Dan Lu

This paper incorporates firm-level distortions into a Melitz model and characterizes welfare under misallocation. We derive an analogue to the well-known ACR result in an economy with distortions. We highlight a channel through which trade can reduce welfare by exacerbating misallocation. A key statistic to infer welfare is the gap between input and output shares. Using Chinese manufacturing data for quantitative analysis, we show that trade integration can lead to a 18% welfare loss coming from a reduction in allocative efficiency. The overall gains to trade is substantially smaller than implied by standard calculations.

We use firm-level data to identify financial frictions in China and explore the extent to which they can explain firms' saving and capital misallocation. We first document the features of the data in terms of firm dynamics and debt financing. State-owned firms have higher leverage and pay much lower interest rates than non-SOEs. Among privately owned firms, smaller firms have lower leverage, face higher interest rates, and operate with a higher marginal product of capital. We then develop a heterogeneous-firm model with two types of financial frictions, default risk, and a fixed cost of issuing loans. Our model generates endogenous borrowing constraints as banks consider the firm's productivity, asset, and debt when providing a loan. Using evidence on the firm size distribution and fin...