Reallocation at Work

One of the main drivers of productivity growth in a market economy is the reallocation of resources from less-efficient firms as they shrink or go out of business under the pressure of competition from more-efficient firms. The economists Allan Collard-Wexler and Jan De Loecker have a new working paper that vividly describes how this relocation process works in practice:

We measure the impact of a drastic new technology for producing steel — the minimill — on the aggregate productivity of U.S. steel producers, using unique plant-level data between 1963 and 2002. We find that the sharp increase in the industry’s productivity is linked to this new technology, and operates through two distinct mechanisms. First, minimills displaced the older technology, called vertically integrated production, and this reallocation of output was responsible for a third of the increase in the industry’s productivity. Second, increased competition, due to the expansion of minimills, drove a substantial reallocation process within the group of vertically integrated producers, driving a resurgence in their productivity, and consequently of the industry’s productivity as a whole.

In a similar vein, one can imagine high-quality charter networks driving a reallocation of resources among conventional public schools, as those best positioned to adapt to the competitive challenge of the new entrants grow at the expense of those that fail to adapt. The obvious challenge is that reallocation is a process that by definition generates tremendous dislocation, and thus tremendous political pressure to protect incumbent firms. 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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