when credit is above its trend, the additional funds flowing in the economy reduce financial frictions, allowing financially constrained but productive firms to implement their projects. The estimated effect explains 7.8% and 5.8% of the variation in the within-sector dispersion in the marginal revenue products of capital and labor respectively, and it is consistent with respect to a wide range of robustness checks. It is larger when evaluating exclusively the manufacturing industry or countries with relatively small domestic credit markets, while tends to disappear for financially developed economies.