Agglomeration, concentration, and misallocation

Abstract

Misallocation may cause extensive productivity and output loss in sectors and coun tries. I use firm-level data for Spain to investigate the misallocation in Spain with a focus on the effect of agglomeration on allocative efficiency. I discover a negative relationship between agglomeration and allocative efficiency despite the higher pro ductivity in denser areas. I explain the negative effect of agglomeration on allocative efficiency with the higher price elasticity of substitution due to higher competition in agglomerated regions. High elasticity in large cities amplifies the effect of existing idiosyncratic distortions on allocative efficiency. I test this argument using a monte carlo simulation of output loss due to misallocation. Finally, I document the low con centration and high competition in agglomerated regions with Herfindahl-Hirschman Index.