Collaborative Research: Understanding the Incidence of Market Distortions

About This Grant

This award funds a research project that combines extremely rich and detailed data with economic theory to study how the burden of market failures is shared in the economy. Market failures prevent resources, such as labor and capital, from being used in the places where they are most valuable. While it is known that market failures are a feature of all economies and contribute to income differences across countries, the question of which types of households are affected most by these market failures is much less researched. This project makes progress on this gap by developing tools to connect and analyze multiple datasets that provide an extensive set of links in the economy between households and firms, between both households and firms and the government, and between the firms themselves. Understanding which groups benefit and which groups lose out from policies that address such market failures is vital to the design of approaches that maximize the welfare of any nation. The research outcomes could be essential for researchers and decisionmakers in shaping optimal U.S. policies and potentially enhancing the wellbeing of households and businesses. This award funds a research project that develops tools to estimate distortions—markups, markdowns, and taxes that prevents resources being allocated to their best uses—at a highly disaggregated level and trace them to individuals through arbitrary trade, employment, and financial networks. This methodology is applied to administrative data, where the research team can map out the flow of goods and money for the entire economy by linking firm-to-firm networks with firm-to-consumer, firm-to-lender, and firm-to-employee networks alongside ownership registries. These methods reveal how the burden of distortions is shared among households belonging to different regions, demographic groups, skill groups, and income levels. In addition, they enable answers to various questions, such as which distortions do the most to compress and expand the distribution of living standards; what trade-offs are observed in approaches designed to improve the impacts of distortions; and to what degree overlapping distortions necessitate our wide-ranging analysis as opposed to focusing on one specific distortion or sector at a time. The theory and methods are developed in a way that they can be applied to any country with similar data. This project advances knowledge in several ways. First, it operationalizes recent theoretical work on general equilibrium models of heterogeneous agents in distorted economic environments. Second, by assembling a complete empirical mapping of economic relationships between agents in an economy, it measures the distributional impact of the main distortions that are present in an economy (those on labor, capital, output, and intermediate inputs) throughout all sectors. This is relevant because studying the impact of reducing distortions in one specific market is influenced by distortions in other markets. Thus, to fully assess the trade-offs of reducing distortions, one needs to go beyond specific distortions and specific sectors. The results have the potential to significantly reshape how economists perceive the implications of market distortions and the policies responding to them. By addressing who bears the costs and who benefits from market distortions, a key theme for decisionmakers, the findings of this research could lead to optimal policies related to market failures and enhance the welfare of the U.S. population. This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.