We test our theory using Portuguese administrative data. Completing insurance markets would increase aggregate productivity and income by 64% and 97%, respectively. (n/n)

Specifically, incomplete markets operate as correlated distortions, leading to a reallocation of capital from more to less productive firms relative to the complete markets benchmark. (4/n)

Incomplete markets tie entrepreneurs’ consumption to the profits generated by their enterprises, making them willing to forgo expected profits to reduce volatility. As a result, the expected MPK are not equalized across firms, i.e. capital is misallocated. (3/n)

In a recent working paper (papers.ssrn.com/sol3/papers....) we build a GE model where risk-averse entrepreneurs with heterogeneous productivity face uninsurable idiosyncratic output shocks and choose how much capital to rent before uncertainty unfolds. (2/n)

Quantitatively, differences in the degree of monopsony account for 42% of observed variation in GDP per capita across countries. At least one-third of the losses are attributable to distorted entrepreneurial decisions and lack of innovation.

Because it penalises high-productivity employers, labor market power acts as a skill-biased force, similar to what has been shown for a wide array of size-dependent policies and correlated distortions.

Labor market power leads to aggregate output losses by 1) reallocating employment towards less-productive, lower-paying employers; 2) allowing low-productivity individuals to reap high benefits from entrepreneurship; and 3) lowering the returns from climbing the productivity ladder for employers.

The paper extends our paper with Nezih Guner (aeaweb.org/articles?id=...) to a dynamic setting with occupational choice, firm growth, and productivity-enhancing investment.