Markups and misallocation with evidence from exchange rate shocks

In a setting with firms that charge variable markups, this paper finds that firm heterogeneity has welfare implications that result exclusively from the differential markup adjustment to global shocks. Changes in allocative efficiency are summarized by a sufficient statistic that can be directly measured with aggregate data. I use Chilean data between 1995 and 2007 to show that exchange rate shocks can be an important driver of allocative efficiency, as there are large changes in misallocation over time due to the way firms pass-through these shocks into markups. At the firm-level, there is evidence that importing firms pass-through real exchange rate appreciations into their markups. Over time, due to the compositional effect that ensues, industries that import a larger share of their inputs become more misallocated. In a structural model with productivity gains from importing, where firm market power increases with size, I show how firm reallocation in response to a positive supply shock rationalizes the reduced-form results.