How important is human capital misallocation across sectors for aggregate productivity differences? Evidence beyond Cobb-Douglas

This paper is number 199 in the <a href="https://www.rug.nl/ggdc/iframe/memoranda" target="_blank">Groningen Growth and Development's Research Memoranda series</a>. <br><br>
<b>Abstract</b><br>
Misallocation of human capital across sectors can have substantial negative implications for an economy’s output per worker. The literature examining this type of labor misallocation has so far mostly assumed a Cobb-Douglas production function, which is at odds with important macroeconomic frameworks and empirical evidence. Our paper hence suggests a new twist to revisit the question: to what extent does human capital misallocation across sectors explain why some countries are so much richer than others? Our innovation consists of incorporating a more flexible and empirically plausible CES production structure with different labor skill types into the misallocation literature. The results from this analysis indicate that human capital misallocation can explain approximately 15% of output per worker variation across countries, which is about one fourth less than under the conventional Cobb-Douglas specification (21%). This suggests that labor market efficiency may be less of a problem for aggregate productivity differences than previously thought.