Identifier

1123

Document Type

Discussion Paper

Date of Paper

Winter 1-2026

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.

Acknowledgements

Forthcoming in the Handbook of Development Economics, volume 6. We are grateful to the editors, Pascaline Dupas, Penny Goldberg, and Rohini Pande, our discussant, Rocco Macchiavello, participants in the Handbook conference and the STEG 2026 Annual Conference, and Francesco Amodio, David Atkin, Natalie Bau, Nicolás de Roux, Dave Donaldson, Maitreesh Ghatak, Joe Kaboski, Huiyu Li, Adrien Matray, David McKenzie, Dilip Mookherjee, Ameet Morjaria, Ben Olken, Richard Rogerson, Chad Syverson, and Lucas Zavala for helpful comments. Canaan Cui, Max Saenz and Camilla Sarzo provided valuable research assistance.

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